Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  if a company has a wacc = 12% and its free cash flow is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. 
B)  the free cash flow valuation model for constant growth, vop = fcf1/(wacc - g), can be used to value firms whose free cash flows are expected to decline at a constant rate, i.e., to grow at a negative rate. 
C)  the value of operations of a stock is the present value of all expected future free cash flows, discounted at the free cash flow growth rate. 
D)  the constant growth model cannot be used for a zero growth stock, where free cash flows are expected to remain constant over time. 
E)  the constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years. 
A)  if a company has a wacc = 12% and its free cash flow is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. 
B)  the free cash flow valuation model for constant growth, vop = fcf1/(wacc - g), can be used to value firms whose free cash flows are expected to decline at a constant rate, i.e., to grow at a negative rate. 
C)  the value of operations of a stock is the present value of all expected future free cash flows, discounted at the free cash flow growth rate. 
D)  the constant growth model cannot be used for a zero growth stock, where free cash flows are expected to remain constant over time. 
E)  the constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years. B

Question 2

The required return for Williamson Heating's stock is 12%, and the stock sells for $40 per share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D4 = $1.00(1.30)4 = $2.8561. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock's expected constant growth rate after t = 4, i.e., what is X?

Accepted Answer

A)  5.17% 
B)  5.44% 
C)  5.72% 
D)  6.02% 
E)  6.34% 
A)  5.17% 
B)  5.44% 
C)  5.72% 
D)  6.02% 
E)  6.34% E

Question 3

Reynolds Construction's value of operations is $750 million based on the free cash flow valuation model. Its balance sheet shows $50 million of short-term investments that are unrelated to operations, $100 million of accounts payable, $100 million of notes payable, $200 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?

Accepted Answer

A)  $429 
B)  $451 
C)  $475 
D)  $500 
E)  $525 
A)  $429 
B)  $451 
C)  $475 
D)  $500 
E)  $525 D

Question 4

The preemptive right is important to shareholders because it

Accepted Answer

A)  will result in higher dividends per share. 
B)  is included in every corporate charter. 
C)  protects the current shareholders against a dilution of their ownership interests. 
D)  protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate. 
E)  allows managers to buy additional shares below the current market price. 
A)  will result in higher dividends per share. 
B)  is included in every corporate charter. 
C)  protects the current shareholders against a dilution of their ownership interests. 
D)  protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate. 
E)  allows managers to buy additional shares below the current market price.

Question 5

Atchley Corporation's last free cash flow was $1.55 million. The free cash flow growth rate is expected to be constant at 1.5% for 2 years, after which free cash flows are expected to grow at a rate of 8.0% forever. The firm's weighted average cost of capital (WACC) is 12.0%. Atchley has $2 million in short-term debt and $14 million in debt and 1 million shares outstanding. What is the best estimate of the intrinsic stock price?

Accepted Answer

A)  $25.05 
B)  $26.16 
C)  $27.30 
D)  $28.48 
E)  $29.70 
A)  $25.05 
B)  $26.16 
C)  $27.30 
D)  $28.48 
E)  $29.70

Question 6

The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

Accepted Answer

A) True 
 B)False

Question 7

Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
$\begin{array}{lcc}
& \mathrm{A}& \underline{\mathrm{B}}\
\text { Beta } &1.10&0.90\
\text { Constant growth rate } & 7.00 \% & 7.00 \%
\end{array}$

Accepted Answer

A)  stock a must have a higher dividend yield than stock b. 
B)  stock b's dividend yield equals its expected dividend growth rate. 
C)  stock b must have the higher required return. 
D)  stock b could have the higher expected return. 
E)  stock a must have a higher stock price than stock b. 
A)  stock a must have a higher dividend yield than stock b. 
B)  stock b's dividend yield equals its expected dividend growth rate. 
C)  stock b must have the higher required return. 
D)  stock b could have the higher expected return. 
E)  stock a must have a higher stock price than stock b.

Question 8

If a firm's stockholders are given the preemptive right, this means that stockholders have the right to call for a meeting to vote to replace the management. Without the preemptive right, dissident stockholders would have to seek a change in management through a proxy fight.

Accepted Answer

A) True 
 B)False

Question 9

If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock's expected dividend yield for the coming year?

Accepted Answer

A)  4.42% 
B)  4.66% 
C)  4.89% 
D)  5.13% 
E)  5.39% 
A)  4.42% 
B)  4.66% 
C)  4.89% 
D)  5.13% 
E)  5.39%

Question 10

Carby Hardware has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?

Accepted Answer

A)  $104.27 
B)  $106.95 
C)  $109.69 
D)  $112.50 
E)  $115.38 
A)  $104.27 
B)  $106.95 
C)  $109.69 
D)  $112.50 
E)  $115.38

Question 11

Justus Motor Co.has a WACC of 11.50%, and its value of operations is $25.00 million. Justus's free cash flow is expected to grow at a constant rate of 7.00%. What was the last free cash flow, FCF0 in millions?

Accepted Answer

A)  $0.95 
B)  $1.05 
C)  $1.16 
D)  $1.27 
E)  $1.40 
A)  $0.95 
B)  $1.05 
C)  $1.16 
D)  $1.27 
E)  $1.40

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A)  two firms with the same expected free cash flows and growth rates must also have the same value of operations. 
B)  it is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant. 
C)  if a company has a weighted average cost of capital wacc = 12%, and if its free cash flows are expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. 
D)  the value of operations is the present value of all expected future free cash flows, discounted at the free cash flow growth rate. 
E)  the constant growth model takes into consideration the capital gains investors expect to earn on a stock. 
A)  two firms with the same expected free cash flows and growth rates must also have the same value of operations. 
B)  it is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant. 
C)  if a company has a weighted average cost of capital wacc = 12%, and if its free cash flows are expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. 
D)  the value of operations is the present value of all expected future free cash flows, discounted at the free cash flow growth rate. 
E)  the constant growth model takes into consideration the capital gains investors expect to earn on a stock.

Question 13

Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at t = 3?

Accepted Answer

A)  $840 
B)  $882 
C)  $926 
D)  $972 
E)  $1,021 
A)  $840 
B)  $882 
C)  $926 
D)  $972 
E)  $1,021

Question 14

You, in analyzing a stock, find that its expected return exceeds its required return. This suggests that you think

Accepted Answer

A)  the stock should be sold. 
B)  the stock is a good buy. 
C)  management is probably not trying to maximize the price per share. 
D)  dividends are not likely to be declared. 
E)  the stock is experiencing supernormal growth. 
A)  the stock should be sold. 
B)  the stock is a good buy. 
C)  management is probably not trying to maximize the price per share. 
D)  dividends are not likely to be declared. 
E)  the stock is experiencing supernormal growth.

Question 15

If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock's expected total return for the coming year?

Accepted Answer

A)  8.37% 
B)  8.59% 
C)  8.81% 
D)  9.03% 
E)  9.27% 
A)  8.37% 
B)  8.59% 
C)  8.81% 
D)  9.03% 
E)  9.27%

Question 16

The free cash flow valuation model cannot be used unless a company doesn't pay dividends.

Accepted Answer

A) True 
 B)False

Question 17

A company is expected to have free cash flows of $0.75 million next year. The weighted average cost of capital is WACC = 10.5%, and the expected constant growth rate is g = 6.4%. The company has $2 million in short-term investments, $2 million in debt, and 1 million shares. What is the stock's current intrinsic stock price?

Accepted Answer

A)  $17.39 
B)  $17.84 
C)  $18.29 
D)  $18.75 
E)  $19.22 
A)  $17.39 
B)  $17.84 
C)  $18.29 
D)  $18.75 
E)  $19.22

Question 18

Which of the following statements is NOT CORRECT?

Accepted Answer

A)  the free cash flow valuation model discounts free cash flows by the required return on equity. 
B)  the free cash flow valuation model can be used to find the value of a division. 
C)  an important step in applying the free cash flow valuation model is forecasting the firm's pro forma financial statements. 
D)  free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value. 
E)  the free cash flow valuation model can be used both for companies that pay dividends and those that do not pay dividends. 
A)  the free cash flow valuation model discounts free cash flows by the required return on equity. 
B)  the free cash flow valuation model can be used to find the value of a division. 
C)  an important step in applying the free cash flow valuation model is forecasting the firm's pro forma financial statements. 
D)  free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value. 
E)  the free cash flow valuation model can be used both for companies that pay dividends and those that do not pay dividends.

Question 19

Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
 $\begin{array}{lcc}
& \underline{X}& \underline{Y} \
\text { Price }&30\$ &30\$\
\text { Expected growth (constant) } & 6 \% &4\%\
\text { Required return } & 12 \% &10\%
\end{array}$

Accepted Answer

A)  stock y has a higher dividend yield than stock x. 
B)  one year from now, stock x's price is expected to be higher than stock y's price. 
C)  stock x has the higher expected year-end dividend. 
D)  stock y has a higher capital gains yield. 
E)  stock x has a higher dividend yield than stock y. 
A)  stock y has a higher dividend yield than stock x. 
B)  one year from now, stock x's price is expected to be higher than stock y's price. 
C)  stock x has the higher expected year-end dividend. 
D)  stock y has a higher capital gains yield. 
E)  stock x has a higher dividend yield than stock y.

Question 20

Young & Liu Inc.'s free cash flow during the just-ended year (t = 0) was $100 million, and FCF is expected to grow at a constant rate of 5% in the future. If the weighted average cost of capital is 15%, what is the firm's value of operations, in millions?

Accepted Answer

A)  $948 
B)  $998 
C)  $1,050 
D)  $1,103 
E)  $1,158 
A)  $948 
B)  $998 
C)  $1,050 
D)  $1,103 
E)  $1,158

Exam 8: Basic Stock Valuation

Which of the following statements is CORRECT?

The preemptive right is important to shareholders because it

The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? Beta 1.10 0.90 Constant growth rate 7.00\% 7.00\%

If a firm's stockholders are given the preemptive right, this means that stockholders have the right to call for a meeting to vote to replace the management. Without the preemptive right, dissident stockholders would have to seek a change in management through a proxy fight.

If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock's expected dividend yield for the coming year?

Carby Hardware has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?

Justus Motor Co.has a WACC of 11.50%, and its value of operations is $25.00 million. Justus's free cash flow is expected to grow at a constant rate of 7.00%. What was the last free cash flow, FCF0 in millions?

Which of the following statements is CORRECT?

Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at t = 3?

You, in analyzing a stock, find that its expected return exceeds its required return. This suggests that you think

If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock's expected total return for the coming year?

The free cash flow valuation model cannot be used unless a company doesn't pay dividends.

Which of the following statements is NOT CORRECT?

Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? Price 30\ 30 \ Expected growth (constant) 6\% 4\% Required return 12\% 10\%

Young & Liu Inc.'s free cash flow during the just-ended year (t = 0) was $100 million, and FCF is expected to grow at a constant rate of 5% in the future. If the weighted average cost of capital is 15%, what is the firm's value of operations, in millions?

An Overview of Financial Management and the Financial Environment

Risk and Return-Part I

Risk and Return-Part II

Bond Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Corporate Valuation and Financial Planning

Corporate Governance

Determining the Cost of Capital

Capital Budgeting: Decision Criteria

Capital Budgeting-Estimating Cash Flows and Analyzing Risk

Real Options

Distributions to Shareholders-Dividends and Repurchases

Capital Structure Decisions

Dynamic Capital Structures and Corporate Valuation

Initial Public Offerings-Investment Banking: and Financial Restructuring

Lease Financing

Hybrid Financing Preferred Stock-Warrants and Convertibles

Supply Chains and Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Enterprise Risk Management

Bankruptcy-Reorganization and Liquidation

Mergers and Corporate Control

Multinational Financial Management

Time Value of Money

Basic Financial Tools: A review

Pension Plan Management

Financial Management in Not for Profit Businesses

Filters