Deck 9: Company Analysis and Stock Valuation

Question 1

The price/cash flow ratio has grown in prominence and use for valuing firms because many analysts contend that a firm's cash flow is less subject to manipulation than the firm's earnings per share.

Answer 1

True

Question 2

By definition growth companies have growth stocks.

Answer 2

False

Question 3

An undervalued stock is a growth stock.

Answer 3

True

Question 4

Present value of free cash flow to equity resembles the present value of earnings concept except that it includes the capital expenditures required to maintain and grow the firm and the change in working capital required for a growing firm.

Question 5

Turnarounds are firms with valuable assets that are hidden on the balance sheet.

Question 6

A defensive company is one whose sales, earnings and cash flows are strongly correlated with the business cycle.

Question 7

The constant growth dividend growth model is not appropriate for the valuation of growth companies.

Question 8

In the present value of operating free cash flow technique, the firm's operating free cash flow to the firm is discounted at the firm's weighted average cost of capital (WACC).

Question 9

A cyclical company's sales and earnings are heavily influenced by aggregate business activity.

Question 10

With a differentiation strategy, a firm seeks to identify itself as unique in its industry in an area that is important to buyers.

Question 11

An overvalued stock is a non-growth stock.

Question 12

Price-to-sales ratio is still considered the predominant firm valuation technique.

Question 13

Price-to-book value ratio cannot be used to estimate the value of firms with negative earnings or negative cash flows.

Question 14

A growth company is a firm that has the opportunities and ability to invest capital in projects that generate rates of return greater than the firm's cost of debt.

Question 15

The best known measure of relative value for common stock is the P/E ratio.

Question 16

A firm's competitive strategy can be either defensive or offensive.

Question 17

A growth company is one whose stock is undervalued by the market.

Question 18

While EVA is considered an internal performance measure, MVA is considered to be an external performance measure.

Question 19

A stock with low systematic risk is considered to be a defensive stock.

Question 20

A negative EVA (Economic Value Added) for the year implies that the firm has not earned enough during the year to cover its capital of capital and the value of the firm has declined.

Question 21

A ____ stock possesses a high probability of low or negative rates of return and a low probability of normal or high rates of return.

A) Growth
B) Defensive
C) Cyclical
D) Speculative
E) Value

Question 22

To benefit from cost leadership a firm must command prices near the industry average.

Question 23

Peter Lynch identified a number of attributes of firms that may result in favourable stock market performances, including

A) Products that are faddish, people like change.
B) Firms that have competitive advantages over their rivals.
C) Firms that can benefit from cost reductions.
D) Choices b and c
E) All of the above.

Question 24

Based on the annual reports of Shoppers it has pursued both a low-cost strategy and a differentiation strategy for different business segments.

Question 25

In Berkshire Hathoway annual reports Warren Buffet highlights business tenants that he believes are important. Which of the following is not a business tenant of Warren Buffet?

A) Is the business unique and technologically advanced?
B) Does the business have a consistent operating history?
C) Does the business have favourable long-term prospects?
D) a and b above.
E) All of the above are business tenants of Warren Buffet.

Question 26

Which of the following statements concerning SWOT analysis is false?

A) Strengths are the factors that give the firm a comparative advantage in the marketplace.
B) Weaknesses result when the company has potentially exploitable advantages over other firms.
C) Opportunities are environmental factors that favour the firm.
D) Threats are environmental factors that can hinder the firm in achieving its goals.
E) All of the above statements are true.

Question 27

The sustainable growth rate can be calculated by taking the dividend payout ratio time return on equity (ROE).

Question 28

Two major competitive strategies are low-cost leadership and low-price leadership.

Question 29

One way to measure a company's intrinsic value is to divide the company's current dividends by the required return less the dividend growth rate.

Question 30

According to Peter Lynch a favourable attribute of a firm that may result in favourable stock performance is when a firm buys back its shares.

Question 31

Which of the following is not a technique for valuing a firm's common stock?

A) Present value of free cash flow to equity
B) Present value of dividends
C) Price-earnings ratio
D) Price-book value ratios
E) Price-cost of goods sold ratio

Question 32

Porter contends that _________ and ______________ are two important competitive strategies.

A) Low cost leadership, barrier to entry
B) New entrant deterrent, differentiation
C) Low cost leadership, differentiation
D) Differentiation, monopolistic
E) Monopolistic simulation, differentiation

Question 33

According to Peter Lynch a favourable attribute of a firm that may result in favourable stock performance is when a firm's product is the latest craze.

Question 34

In a(n) _______________ strategy, a firm seeks to identify itself as unique within its industry.

A) Defensive
B) Offensive
C) Low-cost
D) Differentiation
E) None of the above

Question 35

Operating free cash flow and free cash flow to equity are equivalent cash flow concepts.

Question 36

Underpriced stocks can be ranked using the excess return ratio which is calculated as the Market price/Risk free rate.

Question 37

In Berkshire Hathoway annual reports, Warren Buffet highlights financial tenants that he believes are important. Which of the following is not a financial tenant of Warren Buffet?

A) Focus on return on equity (ROE) not earnings per share (EPS).
B) Calculate owner earnings similar to free cash flow after capital expenditures.
C) High profit margins relative to the industry.
D) Company should create at least one dollar of market value for every dollar retained.
E) All of the above are financial tenants of Warren Buffet.

Question 38

In SWOT analysis, one examines all of the following factors, except

A) Strengths.
B) Weaknesses.
C) Opportunities.
D) Threats.
E) Turnarounds.

Question 39

A speculative stock possesses a ____ probability of ____ return and is currently ____.

A) High, negative, underpriced.
B) High, negative, overpriced.
C) High, positive, overpriced.
D) Low, negative, overpriced.
E) Low, positive, underpriced.

Question 40

A growth company is one that has the ability to

A) Acquire capital at a low cost and is able to invest in projects that yield an average return.
B) Acquire capital at a low cost and is able to invest in projects that yield a below average return.
C) Acquire capital at an average cost and is able to invest in projects that yield an above average return.
D) Acquire capital at an average cost and is able to invest in projects that yield an average return.
E) Acquire capital at an above average cost and is able to invest in projects that yield an average return.

Question 41

Which of the following are tenets of Warren Buffett?

A) Business tenets.
B) Financial tenets.
C) Management tenets.
D) All of the above.
E) None of the above.

Question 42

An inconsistency between a stock's P/E ratio and growth rate can be attributed to all of the following, except

A) A major difference in the risk involved.
B) Inaccurate growth estimates.
C) An undervaluation of the stock.
D) An overvaluation of the stock.
E) Competition.

Question 43

Which of the following is a business tenet of Warren Buffett?

A) Long term prospects.
B) Resistance to institutional imperative.
C) Creation of one dollar of market value for every dollar retained.
D) Purchase at discount to intrinsic value.
E) Product is not faddish

Question 44

Which of the following is a market tenet of Warren Buffett?

A) Long term prospects.
B) Resistance to institutional imperative.
C) Creation of one dollar of market value for every dollar retained.
D) Purchase at discount to intrinsic value.
E) Product is not faddish

Question 45

Which of the following is not considered when looking at free cash flow to equity technique?

A) Depreciation expense
B) Change in working capital
C) Principal debt repayments
D) Change in competitive environment
E) Net income

Question 46

Which of the following is a financial tenet of Warren Buffett?

A) Long term prospects.
B) Resistance to institutional imperative.
C) Creation of one dollar of market value for every dollar retained.
D) Purchase at discount to intrinsic value.
E) Product is not faddish.

Question 47

Market value-added is a measure of ____ performance.

A) External
B) Internal
C) Competitive
D) Economic
E) None of the above.

Question 48

Which of the following factors does not indicate market liquidity?

A) Number of shareholders
B) High price volatility
C) Number of shares outstanding
D) Number of shares traded
E) Institutional interest

Question 49

A growth company can invest in projects that generate a return greater than the firm's

A) Return on equity.
B) Cost of debt.
C) Cost of equity.
D) Cost of capital.
E) Return on assets.

Question 50

Exhibit 9-1
USE THE FOLLOWING INFORMATION FOR THE NEXT QUESTION(S)
Refer to Exhibit 9-1. In the listing above, which three factors influence the earnings multiple for a stock?

A) 1, 4, and 5
B) 1, 4, and 6
C) 2, 4, and 6
D) 2, 5, and 6
E) 4, 5, and 6

Question 51

Exhibit 9-1
USE THE FOLLOWING INFORMATION FOR THE NEXT QUESTION(S)
Refer to Exhibit 9-1. In the listing above, which three factors influence the capital gain component of a growth company?

A) 1, 3, and 5
B) 2, 3, and 4
C) 2, 3, and 6
D) 3, 4, and 5
E) 3, 4, and 6

Question 52

Under the present value of operating free cash flow technique, the firm's operating free cash flow to the firm is discounted at the firm's

A) Weighted average cost of capital.
B) Cost of debt.
C) Internal rate of return.
D) External cost of new equity.
E) Net present value.

Question 53

Evidence that a firm has high business risk would be provided by its volatile ____.

A) Fixed costs.
B) Profit after taxes.
C) Operating profit.
D) Sales.
E) Employee turnover.

Question 54

A set of performance measures called ___________ are directly related to the capital budgeting techniques used in corporate finance.

A) Dividend discount model
B) Aggressive growth indexes
C) Growth indexes
D) Value added
E) Profit sensitization

Question 55

Which of the following is not considered a relative valuation technique?

A) Price-earnings ratio
B) Price/cash flow ratio
C) Price/book value ratio
D) Price/cost of goods sold ratio
E) Price/sales ratio

Question 56

Which of the following is not a value added performance measure?

A) Economic Value Added (EVA)
B) Market Value Added (MVA)
C) Franchise Factor
D) Company Value Added (CVA)
E) None of the above (that is, all are value added performance measures)

Question 57

Which of the following is not considered in the price-earnings ratio technique?

A) Firm's required rate of return on equity (k)
B) Firm's dividend payout ratio (D/E)
C) Firm's expected growth rate of dividends (g)
D) All of the above are components of P/E ratio
E) None of the above are components of P/E ratio

Question 58

"Economic profit" is analogous to ____ in capital budgeting.

A) Weighted average cost of capital
B) Internal rate of return
C) Composite discount rates
D) Discounted cashflows
E) Net present value

Question 59

Which of the following statements concerning global company analysis is false?

A) Analysis of companies within industries should be extended to include foreign companies.
B) There is a problem in obtaining data that is required for a thorough company analysis of foreign companies.
C) Foreign companies' financial risk should be evaluated over time.
D) Differences in relative measures can be explained by the variations in accounting procedures among countries and investors attitudes within each country.
E) All of the above statements are true.

Question 60

Which of the following is a management tenet of Warren Buffett?

A) Long term prospects.
B) Resistance to institutional imperative.
C) Creation of one dollar of market value for every dollar retained.
D) Purchase at discount to intrinsic value.
E) Product is not faddish

Question 61

Which of the following is not a determinant of the capital gain component?

A) The percentage of earnings retained for reinvestment.
B) The relative rate of return earned on the funds retained.
C) The time period for these growth investments.
D) The amount of capital invested in growth investments.
E) All of the above are determinants of the capital gain component.

Question 62

What variables impact the Price/Sales ratio?

A) Sales growth rate, volatility of sales growth, profit margin
B) Earnings growth rate, volatility of sales growth, profit margin
C) Earnings growth rate, volatility of sales growth, operating margin
D) Sales growth rate, volatility of sales growth, operating margin
E) Sales growth rate, volatility of profit margin, profit margin

Question 63

Speculative companies are firms where

A) Sales, earnings and cash flows are extremely uncertain and not necessarily related to the economy.
B) Sales, earnings and cash flows are likely to withstand changes caused by the economic environment.
C) Sales, earnings and cash flows are heavily influenced by aggregate business activity.
D) Sales, earnings and cash flows are growing exponentially.
E) None of the above.

Question 64

What is the implied growth duration of Howard Industries given the following: $\begin{array}{lcc} & \text { S\&P/TSX Industrials } & \text { Howard Industries } \\\hline \text { P/E Ratios } & 14 & 24 \\\text { Average Growth }(\%) & 6.0 & 12.0 \\\text { Dividend Yield } & 07 & .04\end{array}$

A) 11.5 years
B) 16.8 years
C) 22.6 years
D) 18.4 years
E) 20.6 years

Question 65

A firm that follows a differentiation strategy

A) Must heavily discount its prices.
B) Must command prices near the industry average.
C) Must focus on providing exceptional quality and service.
D) All of the above.
E) None of the above.

Question 66

What is the implied growth duration of Casey Industries given the following: $\begin{array}{lcc} & \text { S\&P/TSX Industrials } & \text { Casey Industries } \\\hline \text { P/E Ratios } & 15 & 20 \\\text { Average Growth }(\%) & 5.0 & 15.0 \\\text { Dividend Yield } & .04 & 06\end{array}$

A) 3.2 years
B) 2.8 years
C) 4.8 years
D) 9.6 years
E) 13.2 years

Question 67

A firm that follows a low cost leadership strategy

A) Must heavily discount its prices.
B) Must command prices near the industry average.
C) Must focus on providing exceptional quality and service.
D) All of the above.
E) None of the above.

Question 68

When a firm seeks to identify itself as unique in its industry in an area that is important to buyers it is known as a

A) Defensive strategy
B) Differentiation strategy
C) Low-cost strategy
D) Focused strategy
E) Value strategy

Question 69

A growth company may exist for all of the following reasons except

A) The company holds patents.
B) The company possess unique distribution or marketing strategies.
C) The company is in a competitive environment.
D) Significant barriers to entry exist.
E) All of the above are reasons a growth company may exist.

Question 70

Exhibit 9-2
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Modular Industries currently has a 16% annual growth rate while the market average is 6%. The market multiple is 10.
Refer to Exhibit 9-2. Determine the justified P/E ratio for Modular Industries assuming Modular can maintain its superior growth rate for the next 5 years.

A) 6.4
B) 13.1
C) 16.5
D) 23.8
E) 15.7

Question 71

Exhibit 9-2
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Modular Industries currently has a 16% annual growth rate while the market average is 6%. The market multiple is 10.
Refer to Exhibit 9-2. Determine the P/E ratio for Modular Industries assuming Modular can maintain its superior growth rate for the next 8 years.

A) 6.4
B) 20.5
C) 16.5
D) 23.8
E) 29.5

Question 72

A firm that follows a defensive competitive strategy could

A) Lower production costs.
B) Create a strong brand image.
C) Use its buying power to obtain price concessions.
D) Choices a and b.
E) Choices b and c.

Question 73

What is the implied growth duration of Jones Industries given the following: $\begin{array}{lcc} & \text { S\&P/TSX Industrials } & \text { Jones Industries } \\\hline \text { P/E Ratios } & 12 & 15 \\\text { Average Growth }(\%) & 6.0 & 10.0 \\\text { Dividend Yield } & 05 & 03\end{array}$

A) 7.2 years
B) 10.9 years
C) 12.5 years
D) 13.9 years
E) 15.2 years

Question 74

What is the implied growth duration of Freed Industries given the following: $\begin{array}{lcc} & \text { S\&P/TSX Industrials } & \text { Freed Industries } \\\hline \text { P/E Ratios } & 19 & 22 \\\text { Average Growth }(\%) & 11.0 & 16.0 \\\text { Dividend Yield } & .033 & 08\end{array}$

A) 1.8 years
B) 1.3 years
C) 5.0 years
D) 4.5 years
E) 3.5 years

Question 75

Cyclical companies are firms where

A) Sales, earnings and cash flows are extremely uncertain and not necessarily related to the economy.
B) Sales, earnings and cash flows are likely to withstand changes caused by the economic environment.
C) Sales, earnings and cash flows are heavily influenced by aggregate business activity.
D) Sales, earnings and cash flows are growing exponentially.
E) None of the above.

Question 76

Studies that have examined the relationship between EVA and MVA have found

A) An inverse relationship.
B) A positive relationship.
C) A poor relationship.
D) EVA always exceeded MVA.
E) MVA always exceeded EVA.

Question 77

What is the implied growth duration of Bowe Industries given the following: $\begin{array}{lcc} & \text { S\&P/TSX Industrials } & \text { Bowe Industries } \\\hline \text { P/E Ratios } & 15 & 25 \\\text { Average Growth }(\%) & 5.0 & 15.0 \\\text { Dividend Yield } & 06 & 02\end{array}$

A) 3.2 years
B) 6.6 years
C) 8.6 years
D) 9.7 years
E) 10.6 years

Question 78

Defensive companies are firms where

A) Sales, earnings and cash flows are extremely uncertain and not necessarily related to the economy.
B) Sales, earnings and cash flows are likely to withstand changes caused by the economic environment.
C) Sales, earnings and cash flows are heavily influenced by aggregate business activity.
D) Sales, earnings and cash flows are growing exponentially.
E) None of the above.

Question 79

The franchise P/E is a function of

A) Relative rate of return on new business opportunities
B) Size of superior return opportunities.
C) Duration of earnings growth.
D) Choices a and b.
E) Choices a, b, and c.

Question 80

Exhibit 9-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Harcourt Industries currently has an 18% annual growth rate while the market average is 8%. The market multiple is 12.
Refer to Exhibit 9-3. Determine the justified P/E ratio for Harcourt Industries assuming Harcourt can maintain its superior growth rate for the next 9 years.

A) 5.98
B) 13.13
C) 21.20
D) 58.68
E) 26.65