Deck 18: Equity Valuation Models

Question 1

_________ is equal to common shareholders' equity divided by common shares outstanding.

A)Book value per share
B)Liquidation value per share
C)Market value per share
D)Tobin's Q

Answer 1

A

Question 2

________ are analysts who use information concerning current and prospective profitability of a firm to assess the firm's fair market value.

A)Credit analysts
B)Fundamental analysts
C)Systems analysts
D)Technical analysts

Answer 2

B

Question 3

Think Tank Company has an expected ROE of 26%.The dividend growth rate will be _______ if the firm follows a policy of plowing back 90% of earnings.

A)2.6%
B)10%
C)23.4%
D)90% 26% * 0.90 = 23.4%.

Answer 3

23.4%

Question 4

________ is equal to the total market value of the firm's common stock divided by (the replacement cost of the firm's assets less liabilities).

A)Book value per share
B)Liquidation value per share
C)Market value per share
D)Tobin's Q

Question 5

The _______ is defined as the present value of all cash proceeds to the investor in the stock.

A)dividend-payout ratio
B)intrinsic value
C)market-capitalization rate
D)plowback ratio

Question 6

You wish to earn a return of 13% on each of two stocks, X and Y.Stock X is expected to pay a dividend of $3 in the upcoming year while stock Y is expected to pay a dividend of $4 in the upcoming year.The expected growth rate of dividends for both stocks is 7%.The intrinsic value of stock X

A)will be greater than the intrinsic value of stock Y.
B)will be the same as the intrinsic value of stock Y.
C)will be less than the intrinsic value of stock Y.
D)will be the same or greater than the intrinsic value of stock Y.

Question 7

_______ is the amount of money per common share that could be realized by breaking up the firm, selling the assets, repaying the debt, and distributing the remainder to shareholders.

A)Book value per share
B)Liquidation value per share
C)Market value per share
D)Tobin's Q

Question 8

Light Construction Machinery Company has an expected ROE of 11%.The dividend growth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends.

A)3.0%
B)4.8%
C)8.25%
D)9.0% 11% * 0.75 = 8.25%.

Question 9

Since 1955, Treasury bond yields and earnings yields on stocks have been

A)identical.
B)negatively correlated.
C)positively correlated.
D)uncorrelated.

Question 10

Xlink Company has an expected ROE of 15%.The dividend growth rate will be _______ if the firm follows a policy of plowing back 75% of earnings.

A)3.75%
B)11.25%
C)8.25%
D)15.0% 15%* 0.75 = 11.25%.

Question 11

The Gordon model

A)is a generalization of the perpetuity formula to cover the case of a growing perpetuity.
B)is valid only when g is less than k.
C)is valid only when k is less than g.
D)is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when g is less than k.

Question 12

Low Tech Company has an expected ROE of 10%.The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends.

A)6.0%
B)4.8%
C)7.2%
D)3.0% 10% *0.60 = 6.0%.

Question 13

High Speed Company has an expected ROE of 15%.The dividend growth rate will be ________ if the firm follows a policy of paying 50% of earnings in the form of dividends.

A)3.0%
B)4.8%
C)7.5%
D)6.0% 15% *0.50 = 7.5%.

Question 14

High P/E ratios tend to indicate that a company will _______, ceteris paribus.

A)grow quickly
B)grow at the same speed as the average company
C)grow slowly
D)not grow

Question 15

The ______ is a common term for the market consensus value of the required return on a stock.

A)dividend payout ratio
B)intrinsic value
C)market capitalization rate
D)plowback rate

Question 16

Bubba Gumm Company has an expected ROE of 9%.The dividend growth rate will be _______ if the firm follows a policy of plowing back 10% of earnings.

A)90%
B)10%
C)9%
D)0.9% 9% * 0.10 = 0.9%.

Question 17

Medtronic Company has an expected ROE of 16%.The dividend growth rate will be ________ if the firm follows a policy of paying 70% of earnings in the form of dividends.

A)3.0%
B)6.0%
C)7.2%
D)4.8% 16% * 0.30 = 4.8%.

Question 18

Historically, P/E ratios have tended to be

A)higher when inflation has been high.
B)lower when inflation has been high.
C)uncorrelated with inflation rates but correlated with other macroeconomic variables.
D)uncorrelated with any macroeconomic variables, including inflation rates.

Question 19

Music Doctors Company has an expected ROE of 14%.The dividend growth rate will be ________ if the firm follows a policy of paying 60% of earnings in the form of dividends.

A)4.8%
B)5.6%
C)7.2%
D)6.0% 14%* 0.40 = 5.6%.

Question 20

If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces to

A)V₀ = (Expected dividend yield in year 1)/k.
B)V₀ = (Expected EPS in year 1)/k.
C)V₀ = (Treasury bond yield in year 1)/k.
D)V₀ = (Market return in year 1)/k. If ROE = k, no growth is occurring; b = 0; EPS = DPS.

Question 21

Paper Express Company has a balance sheet which lists $85 million in assets, $40 million in liabilities, and $45 million in common shareholders' equity.It has 1,400,000 common shares outstanding.The replacement cost of the assets is $115 million.The market share price is $90. What is Paper Express's book value per share?

A)$1.68
B)$2.60
C)$32.14
D)$60.71

Question 22

Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year.Dividends are expected to grow at the rate of 6% per year.The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%.The stock of Torque Corporation has a beta of 1.2. What is the intrinsic value of Torque's stock?

A)$14.29
B)$14.60
C)$12.33
D)$11.62

Question 23

A preferred stock will pay a dividend of $6.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow.You require a return of 10% on this stock.Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

A)$0.60
B)$6.00
C)$600
D)$60.00

Question 24

A preferred stock will pay a dividend of $3.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow.You require a return of 9% on this stock.Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

A)$33.33
B)$0.27
C)$31.82
D)$56.25 3.00/.09 = 33.33.

Question 25

The most popular approach to forecasting the overall stock market is to use

A)the dividend multiplier.
B)the aggregate return on assets.
C)the historical ratio of book value to market value.
D)the aggregate earnings multiplier.

Question 26

You are considering acquiring a common stock that you would like to hold for one year.You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year.The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.

A)$30.23
B)$24.11
C)$26.52
D)$27.50

Question 27

You are considering acquiring a common stock that you would like to hold for one year.You expect to receive both $0.75 in dividends and $16 from the sale of the stock at the end of the year.The maximum price you would pay for the stock today is _____ if you wanted to earn a 12% return.

A)$23.91
B)$14.96
C)$26.52
D)$27.50

Question 28

High Tech Chip Company paid a dividend last year of $2.50.The expected ROE for next year is 12.5%.An appropriate required return on the stock is 11%.If the firm has a plowback ratio of 60%, the dividend in the coming year should be

A)$1.00.
B)$2.50.
C)$2.69.
D)$2.81.

Question 29

A preferred stock will pay a dividend of $1.25 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow.You require a return of 12% on this stock.Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

A)$11.56
B)$9.65
C)$11.82
D)$10.42 1.25/.12 = 10.42.

Question 30

Fools Gold Mining Company is expected to pay a dividend of $8 in the upcoming year.Dividends are expected to decline at the rate of 2% per year.The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%.The stock of Fools Gold Mining Company has a beta of -0.25.The return you should require on the stock is

A)2%.
B)4%.
C)6%.
D)8%.

Question 31

Suppose that the average P/E multiple in the oil industry is 20.Dominion Oil is expected to have an EPS of $3.00 in the coming year.The intrinsic value of Dominion Oil stock should be

A)$28.12.
B)$35.55.
C)$60.00.
D)$72.00.

Question 32

A preferred stock will pay a dividend of $3.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow.You require a return of 11% on this stock.Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

A)$0.39
B)$0.56
C)$31.82
D)$56.25 3.50/.11 = 31.82.

Question 33

A preferred stock will pay a dividend of $2.75 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow.You require a return of 10% on this stock.Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

A)$0.275
B)$27.50
C)$31.82
D)$56.25 2.75/.10 = 27.50.

Question 34

One of the problems with attempting to forecast stock market values is that

A)there are no variables that seem to predict market return.
B)the earnings multiplier approach can only be used at the firm level.
C)the level of uncertainty surrounding the forecast will always be quite high.
D)dividend-payout ratios are highly variable.

Question 35

Sure Tool Company is expected to pay a dividend of $2 in the upcoming year.The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%.Analysts expect the price of Sure Tool Company shares to be $22 a year from now.The beta of Sure Tool Company's stock is 1.25. What is the intrinsic value of Sure's stock today?

A)$20.60
B)$20.00
C)$12.12
D)$22.00

Question 36

A company paid a dividend last year of $1.75.The expected ROE for next year is 14.5%.An appropriate required return on the stock is 10%.If the firm has a plowback ratio of 75%, the dividend in the coming year should be

A)$1.80.
B)$2.12.
C)$1.77.
D)$1.94. g = .145 *.75 = 10.875%; $1.75(1.10875) = $1.94.

Question 37

Midwest Airline is expected to pay a dividend of $7 in the coming year.Dividends are expected to grow at the rate of 15% per year.The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%.The stock of Midwest Airline has a beta of 3.00.The return you should require on the stock is

A)10%.
B)18%.
C)30%.
D)42%.

Question 38

You are considering acquiring a common stock that you would like to hold for one year.You expect to receive both $2.50 in dividends and $28 from the sale of the stock at the end of the year.The maximum price you would pay for the stock today is _____ if you wanted to earn a 15% return.

A)$23.91
B)$24.11
C)$26.52
D)$27.50

Question 39

Sure Tool Company is expected to pay a dividend of $2 in the upcoming year.The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%.Analysts expect the price of Sure Tool Company shares to be $22 a year from now.The beta of Sure Tool Company's stock is 1.25. The market's required rate of return on Sure's stock is

A)14.0%.
B)17.5%.
C)16.5%.
D)15.25%.

Question 40

Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year.Dividends are expected to grow at the rate of 6% per year.The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%.The stock of Torque Corporation has a beta of 1.2. What is the return you should require on Torque's stock?

A)12.0%
B)14.6%
C)15.6%
D)20%

Question 41

Consider the free cash flow approach to stock valuation.Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year.The firm's corporate tax rate is 30%.It is expected that $200,000 of operating cash flow will be invested in new fixed assets.Depreciation for the year will be $100,000.After the coming year, cash flows are expected to grow at 6% per year.The appropriate market-capitalization rate for unleveraged cash flow is 15% per year.The firm has no outstanding debt.The projected free cash flow of Utica Manufacturing Company for the coming year is

A)$150,000.
B)$180,000.
C)$300,000.
D)$380,000.

Question 42

Low Tech Chip Company is expected to have EPS of $2.50 in the coming year.The expected ROE is 14%.An appropriate required return on the stock is 11%.If the firm has a dividend payout ratio of 40%, the intrinsic value of the stock should be

A)$22.73.
B)$27.50.
C)$28.57.
D)$38.46. g = 14% *0.6 = 8.4%; Expected DPS = $2.50(0.4) = $1.00; P = 1/(.11 - .084) = $38.46.

Question 43

Suppose that the average P/E multiple in the oil industry is 22.Exxon is expected to have an EPS of $1.50 in the coming year.The intrinsic value of Exxon stock should be

A)$33.00.
B)$35.55.
C)$63.00.
D)$72.00.

Question 44

Mature Products Corporation produces goods that are very mature in their product life cycles.Mature Products Corporation is expected to pay a dividend in year 1 of $2.00, a dividend of $1.50 in year 2, and a dividend of $1.00 in year 3.After year 3, dividends are expected to decline at a rate of 1% per year.An appropriate required rate of return for the stock is 10%.The stock should be worth

A)$9.00.
B)$10.57.
C)$20.00.
D)$22.22.

Question 45

Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year.Dividends are expected to grow at the rate of 6% per year.The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%.The stock of Sunshine Corporation has a beta of 0.75.The intrinsic value of the stock is

A)$10.71.
B)$15.00.
C)$17.75.
D)$25.00.

Question 46

Suppose that the average P/E multiple in the oil industry is 16.Shell Oil is expected to have an EPS of $4.50 in the coming year.The intrinsic value of Shell Oil stock should be

A)$28.12.
B)$35.55.
C)$63.00.
D)$72.00.

Question 47

An analyst has determined that the intrinsic value of IBM stock is $80 per share using the capitalized earnings model.If the typical P/E ratio in the computer industry is 22, then it would be reasonable to assume the expected EPS of IBM in the coming year is

A)$3.64.
B)$4.44.
C)$14.40.
D)$22.50. $80(1/22) = $3.64.

Question 48

An analyst has determined that the intrinsic value of Dell stock is $34 per share using the capitalized earnings model.If the typical P/E ratio in the computer industry is 27, then it would be reasonable to assume the expected EPS of Dell in the coming year will be

A)$3.63.
B)$4.44.
C)$14.40.
D)$1.26. $34(1/27) = $1.26.

Question 49

A firm's earnings per share increased from $10 to $12, dividends increased from $4.00 to $4.80, and the share price increased from $80 to $90.Given this information, it follows that

A)the stock experienced a drop in the P/E ratio.
B)the firm had a decrease in dividend-payout ratio.
C)the firm increased the number of shares outstanding.
D)the required rate of return decreased.

Question 50

JCPenney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of $1.97, and a dividend in year 3 of $2.54.After year 3, dividends are expected to grow at the rate of 8% per year.An appropriate required return for the stock is 11%.The stock should be worth _______ today.

A)$33.00
B)$40.67
C)$71.80
D)$66.00

Question 51

Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the coming year.Dividends are expected to decline at the rate of 2% per year.The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%.The stock of Old Quartz Gold Mining Company has a beta of -0.25.The intrinsic value of the stock is

A)$80.00.
B)$133.33.
C)$200.00.
D)$400.00.

Question 52

Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year.Dividends are expected to grow at a rate of 10% per year.The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%.The stock is trading in the market today at a price of $90.00. What is the approximate beta of Risk Metrics's stock?

A)0.8
B)1.0
C)1.1
D)1.4

Question 53

The market-capitalization rate on the stock of Flexsteel Company is 12%.The expected ROE is 13%, and the expected EPS are $3.60.If the firm's plowback ratio is 50%, the P/E ratio will be

A)7.69.
B)8.33.
C)9.09.
D)11.11.

Question 54

Suppose that the average P/E multiple in the gas industry is 17.KMP is expected to have an EPS of $5.50 in the coming year.The intrinsic value of KMP stock should be

A)$28.12.
B)$93.50.
C)$63.00.
D)$72.00.

Question 55

Antiquated Products Corporation produces goods that are very mature in their product life cycles.Antiquated Products Corporation is expected to pay a dividend in year 1 of $1.00, a dividend of $0.90 in year 2, and a dividend of $0.85 in year 3.After year 3, dividends are expected to decline at a rate of 2% per year.An appropriate required rate of return for the stock is 8%.The stock should be worth

A)$8.98.
B)$10.57.
C)$20.00.
D)$22.22.

Question 56

Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year.Dividends are expected to grow at a rate of 10% per year.The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%.The stock is trading in the market today at a price of $90.00. What is the market-capitalization rate for Risk Metrics?

A)13.6%
B)13.9%
C)15.6%
D)16.9%

Question 57

Low Fly Airline is expected to pay a dividend of $7 in the coming year.Dividends are expected to grow at the rate of 15% per year.The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%.The stock of Low Fly Airline has a beta of 3.00.The intrinsic value of the stock is

A)$46.67.
B)$50.00.
C)$56.00.
D)$62.50.

Question 58

The market-capitalization rate on the stock of Flexsteel Company is 12%.The expected ROE is 13%, and the expected EPS are $3.60.If the firm's plowback ratio is 75%, the P/E ratio will be

A)7.69.
B)8.33.
C)9.09.
D)11.11.

Question 59

Consider the free cash flow approach to stock valuation.Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year.The firm's corporate tax rate is 30%.It is expected that $200,000 of operating cash flow will be invested in new fixed assets.Depreciation for the year will be $100,000.After the coming year, cash flows are expected to grow at 6% per year.The appropriate market capitalization rate for unleveraged cash flow is 15% per year.The firm has no outstanding debt.The total value of the equity of Utica Manufacturing Company should be

A)$1,000,000.
B)$2,000,000.
C)$3,000,000.
D)$4,000,000.

Question 60

An analyst has determined that the intrinsic value of HPQ stock is $20 per share using the capitalized earnings model.If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of HPQ in the coming year is

A)$3.63.
B)$4.44.
C)$0.80.
D)$22.50. $20(1/25) = $0.80.

Question 61

Dividend discount models and P/E ratios are used by __________ to try to find mispriced securities.

A)technical analysts
B)statistical analysts
C)fundamental analysts
D)dividend analysts

Question 62

According to James Tobin, the long-run value of Tobin's Q should move toward

A)0.
B)1.
C)2.
D)infinity.

Question 63

The growth in dividends of ABC, Inc.is expected to be 15% per year for the next three years, followed by a growth rate of 8% per year for two years.After this five-year period, the growth in dividends is expected to be 3% per year, indefinitely.The required rate of return on ABC, Inc.is 13%.Last year's dividends per share were $1.85.What should the stock sell for today?

A)$8.99
B)$25.21
C)$40.00
D)$27.74

Question 64

Which of the following is the best measure of the floor for a stock price?

A)Book value
B)Liquidation value
C)Replacement cost
D)Market value

Question 65

Investors want high plowback ratios

A)for all firms.
B)Whenever ROE >k.
C)Whenever k>ROE.
D)only when they are in low tax brackets.

Question 66

If a firm has a required rate of return equal to the ROE,

A)the firm can increase market price and P/E by retaining more earnings.
B)the firm can increase market price and P/E by increasing the growth rate.
C)the amount of earnings retained by the firm does not affect market price or the P/E.
D)the firm can increase market price and P/E by retaining more earnings and increasing the growth rate.

Question 67

Assume that Bolton Company will pay a $2.00 dividend per share next year, an increase from the current dividend of $1.50 per share that was just paid.After that, the dividend is expected to increase at a constant rate of 5%.If you require a 12% return on the stock, the value of the stock is

A)$28.57.
B)$28.79.
C)$30.00.
D)$31.78.

Question 68

A firm has a return on equity of 20% and a dividend-payout ratio of 30%.The firm's anticipated growth rate is

A)6%.
B)10%.
C)14%.
D)20%.

Question 69

According to Peter Lynch, a rough rule of thumb for security analysis is that

A)the growth rate should be equal to the plowback rate.
B)the growth rate should be equal to the dividend-payout rate.
C)the growth rate should be low for emerging industries.
D)the growth rate should be equal to the P/E ratio.

Question 70

Sales Company paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of earnings as dividends for the foreseeable future.If the firm is expected to generate a 10% return on equity in the future, and if you require a 12% return on the stock, the value of the stock is

A)$17.67.
B)$13.00.
C)$16.67.
D)$18.67. g = 10% * 0.6 = 6%; P = 1 (1.06)/(.12 - .06) = $17.67.

Question 71

The goal of fundamental analysts is to find securities

A)whose intrinsic value exceeds market price.
B)with a positive present value of growth opportunities.
C)with high market capitalization rates.
D)All of the options are correct.

Question 72

A firm has a return on equity of 14% and a dividend-payout ratio of 60%.The firm's anticipated growth rate is

A)5.6%.
B)10%.
C)14%.
D)20%.

Question 73

Many stock analysts assume that a mispriced stock will

A)immediately return to its intrinsic value.
B)return to its intrinsic value within a few days.
C)never return to its intrinsic value.
D)gradually approach its intrinsic value over several years.

Question 74

In the dividend discount model, which of the following are not incorporated into the discount rate?

A)Real risk-free rate
B)Risk premium for stocks
C)Return on assets
D)Expected inflation rate The real risk-free rate, risk premium for stocks, and expected inflation rate are incorporated into the discount rate used in the dividend discount model.

Question 75

If a firm follows a low-investment-rate plan (applies a low plowback ratio), its dividends will be _______ now and _______ in the future than a firm that follows a high-reinvestment-rate plan.

A)higher; higher
B)lower; lower
C)lower; higher
D)higher; lower

Question 76

Other things being equal, a low ________ would be most consistent with a relatively high growth rate of firm earnings.

A)dividend-payout ratio
B)degree of financial leverage
C)variability of earnings
D)inflation rate

Question 77

A company whose stock is selling at a P/E ratio greater than the P/E ratio of a market index most likely has

A)an anticipated earnings growth rate which is less than that of the average firm.
B)a dividend yield which is less than that of the average firm.
C)less predictable earnings growth than that of the average firm.
D)greater cyclicality of earnings growth than that of the average firm. Firms with lower than average dividend yields are usually growth firms, which have a higher P/E ratio than average.

Question 78

The dividend discount model

A)ignores capital gains.
B)incorporates the after-tax value of capital gains.
C)includes capital gains implicitly.
D)restricts capital gains to a minimum.

Question 79

The growth in dividends of XYZ, Inc.is expected to be 10% per year for the next two years, followed by a growth rate of 5% per year for three years.After this five-year period, the growth in dividends is expected to be 2% per year, indefinitely.The required rate of return on XYZ, Inc.is 12%.Last year's dividends per share were $2.00.What should the stock sell for today?

A)$8.99
B)$25.21
C)$40.00
D)$110.00

Question 80

The growth in dividends of Music Doctors, Inc.is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years.After this five-year period, the growth in dividends is expected to be 3% per year, indefinitely.The required rate of return on Music Doctors, Inc.is 11%.Last year's dividends per share were $2.75.What should the stock sell for today?

A)$8.99
B)$25.21
C)$39.71
D)$110.00