Deck 10: Common Stock Valuation

Question 1

Carl is evaluating a stock that just paid a dividend of $2.00 per share. He expects this dividend to grow by 4% per year, and he has determined that 11% is the appropriate required return. What is the most he should pay for the stock?

A) $18.18
B) $18.91
C) $28.57
D) $29.71

Answer 1

D

Question 2

The free cash flow to the firm model uses which of the following as the discount rate?

A) The required return on equity
B) The before-tax cost of debt
C) The after-tax cost of equity
D) The weighted average cost of capital

Answer 2

D

Question 3

Janice is evaluating a stock that currently pays a dividend of $0.25 per share. She expects this level of dividend to continue indefinitely, and she has determined that 5% is the appropriate required return for the stock. What is the most she should pay for the stock?

A) $1.25 per share
B) $2.50 per share
C) $5.00 per share
D) $7.50 per share

Answer 3

C

Question 4

Which of the following increases the price an investor is willing to pay for a stock?

A) The investor increases his estimate of the constant growth rate for dividends.
B) The investor decreases his estimate of the constant growth rate for dividends.
C) The investor increases his estimate of the required rate of return.
D) The investor assumes a higher beta for the stock.

Question 5

What is the major

A) Prices in the stock market move from moment to moment.
B) Small changes to the assumptions of k or g result in major changes in the estimated value.
C) It is extremely unlikely that a stream of cash flows will continue to grow at the same rate.
D) The relative valuation techniques are more accurate approaches.

Question 6

Which of the following is not one of the steps in using discounted cash flow to value a company?

A) Estimate the amount and timing of the future stream of cash flows
B) Estimate an appropriate discount rate
C) Use a present value model to calculate an intrinsic value
D) Compare the intrinsic value to the relative value metric

Question 7

Which measure relies on the cash flow remaining after capital expenditures and after interest and principal repayments on debt have been made?

A) Free cash flow to the firm
B) Weighted average cost of capital
C) Economic value added
D) Free cash flow to equity

Question 8

Which of the following represent two major approaches used to value stocks?

A) Discounted cash flow techniques and absolute valuation techniques
B) Discounted cash flow techniques and relative valuation techniques
C) Compound free cash flow techniques and relative valuation techniques
D) Markowitz diversification techniques and relative valuation techniques

Question 9

Mr. & Mrs. Jones plan to buy stock to earn the funds needed for their son's college education. They will sell the stock in 7 years to pay tuition. What amount should they use as an estimate for the stock price when they sell in year 7?

A) The discounted value of the dividends for years 1 through 6.
B) The discounted value of all the dividends from year 7 on.
C) The discounted value of all dividends from year 1 on.
D) The price that is currently quoted in the stock market.

Question 10

Jed plans to purchase a deferred dividend preferred stock. The stock has a dividend rate of 5%, a $100 par value, and will pay its first annual dividend in six years. If Jed's required return on the stock is 6.75%, what price should he pay for the stock now?

A) $50.06
B) $53.44
C) $58.04
D) $74.07

Question 11

Which of the following descriptions of the price/earnings ratio is the most accurate?

A) Investors are generally more pessimistic about the prospects for high P/E stocks.
B) Historically, the average P/E for the market has been approximately 10.
C) Companies with high growth rates generally have higher P/E ratios.
D) All else the same, investors prefer to purchase stocks with relatively high P/E ratios.

Question 12

Which of the following is not a term used to describe the denominator in the discounted cash flow model?

A) Discount rate
B) Compounding rate
C) Required rate of return
D) Capitalization rate

Question 13

Which of the following is frequently used as a measure of cash flow in the P/CF ratio?

A) Revenue
B) Gross Profit
C) EBITDA
D) Income from continuing operations

Question 14

What is used as "earnings" in the price/earnings ratio?

A) The net income shown in the company's most recent annual report
B) Earnings from the firm's last four published quarterly income statements
C) The firm's estimated earnings for the next 12 months
D) All of these definitions of earnings are used by analysts

Question 15

Charlie is valuing a common stock with forecast dividends as shown below. He thinks that 10% is an appropriate discount rate. What is the most he should pay for the stock? $$\begin{array} { | c | c | c | c | c | } \hline \mathbf { D } _ { \mathbf { 1 } } & \mathbf { D } _ { \mathbf { 2 } } & \mathbf { D } _ { \mathbf { 1 } } & \mathbf { D } _ { \mathbf { 4 } } & \text { Later } \\\hline \$ 2.00 & \$ 2.40 & \$ 2.76 & \$ 3.17 & \mathbf { 6 \% } \text { prowth } \\\hline\end{array}$$

A) $60.20
B) $63.25
C) $65.42
D) $84.01

Question 16

Which of the following is not used in relative valuation comparisons?

A) The relative value measure from past periods.
B) The relative value measure for the industry under consideration.
C) The relative value measure for a comparable firm.
D) The relative value measure derived from the DCF model.

Question 17

Sam is evaluating a stock that is expected to pay a $1.25 per share dividend at the beginning of next year. He expects the dividend to grow by 10% per year and has determined that 12% is an appropriate required return for the stock. What is the highest amount he should pay for the stock?

A) $1.25
B) $12.50
C) $15.00
D) $62.50

Question 18

Hannett Inc. has a stock price of $40 and just reported earnings of $3 per share. The firm maintains a constant dividend payout of 65% and has an expected return on equity (ROE) of 16%. Based on the constant growth model, Hannett's expected return is closest to:

A) 10.50%.
B) 10.75%.
C) 13.10%.
D) 13.50%.

Question 19

Stephen used the dividend discount model to determine that the price of a stock should be $23.50. Stephen checks on the internet and finds the latest price quoted for the stock is $27.00. What should he do?

A) Buy the stock at $27.00
B) Sell the stock at $27.00, or sell short if he does not own it
C) Do nothing, as his estimate of the intrinsic value may be off as much as 15%
D) Buy the stock at $23.50 because that is all it is worth

Question 20

The estimated EPS and dividend per share (DPS) for Herker Corp. next year are $4 and $2, respectively. Herker's stock price is $92 and analysts estimate Herker's required return at 8%. What is the present value of growth opportunities (PVGO) for Herker?

A) $25
B) $42
C) $50
D) $67

Question 21

Seaside Boats currently earns $4.00 per share and has a retention ratio of 75%. It is expected to have a constant growth rate of 5 percent per year. The required return is 15 percent. What is the intrinsic value of this stock?

A) $10
B) $10.50
C) $40
D) $42

Question 22

Sometimes analysts use other ratios such as price-to-book or price-to-sales ratio. Which of the following is a weakness of the use of these ratios?

A) Some companies are structured very differently, especially across industries.
B) A price-to-book value less than one cannot be assessed.
C) A high price-to-sales ratio cannot be assessed.
D) The price-to-sales ratio cannot be used for companies that report a net loss.

Question 23

Economic value added (EVA) indicates the amount by which a company's operating profit exceeds its cost of capital.

Question 24

Technology stocks generally have P/E ratios that are higher than the market average.

Question 25

The P/E ratio is one of the most widely used measures to assess the financial attractiveness of potential stock investments.

Question 26

Rita has calculated the discounted value of the free cash flows to the firm (FCFFs) for a company that has no preferred stock. What additional adjustment(s) does she have to make to her calculated discounted value to derive an estimate of the firm's stock price?

A) Subtract the value of debt and divide by shares outstanding
B) Add the value of debt and divide by shares outstanding
C) Subtract the value of capital expenditures and divide by shares outstanding
D) Divide by shares outstanding

Question 27

Tanex Inc. has a return on assets (ROA) of 12%, a return on equity (ROE) of 15%, and a dividend payout ratio of 60%. Based on the sustainable growth formula, Tanex's estimated growth is:

A) 4.8%.
B) 6.0%.
C) 7.2%.
D) 9.0%.

Question 28

No one knows with precision which valuation model to apply for any particular stock.

Question 29

Sara estimated the revenue per share for Firm A as $5.50 and estimated the appropriate P/B ratio, P/E ratio, and P/S ratio as 1.9, 14.5, and 2.6, respectively. What is the estimated intrinsic value for Firm A?

A) $10.45
B) $79.75
C) $14.30
D) $2.12

Question 30

Which factor is least likely to explain why a company has a higher P/E than another?

A) The company has a higher growth rate of earnings.
B) The company has a higher required return.
C) The company has a higher current ratio.
D) The company has a higher return on equity.

Question 31

Investors will arrive at the same intrinsic valuation for common stocks because valuation is based on an objective approach.

Question 32

If a stock's dividend growth rate or discount rate changes even a small amount, the change in the price calculated by the constant growth model can be very large.

Question 33

Stan expects Terta Corp. to pay its first dividend of $3 in five years. He expects the dividend to grow at 6% thereafter, and his required return on the stock is 9.5%. The largest amount that Stan should pay for the stock is closest to:

A) $54.
B) $60.
C) $68.
D) $86.

Question 34

Many analysts prefer to use a relative valuation technique, such as comparing P/E ratios, because these techniques are more grounded in theory than the DCF approaches.

Question 35

The only reliable way to value a common stock is to discount the future flow of dividends at a discount rate appropriate to the riskiness of the company.

Question 36

The required return needed to discount a stock's future cash flows can be determined using the CAPM.

Question 37

Which of the following is most likely to increase a company's P/E ratio?

A) The company announces a new product, which will increase sales and profits.
B) The company's beta increases.
C) The expected inflation rate increases.
D) Interest rates increase for all borrowers.

Question 38

To estimate the intrinsic value of a security, investors should rely on:

A) the approach that they are most comfortable using.
B) the approach that is easiest to apply and interpret.
C) the approach that generally gives the most conservative value.
D) more than one approach.

Question 39

Which of the following is a component of a firm's enterprise value?

A) EBITDA
B) Accounts receivable
C) Bonds
D) Fixed assets

Question 40

Riza Corporation's preferred stock has a par value of $100 and a dividend rate of 6%. If the required return on the stock is 8%, its intrinsic value is closest to:

A) $75.
B) $94.
C) $133.
D) $300.

Question 41

For a profitable firm, its forward P/E generally exceeds its trailing P/E.

Question 42

THC Inc. just paid a $1.60 per share dividend. Clarice projects that THC's dividend will grow at the following rates over the next three years: 16%, 12% and 8%, respectively. Clarice expects the dividend to grow at 5% thereafter. If Clarice has a 9.5% required return on the stock, what value should she place on the stock now?

Question 43

The Huskie Corporation's stock paid a $3.85 dividend ten years ago and just paid a $7.75 dividend this year. Assume you expect the dividend to grow at this same rate into the future and your required return on the stock is 12.5%. What value should you place on the stock?

Question 44

The YTC Corporation just paid an annual dividend of $1.50. Harry expects the dividends of the YTC Corporation to grow at 12% for the next four years and at 7% thereafter. The beta of YTC is 1.25 and Harry considers the market risk premium to be 4.2%. A five-year, zero-coupon Treasury bond is yielding 4.01%. What value should Harry place on the stock?

Question 45

SRD Corporation's stock is currently selling at $36 per share. SRD reported total revenues of $5.26 billion over the past year, has a book value of equity of $2.9 billion, and has 296 million shares outstanding. Based on comparable firms, the appropriate P/S and P/B for SRD are 2.85 and 4.75, respectively.
A. What is the stock's approximate intrinsic value based on the P/S multiplier?

Question 46

In the past year, CRA Corp. paid a $2.50 per share dividend. The annual dividends are projected to be $4.00, $5.00, and $6.00 over the next 3 years, respectively. The dividend is expected to grow at 5% following the $6 dividend. Assuming the required return on the stock is 9.5%, what is the estimated stock value?

Question 47

The P/B ratio is considered relatively useful for firms with high levels of intangible assets.

Question 48

An increase in interest rates generally reduces P/E ratios and stock prices.

Question 49

Next year's expected EPS for Swanti Industries is $5 and the firm has a 60% payout ratio. Swanti's stock has a beta of 1.1, a required return of 10% and is selling at $120. Find Swanti's present value of growth opportunities (PVGO) and the percent PVGO is of Swanti's current price.

Question 50

Helen plans to purchase a stock that is currently paying no dividend. Helen expects the stock to pay its first dividend of $5.00 per share in eight years. Furthermore, she expects the firm to have an ROE of 16% and a dividend payout ratio of 60% thereafter. What value should Helen place on the stock now if her required return on the stock is 8.75%?

Question 51

As an electric utility, Arbot Industries is expected to maintain a constant dividend payout ratio and constant growth rate of earnings for the foreseeable future. Earnings were $4.50 per share in the recently completed fiscal year. In recent years, the dividend payout ratio has been a constant 65% and is expected to remain so. Arbot's return on equity (ROE) is expected to be 14% in future years. Assume your required return on the stock is 8.5%. Based on the constant growth model, what is Arbot's intrinsic value?

Question 52

Historically, the average P/E for the S&P 500 is approximately 16.

Question 53

Weldon Corp. is in the expansion stage of its life cycle and just paid its first dividend of $2 per share. An analyst forecasts that the dividend will grow at 16% in the near term but will decline linearly to 6% long-term growth over the next 10 years. The analyst believes the required return on Weldon's stock is 9%. Based on the analysts estimates and using the H-model, determine Weldon's intrinsic value.