Deck 8: Share Valuation

Question 1

Which one of the following is most likely to increase the price of a share?

A) Rapid growth in sales.
B) Rapid growth in dividends.
C) Rapid increases in bond interest rates.
D) Rapid growth in earnings.

Answer 1

D

Question 2

Over the last year, a firm's earnings per share increased from $1.20 to $1.40, its dividends per share increased from $0.50 to $0.60, and its share price increased from $21 to $24. The firm maintained a relative P/E of 1.10 over the entire time period. Given this information, it follows that the

A) shares experienced an increase in its P/E ratio.
B) overall market P/E is declining.
C) current P/E of the overall market is 26.4.
D) company had a decrease in its dividend payout ratio.

Answer 2

B

Question 3

Which of the following contributes to high P/E ratios?

A) Periods of high inflation.
B) High dividend payout ratios.
C) High debt ratios.
D) High rate of earnings growth.

Answer 3

D

Question 4

The single most important variable in the dividends- and- earnings approach is the

A) applicable beta.
B) amount of the future dividends.
C) appropriate P/E multiple.
D) rate of growth.

Question 5

The intrinsic value of a share provides a purchase price for the share

A) that is reasonable given the associated level of risk.
B) which will assuredly yield the anticipated capital gain.
C) that is always below the market value but yet yields the expected rate of return.
D) which will guarantee the expected rate of return.

Question 6

A company has an annual dividend growth rate of 5% and a retention rate of 40%. The company's dividend payout ratio is

A) 45%.
B) 35%.
C) 40%.
D) 60%.

Question 7

Stephanie is an investor who believes that the real key to a company's future share price lies in its future earnings. When investing in a company, she carefully studies its future earnings potential, and sells a company's share at the first sign of any trouble. This information indicates that Stephanie would correctly be classified as

A) a growth investor.
B) a buy- and- hold investor.
C) an index investor.
D) a value investor.

Question 8

Which of the following will most directly influence a company's market value?

A) The book value of its assets.
B) The use of financial leverage.
C) Its future cash flows.
D) The state of the economy.

Question 9

Even if a company does not officially follow a fixed- dividend policy, dividend payments are

A) directly tied to a company's P/E ratio.
B) fairly stable from one time period to another.
C) extremely difficult to predict.
D) very volatile and subject to economic conditions.

Question 10

The dividends- and- earnings (D&E) approach to share valuation and the variable- growth DVM approach are similar in that both approaches

A) use the historical dividend growth rate as the key input figure.
B) consider the future selling price of the share but ignore future dividends.
C) consider dividends only and ignore the future selling price of the share.
D) are present- value based.

Question 11

The ordinary shares of Jennifer's Furniture Outlet is currently selling at $32.60 a share. The company adheres to a 60% dividend payout ratio and has a P/E ratio of 19. There are 21,000 shares of stock outstanding. What is the amount of the annual net income for the firm?

A) $21,619
B) $48,327
C) $60,053
D) $36,032

Question 12

A firm with a price- to- sales ratio of 1 would usually be considered

A) undervalued.
B) overvalued.
C) near bankruptcy.
D) correctly valued.

Question 13

Markhem Enterprises is expected to earn $1.34 per share this year. The company has a dividend payout ratio of 40% and a P/E ratio of 18. What should the shares of ordinary shares in Markhem Enterprises be selling for in the market?

A) $14.47
B) $24.12
C) $33.77
D) $9.65

Question 14

The Highlight Company has a book value of $56.50 per share, and is currently trading at a price of $59.00 per share. You are interested in investing in Highlight, and have just used a present- value based share valuation model to calculate a present (intrinsic) value of $55.00 per share. Assuming that your calculations are correct you should

A) buy the share, because the book value and the current trading price are very close to one another in value.
B) not buy the share, because the present value is less than the market price per share.
C) buy the share, because the current market price per share is higher than the present value.
D) buy the share, because the book value per share is greater than the present value.

Question 15

Winifred, Inc. paid $1.64 as an annual dividend per share last year. The company is expected to increase their annual dividends by 3% each year. How much should you pay to purchase one share of this stock if you require a 9% rate of return on this investment?

A) $27.33
B) $18.22
C) $18.77
D) $28.15

Question 16

Which one of the following is a correct equation to calculate earnings per share?

A) (ROA)(book value per share)
B) (profit margin)(equity multiplier)(book value per share)
C) (profit margin)(total asset turnover)(equity multiplier)(book value per share)
D) (profit margin)(book value per share)

Question 17

A company that wants to maintain both a constant-growth rate in dividends and a constant payout ratio will have to

A) increase assets at the same rate as dividends.
B) grow earnings faster than dividends.
C) increase shareholders' equity at the same rate as dividends.
D) grow earnings at the same rate as dividends.

Question 18

When using the constant- growth dividend valuation model, which of the following will lower the value of the share?

A) An increase in the required rate of return.
B) A decrease in the required rate of return.
C) An increase in the growth rate of the dividends.
D) An increase in the dividend payout ratio.

Question 19

The price- to- cash- flow method of share valuation generally

A) uses EBITDA as the cash flow value.
B) applies the P/E multiple to the cash flow per share value.
C) produces a cash flow multiple that is greater than the P/E multiple.
D) relies on historical cash flows.

Question 20

P/E ratios could rise even as earnings fall if

A) earnings fall at a faster rate than share prices.
B) investors expect lower share prices to be permanent.
C) earnings fall at a slower rate than share prices.
D) investors expect lower earnings to be permanent.

Question 21

Zephyr Inc. sells wind based systems for generating electricity. The company pays no dividends, but you estimate the share will be worth $50 per share 5 years from now and you require a 15% rate of return for share investments of this type. What price should you be willing to pay for this share?

A) $57.50
B) $24.86
C) $12.50
D) $43.48

Question 22

If the market multiple is 23.0 and the P/E ratio of a company is 27.4, then the share's relative P/E is

A) 3.21.
B) 4.40.
C) 1.19.
D) 0.84.

Question 23

Michelak's Maritime Industries has relatively stable earnings and pays an annual dividend of $2.50 per share. This dividend has remained constant over the past few years and is expected to remain constant for some time to come. If you want to earn 12% on an investment in the company's shares, how much should you pay to purchase each share?

A) $20.83
B) $25.00
C) $18.88
D) $12.50

Question 24

The single most important issue in the share valuation process is a company's

A) historic dividend growth rate.
B) expected future returns.
C) capital structure.
D) past earnings record.

Question 25

What is the required rate of return on a ordinary share that is expected to pay a $0.75 annual dividend next year if dividends are expected to grow at 2 percent annually and the current share price is $8.59?

A) 8.73%.
B) 8.91%.
C) 11.38%.
D) 10.73%.

Question 26

Martin's Inc. is expected to pay annual dividends of $2.50 a share for the next three years. After that, dividends are expected to increase by 3% annually. What is the current value of this share to you if you require a 9% rate of return on this investment?

A) $42.92
B) $40.11
C) $41.81
D) $39.47

Question 27

The value of a share is a function of

A) past returns.
B) historic dividend growth rate.
C) future returns.
D) most recent earnings per share.

Question 28

One share valuation model holds that the value of a share is a function of its future dividends, and that the dividends will increase at an annual rate which will remain unchanged over time. This share valuation model is known as the

A) constant- growth dividend valuation model.
B) dividend reinvestment model.
C) holding period return model.
D) approximate yield model.

Question 29

An internal rate of return (IRR) is the discount rate that

A) produces a present value of future benefits equal to the market price of a share.
B) is the minimal rate of return an investor will accept.
C) provides an investor with their required return.
D) represents the minimal rate required to create a positive net present value.

Question 30

The current annual sales of Flower Bud, Inc. are $178,000. Sales are expected to increase by 4% next year. The company has a net profit margin of 5% which is expected to remain constant for the next couple of years. There are 10,000 shares outstanding. The market multiple is 16.4 and the relative P/E of the firm is 1.21. What is the expected market price per share for next year?

A) $19.29
B) $18.37
C) $17.66
D) $15.18

Question 31

The major forces behind earnings per share are

A) return on assets and total asset turnover.
B) return on equity and the equity multiplier.
C) return on equity and book value.
D) return on assets and book value.

Question 32

James is willing to settle for a 10% rate of return on EG shares at a time when investors, on average, are requiring an 11% rate of return on the same shares. Which of the following will happen?

A) James will be have to pay more for the shares than he was willing to pay.
B) James will be happy to buy the shares for less than he was willing to pay.
C) Investors with different required rates of return will pay different prices for the shares.
D) James will not be able to buy the shares unless the price changes.

Question 33

The Frisco Company just paid $2.20 as its annual dividend. The dividends have been increasing at a rate of 4% annually and this trend is expected to continue. The share is currently selling for $63.60 a share. What is the rate of return on this share?

A) 7.60%.
B) 3.60%.
C) 3.46%.
D) 7.46%.

Question 34

William is the type of share market investor who focuses on factors such as a company's book value, debt load, return on equity, and cash flow. In searching for share investments, he looks at a company's historical performance and attempts to find undervalued shares. This information indicates that William is the type of investor known as

A) a value investor.
B) a growth investor.
C) a premium investor.
D) an earnings investor.

Question 35

The Merry Co. has current annual sales of $350,000 and a net profit margin of 6%. Sales are expected to increase by 5% annually while the profit margin is expected to remain constant. What is the projected after- tax earnings for two years from now?

A) $23,100
B) $23,153
C) $19,294
D) $22,050

Question 36

GLOO stock's P/E ratio is 45 at a time when the market's P/E ratio is 15. GLOO's realtive P/E ratio is

A) - 30.
B) 3.
C) 30.
D) )33.

Question 37

In applying the variable- growth dividend valuation model to a company's share, analysts frequently define the growth rate, g, as equal to

A) ROE divided by the dividend payout ratio.
B) ROE multiplied by the firm's retention rate.
C) the dividend payout ratio multiplied by the firm's retention rate.
D) P/E multiplied by the dividend payout ratio.

Question 38

ABC Company share currently has a market value equivalent to its intrinsic value. Marco perceives that ABC Company is increasing its level of risk and therefore Marco increases his required rate of return on ABC share. This change in the required rate of return

A) will change the intrinsic value but the direction of the change cannot be determined.
B) will reduce the intrinsic value of ABC share to Marco.
C) is a signal to Marco that he should buy more ABC Company share.
D) will increase the intrinsic value of ABC share to Marco.

Question 39

The constant- growth dividend valuation model is best suited for use with

A) small- cap shares within growing industries.
B) shares of new or emerging companies.
C) the shares of mature, dividend- paying companies.
D) the shares of cyclical companies.

Question 40

One common method of estimating the growth rate of dividends is to

A) multiply the return on equity by the dividend payout ratio.
B) randomly assign an annual growth rate of 4% to the latest dividend amount.
C) multiply the return on equity by the firm's retention rate.
D) multiply the return on assets by the dividend payout ratio.

Question 41

In the price/earnings approach to share valuation,

A) the P/E ratio is computed by multiplying the share price by the earnings per share.
B) the market P/E ratio, adjusted by beta, is used to value individual shares.
C) forecasted EPS are typically used.
D) historical share prices are utilised.

Question 42

EBITDA is an acronym for

A) Earnings Based Information, Total Development Approach.
B) Earnings Before Interest, Taxes, Dividends, and Asset replacement.
C) Earnings Before Interest, Taxes, Depreciation, and Amortisation.
D) Ernst, Bostwick, Davenport, Innes Approach.

Question 43

According to the price/earnings approach to share valuation, if the dividend growth rate is expected to drop or if the required return goes up, the net effect is a

A) higher P/E ratio.
B) higher share price.
C) lower P/E ratio.
D) higher retention rate.

Question 44

A share's internal rate of return (IRR) is the discount rate that cause the present value of future dividends to equal the price of the share.

Question 45

In general, the higher the retention ratio

A) the lower the future book value per share.
B) the higher the future growth rate of the company.
C) the higher the dividends per share of ordinary share.
D) the higher the future debt- equity ratio.

Question 46

Ivonne has bought shares of RIO, Inc. for $25.00 per share. She expects a $1.00 dividend at the end of this year. After 2 years, she expects to receive a dividend of $1.25 and to sell the share for $28.75. What is Ivonne's required rate of return?

A) 24.0%.
B) 15.2%.
C) 4.0%.
D) 11.6%.

Question 47

The dividend valuation model (DVM) is very sensitive to the growth rate (g) being used, because it affects both the model's numerator and its denominator.

Question 48

The dividend valuation model estimates the value of a share as the future value of all dividends.

Question 49

Higher rates of growth and lower debt levels contribute to higher P/E ratios.

Question 50

The risk-free rate is 2%. The expected rate of return on the market is 12%. Beta and the expected rate of return for four shares are as follows.: ABC .8, 10%; DEF 1, 12%; GHI 1.2, 13%, and JKL 2, 22%. Which of these shares should not be purchased?

A) GHI.
B) JKL.
C) DEF.
D) ABC.

Question 51

Newton, Inc. just paid an annual dividend of $0.95. Their dividends are expected to increase by 4% annually. Newton Company share is selling for $11.54 a share. What is the capitalisation rate on this share?

A) 12.2%.
B) 13.9%.
C) 8.23%.
D) 12.6%.

Question 52

Lindell, Inc. has 8%, $100 par value preference shares outstanding. To earn 12% on an investment in this share, you need to purchase the shares at a per share price of

A) $66.67.
B) $150.00.
C) $9.60.
D) $96.00.

Question 53

For which one of the following situations will the price- to- sales valuation model work but the dividend and cash flow models will not?

A) Top- performing firm in a mature industry.
B) Newly- formed biotechnology company with negative earnings.
C) Water- powered electric utility company.
D) Mature firm with minimal growth opportunities.

Question 54

The variable- growth dividend valuation model

A) assumes the rate of dividend growth will vary indefinitely.
B) is valuable because it accounts for the general growth patterns of most companies.
C) develops the value of a share using the future value of dividends minus a rate of capital gain growth.
D) is invalid if at any point in time the growth rate exceeds the required rate of return.

Question 55

The estimated price of a share in the future is important because it includes the projected capital gain on the share.

Question 56

The risk- free rate of return is 4.2 percent, the expected market return is 9 percent, and the beta for Lea, Inc. is 1.12. What is Lea's required rate of return?

A) 13.70%.
B) 9.58%.
C) 14.28%.
D) 10.08%.

Question 57

Which of the following approaches to share valuation is not based on a multiple of some figure from the financial statements?

A) The price to earnings approach.
B) The price-to-cash-flow approach.
C) The price-to-sales approach.
D) The dividends- and- earnings approach.

Question 58

There is no assurance that the actual rate of return on an asset will be similar to the projected rate of return.

Question 59

High P/E ratios can be expected when investors expect

A) high interest rates.
B) a high rate of growth in earnings.
C) a bear market.
D) low earnings. relative to market prices.

Question 60

An investor should purchase a share when

A) the market price is greater than the justified price.
B) the expected rate of return equals or exceeds the required return.
C) the capital gains rate is less than the required return and no dividends are paid.
D) the market price exceeds the intrinsic value.

Question 61

A relative P/E ratio greater than 1 indicates that a company may be undervalued.

Question 62

Risk is brought into the share valuation process through the required rate of return.

Question 63

A temporary decline in earnings per share usually results in a temporary reduction of dividends.

Question 64

As a company's beta rises, the required return on the share should fall, all other things being equal.

Question 65

The price of a share with a low relative P/E will tend to be more volatile than the price of a share with a high relative P/E.

Question 66

Companies with high P/E ratios tend to also have high dividend payout ratios.

Question 67

When an investor multiplies future estimated earnings per share by a price/earnings ratio to compute the value of a share that investor is using the price/earnings approach to valuation.

Question 68

If net income rises, but the number of shares outstanding remains the same, EPS will rise.

Question 69

If the annual dividend on a share never changes, its price will never change.

Question 70

A drawback to the price- to- cash- flow method of valuation is that there is no generally accepted cash flow measure.

Question 71

The P/E approach is too complicated to be widely used in practice.

Question 72

The rate of dividend growth can be estimated by multiplying the return on equity rate by the dividend payout ratio.

Question 73

One method of estimating the dividend growth rate is to calculate the discount rate that equates today's dividend with the dividend paid ten years ago.

Question 74

Generally speaking, the higher the price- to- sales ratio, the better.

Question 75

The key to the future behaviour of a company lies in the sales growth and the net profit margin.

Question 76

The approach to share valuation which holds that the value of a share is a function of its future dividends is known as the dividend valuation model (DVM).

Question 77

The primary reason an investor should look at the past performance of a company is to gain insight into the future direction and profitability of the firm.

Question 78

One of the easiest aspects of the dividend valuation model (DVM) is specifying the appropriate growth rate for a firm's dividends over time.

Question 79

High price/sales multiples go with high profit margins.

Question 80

The common- size income statement expresses every item on the income statement as a percentage of sales.