Deck 7: Equity Valuation

Question 1

A bond and a preferred share_________________________

A)both have a fixed payment amount.
B)both have the same risk profile.
C)always have a maturity date.
D)are claims on the debt of the firm.

Answer 1

both have a fixed payment amount.

Question 2

Which of the following is NOT a true statement?

A)Common shareholders are the true owners of the corporation.
B)Common shareholders are the residual claimants of the corporation.
C)Common shareholders are entitled to the remaining assets before all other claims have been satisfied in the case of liquidation of the corporation.
D)Common shareholders have the right to vote on major issues, such as takeovers, corporate restructuring, and so on.

Answer 2

Common shareholders are entitled to the remaining assets before all other claims have been satisfied in the case of liquidation of the corporation.

Question 3

Which of the following is/are needed when the discounted cash flow approach is used to value equity securities?

A)Estimate the expected future cash flows associated with the security.
B)Determine the appropriate discount rate based on an estimate of the risk associated with the security.
C)Estimate the size and timing of the expected cash flows associated with the security.
D)All of these.

Answer 3

All of these.

Question 4

Which of the following is a FALSE statement about preferred shares?

A)Always have voting rights.
B)Dividends must be paid in their entirety before common shareholders may receive any dividends.
C)Have preference over common shares with respect to income and assets.
D)Provide the owner with a claim to a fixed amount of equity.

Question 5

If the required rate of return is higher than the dividend rate of a preferred share, the par value is _________________ the current market value of the preferred share.

A)equal to
B)higher than
C)less than
D)independent of

Question 6

Infinity Inc.has 750,000 preferred shares outstanding, which pay a dividend rate of 5.25%.Currently, the market value of these preferred shares is $22.5 million and the short-term government T-bills yield is 5.0%.What is the par or stated value of these shares if investors require a risk premium of 3.75%?

A)$7.14
B)$18.00
C)$30.00
D)$50.00

Question 7

The value of a share increases as:

A)the required rate of return decreases.
B)the required rate of return increases.
C)the dividend growth rate increases.
D)a and c are both correct.

Question 8

The value of a common share today depends on:

A)the industry analysts.
B)the expected future dividends and the discount rate.
C)the expected future common earnings per share.
D)the number of authorized shares.

Question 9

Ontario Transportation Inc.has issued $2.5 million in preferred shares with a par value of $25 each and an annual dividend rate of 10.0%.The market value of the preferred shares is ____________ if the required rate of return is 8.0%.

A)$3,125,000
B)$2,500,000
C)$2,000,000
D)$34,380,000

Question 10

Wild Berries Inc.'s preferred shares have a par value of $60 and are selling for $50.What is the required rate of return if the preferred shares pay an annual dividend of 6.0%?

A)5.00%
B)6.00%
C)7.2%
D)11.11%

Question 11

Determine the market price of a $50 par value preferred share that pays annual dividends based on a 4.0% dividend rate when the market rate is 5%?

A)$50
B)$40
C)$35
D)$60

Question 12

Which of the following is NOT a correct statement about equity securities?

A)No fixed maturity date.
B)Dividends are a tax-deductible expense for the issuer.
C)Shareholders pay lower taxes on dividends than they would on interest payments.
D)Ownership interests in an underlying entity.

Question 13

Montreal Growers Inc.issued 1 million preferred shares at a stated value of $20 and the dividend rate is 10%.If the risk-free rate is 4% and the risk premium is 3%, what is the preferred share price?

A)$50.00
B)$28.57
C)$35.00
D)$14.00

Question 14

In the case of bankruptcy and liquidation of assets, what is the order of the claimants?

A)Equity holders, debt holders, preferred shareholders
B)Debt holders, preferred shareholders, equity holders
C)Debt holders, equity holders, preferred shareholders
D)Debt holders, equity holders and preferred shareholders equally.

Question 15

Alpine Ski Equipment has 2 million preferred shares issued at a stated value of $40.The preferred shares are currently selling at $33.25 per share and the required rate is 8.42%.What is the dividend rate?

A)7.00%
B)8.42%
C)9.00%
D)10.13%

Question 16

The 1.2 million preferred shares of Mighty Machines Ltd., which pay a dividend rate of 6.5% on a stated value of $40, have a current market value of $42,000,000.What is the risk premium associated with these preferred shares if the risk-free rate is 4.25 %?

A)1.97%
B)2.25%
C)2.57%
D)3.18%

Question 17

Of the following, what are sources of uncertainty in the valuation of common equities?

A)Discount rate only
B)Cash flow size and timing only
C)Cash flow size, timing, and discount rate
D)Cash flow size, timing, and risk-free rate

Question 18

Traditional preferred shares

A)are often referred to as fixed-income investments.
B)have a maturity date.
C)pay dividends at irregular intervals.
D)pay dividends of various amounts.

Question 19

Use the following two statements to answer this question:
I.Dividends are a legal obligation of the firm.
II.Interest payments are a legal obligation of the firm only after the board of directors declares them.

A)I and II are correct.
B)I and II are incorrect.
C)I is correct, II is incorrect.
D)I is incorrect, II is correct.

Question 20

Determine the required rate of return on preferred shares that provide a $10 annual dividend if they are selling for $60?

A)17.14%
B)16.66%
C)15.66%
D)18.14%

Question 21

Use the following two statements to answer this question:
I.The Dividend Discount Model (DDM)assumes that common shares are valued according to the present value of their expected future dividends.
II.The DDM argues that the selling price at any point (say, time n)will equal the present value of all the expected future dividends from period n to infinity.

A)I is incorrect, II is correct.
B)I is correct, II is incorrect.
C)I and II are incorrect.
D)I and II are correct.

Question 22

The Dividend Discount Model (DDM)links common share prices to three important fundamentals: corporate profitability, the general level of interest rates, and risk.All else being equal, the DDM predicts that common share prices will be lower

A)when profits are high.
B)when interest rates are lower.
C)when risk premiums are lower.
D)None of the above

Question 23

The dividend growth rate for a stable firm can be estimated as:

A)retention ratio * the return on equity (ROE).
B)retention ratio / the return on equity (ROE).
C)retention ratio +the return on equity (ROE).
D)retention ratio - the return on equity (ROE).
E)none of the above

Question 24

How much would you pay for a common share today if you expect it will pay a dividend of $2.50 each year and will sell for $58 two years from now? Assume your required rate of return on this share is 13.0%.

A)$60.50
B)$55.50
C)$53.54
D)$49.59

Question 25

Which of the following is TRUE about the implicit assumption of the Dividend Discount Model (DDM)that "investors are rational"?
I.It assumes that at each period of time, investors react rationally and value the shares based on what they rationally expect to receive next year.
II.It rules out "speculative bubbles" or what is colloquially known as the "bigger fool theorem."

A)I is correct, II is incorrect.
B)I is incorrect, II is correct.
C)I and II are correct.
D)I and II are incorrect.

Question 26

You paid $20 for one common share of HyperTension Inc.today.What is the expected one-year holding period return if the share pays a $1.25 dividend and sells for $21.50 one year from now?

A)6.25%
B)7.50%
C)11.50%
D)13.75%

Question 27

Jack had an investment return of -24.0% on a share that he bought for $100 one year ago.For how much did Jack sell the share assuming he received a dividend of $1.75 during the year?

A)$72.75
B)$74.25
C)$76.00
D)$77.75

Question 28

Use the following two statements to answer this question:
I.There is no requirement that common shares pay dividends at all.
II.The level of dividend payment of common shares is discretionary.

A)I is incorrect, II is correct.
B)I is correct, II is incorrect.
C)I and II are incorrect.
D)I and II are correct.

Question 29

Which of the following statements is TRUE?

A)The only cash flows that an investor will receive until he or she sells their shares will be the dividends.
B)A firm's residual earnings technically belong to the preferred shareholders.
C)Corporations generally pay all their earnings as dividends.
D)Corporations typically reinvest none of their earnings to enhance future earnings.

Question 30

How much would you pay for a common share today, if you expect it will pay a dividend of $2.50 each year and will sell for $58 one year from now? Assume your required rate of return on this share is 13.0%.

A)$60.50
B)$55.50
C)$53.54
D)$49.59

Question 31

Manic Corporation issued 200,000 preferred shares with a book value of $10 million three years ago.If the required return is 8.42% and the current market value of these preferred shares is $9.5 million, what is the annual dividend?

A)$4.00
B)$4.71
C)$2.50
D)Cannot be calculated

Question 32

The 800,000 preferred shares of Fantastic Services have a total current market value of $9,192,000 and a book value of $10,000,000.What is the dividend rate if the risk-free rate is 3.15% and the risk premium is 3.65%?

A)7.40%
B)7.25%
C)6.80%
D)6.25%

Question 33

Manic Corporation issued 400,000 preferred shares with a book value of $10 million three years ago.The preferred shares pay an annual dividend of $2.What is the required return if the current market value of these preferred shares is $9.5 million?

A)8.42%
B)8.00%
C)5.26%
D)4.21%

Question 34

The current market value of the 500,000 preferred shares of Clumsy Sports Inc.is $25 million.If the shares pay a quarterly dividend of $1.25 on a stated value of $85 and the risk premium is 4.50%, what is the implied risk-free rate?

A)4.00%
B)4.50%
C)5.00%
D)5.50%

Question 35

The rate of return required by equity investors is estimated as:

A)dividend yield plus expected capital gains yield.
B)dividend yield minus expected capital gains yield.
C)dividend yield / expected capital gains yield.
D)none of the above.

Question 36

Which of the following is a FALSE statement about the Dividend Discount Model (DDM)?

A)It does not work well for firms that are non-cyclical in nature and often display steady growth in earnings and dividends.
B)It does not work well for firms in distress.
C)It does not work well for firms that are in the process of restructuring.
D)It does not work well for firms involved in acquisitions.

Question 37

Use the following two statements to answer this question:
I.A firm's sustainable growth rate decreases with higher profit margins, higher asset turnover, and higher debt.
II.A firm's sustainable growth rate can be estimated by multiplying the earnings retention ratio by the return on equity.

A)I is correct, II is incorrect.
B)I is incorrect, II is correct.
C)I and II are correct.
D)I and II are incorrect.

Question 38

Charlotte purchased a common share for $50 one year ago.She received $2.40 in dividends and then sold the share for $52.If the inflation rate over the year was 2.6%, her exact real rate of return is

A)6.04%
B)8.8%
C)11.4%
D)16.28%

Question 39

The current market value of the 500,000 preferred shares of Clumsy Sports Inc.is $25 million.If the shares pay an annual dividend of $5 on a par value of $85 and the risk-free rate is 5.5 %, what is the implied risk premium?

A)4.00%
B)4.50%
C)5.00%
D)5.50%

Question 40

Which of the following is NOT a correct statement of the Constant Growth DDM?

A)It holds only when growth in dividends is expected to occur at the same rate indefinitely.
B)It holds only when k_c < g.
C)It is a version of the dividend discount model for valuing common shares that assumes that dividends grow at a constant rate indefinitely.
D)Only future estimated cash flows and estimated growth in these cash flows are relevant.

Question 41

Prairies Oil Sands Inc.is expected to pay a dividend of $1 in one year.If the dividend growth rate is 2.0% indefinitely and the required rate of return is 10.0%, what should the share be sold for five years from now?

A)$13.53
B)$13.80
C)$14.08
D)$14.62

Question 42

Maple Drinks Corp.has just announced a dividend of $0.80 for this year and $0.835 for the next year.Dividends are expected to grow at a constant rate indefinitely.What is the current share price if the required return is 13.1%?

A)$7.12
B)$8.55
C)$9.35
D)$10.37

Question 43

Suppose Delightful Inc.'s present value of growth opportunities (PVGO)per share is $6 and its current share price is $18.What is the firm's required rate of return if its expected EPS is $2.25?

A)9.38%
B)12.16%
C)15.42%
D)18.75%

Question 44

Zigzag Corporation's common shares are currently selling for $22 per share.Zigzag's EPS is expected to be $2 next year, and the required rate of return is 12%.What is the present value of growth opportunities (PVGO)per share?

A)$ 5.33
B)$16.67
C)$20.00
D)$38.67

Question 45

The market value and book value of Visual Image Inc.'s outstanding 2 million common shares are $60 million and $30 million, respectively.The company's recent net profit was $3,500,000.What is the company's sustainable dividend growth rate if it uses a dividend payout ratio of 60.0%?

A)2.33%
B)3.50%
C)4.67%
D)7.00%

Question 46

Poutine Professionals Inc.has just paid a dividend of $0.55 per share.The dividends are expected to grow at an annual rate of 5.0% indefinitely.What is today's share price if the required return is 12.5%?

A)$4.62
B)$7.33
C)$7.70
D)$11.55

Question 47

Toronto Skates Inc.'s common shares are selling at $22.22 per share.Investors expect to receive a dividend of $1.80.The 90-day government T-bill yield is 4.3 %.What is the dividend growth rate if the risk premium on comparable companies is 6.2 %?

A)2.22%
B)2.40%
C)3.12%
D)3.54%

Question 48

The market value of Monteregie Corporation's 1 million outstanding common shares is $22.5 million.The firm is expected to have earnings of $1,750,000 next year.The 90-day government T-bill yields 3.75%.What is the present value of growth opportunities (PVGO)if the risk premium is 8.4%?

A)$ 1.67
B)$ 8.10
C)$14.40
D)$20.83

Question 49

DH Corporation had net earnings of $200,000 this past year and paid $80,000 in dividends on the company's equity of $1,800,000.What is the sustainable growth rate of this company?

A)6.67%
B)11.11%
C)4.44%
D)0%

Question 50

Lac Superior Enterprises has just paid a dividend of $1.05 and will pay $1.10 next year.Dividends are expected to grow at a constant rate indefinitely.What is the required rate of return if the share is selling for $30 today?

A)8.26%
B)8.43%
C)8.60%
D)8.92%

Question 51

BC Electrics Inc.pays a constant dividend of $2 every year.What will the share sell for three years from now if the required rate of return is 9.0%?

A)$22.22
B)$21.30
C)$25.70
D)$28.78

Question 52

Atlantic Fishing Ltd.common shares have just paid a dividend of $1.80 per share and are selling for $34.48 each.The firm expects its dividend to grow at a constant rate of 6.3% each year.What is the risk premium associated with the share if the risk-free rate is 4.25 %?

A)7.27%
B)7.60%
C)11.52%
D)11.85%

Question 53

BC Corporation has just paid a dividend of $2.20 per share on its common shares.Its dividend is expected to grow at a rate of 5% per year indefinitely.The current share price is $30 and the risk premium associated with this share is 8.7%.What is the implied risk-free rate?

A)3.63%
B)3.70%
C)4.00%
D)4.42%

Question 54

Toronto Skates Inc.is paying dividends on its common shares on a regular basis with a constant growth rate.The dividend last year was $1.00 and this year the dividend is $1.25.If the required rate of return is 12%, what is the current price of the common share?

A)$10.42
B)$8.33
C)5.00
D)Cannot be calculated

Question 55

The common shares of Atlantic Fishing Ltd.currently sell for $48 per share.The firm has a constant dividend growth rate of 6.0%.If the required rate of return is 15.0%, what is the expected dividend yield on the share?

A)6.00%
B)8.49%
C)9.00%
D)15.00%

Question 56

According to the Dividend Discount Model (DDM), if a firm increases its retention rate what happens to the firm's share price assuming no earnings growth?

A)The price will stay the same.
B)The price will increase.
C)The price will decrease.
D)Cannot be determined.

Question 57

Toronto Skates Inc.is offering a dividend of $1 next year and the share currently sells for $20 per share.If the required rate of return is 8.0%, what is the dividend growth rate?

A)5%
B)13%
C)3%
D)12.5%

Question 58

Analysts announced estimated dividends per share of $2 for the coming year for Toronto Skates Ltd.They expect dividends to grow at 4% forever.If the required rate of return is 7%, then the current share price is:

A)$50.00
B)$28.57
C)$87.50
D)$66.67

Question 59

The shares of Townships Ski Resorts Inc.just paid a dividend of $0.78.What are the expected capital gains yield if the share is selling for $28.25 today and the required rate of return is 15.0%?

A)13.62%
B)12.30%
C)11.91%
D)10.73%

Question 60

Gadgets Inc.just paid a dividend of $1.55.It expects its earnings and dividends to decline at a rate of 3.0% per year indefinitely.What is the value of the share today if the required return is 12.5%?

A)$9.70
B)$10.00
C)$16.32
D)$16.81

Question 61

Polar Express Corporation has just reported a net income of $400,000.It has 250,000 common shares outstanding with a book value of $2 million.The firm always maintain a retention ratio of 25%.What is the firm's price-earnings ratio if its required return is 10%?

A)5
B)10
C)15
D)20

Question 62

Suppose a firm has just reported an EPS of $2.50 and expects to maintain a dividend payout ratio of 40%.If the firm's price-earnings ratio is 9.3 and its return on equity is 12%, what is its required rate of return?

A)13.80%
B)11.5%
C)13.35%
D)12%

Question 63

Suppose a firm's price/earnings ratio is 12.It has just paid a dividend of $2 per share to maintain a 40% payout ratio.What is the firm's return on equity if its price is $65?

A)13.89%
B)20.83%
C)34.25%
D)38.89%

Question 64

Dream Homes Corporation had net earnings of $200,000 this past year and paid $80,000 in dividends on the company's equity of $1,800,000.Dream Homes had 500,000 shares outstanding throughout the entire fiscal year, with a current market value of $5 per share.What is the firm's present value of growth opportunities (PVGO)if the required rate of return is 10.08%?

A)$0.77
B)$0.84
C)$0.86
D)$0.90

Question 65

Macaroni Inc.announced that it would pay the following dividends over the next five years: $0.50, $0.75, $1.50, $3, and $4.Afterwards, dividends will decline at a rate of 3% per year indefinitely.What is the firm's current share price if the required rate of return is 13%?

A)$30.33
B)$24.25
C)$19.25
D)$17.73

Question 66

Suppose a firm's price/earnings ratio is 10.It expects to pay a dividend of $1.20 per share to maintain a 60% payout ratio.What is the firm's required return if its return on equity is 13.5%?

A)14.10%
B)13.20%
C)12.30%
D)11.40%

Question 67

Suppose a firm's price/earnings ratio is 16.It has just paid a dividend of $1.80 per share to maintain a 45% payout ratio.What is the firm's current market price if its return on equity is 12%?

A)$68.22
B)$67.46
C)$66.54
D)$65.78

Question 68

Which of the following statements is correct?

A)Companies with higher expected growth opportunities sell for a lower P/E ratio, assuming everything else is constant.
B)Companies with higher expected growth opportunities sell for a higher P/E ratio, assuming everything else is constant.
C)Need additional information.

Question 69

Which of the following statements is FALSE?

A)The higher the expected payout ratio, the higher the P/E.
B)The higher the expected growth rate, g, the higher the P/E.
C)The lower the required rate of return, k_c, the lower the P/E.
D)The relevant input is the expected earnings, not historical earnings.

Question 70

Which one of the following is NOT a fundamental factor that affects the P/E ratio directly?

A)Expected payout ratio
B)Required rate of return
C)Preferred shares dividend
D)Expected growth of dividend

Question 71

Suppose a firm has just reported an EPS of $2.50 and expects to maintain a dividend payout ratio of 40%.What is the firm's price-earnings ratio if its return on equity is 12% and the required return is 11.5%?

A)11.50
B)9.30
C)7.20
D)5.97

Question 72

MacLean Inc.currently pays no dividends.Today, the firm announced that it will pay its first dividend of $1 per share in four years, then $1.50 in each of the following three years, after which dividends are expected to grow at a constant rate of 5% per year.What is the share price today if the risk-free rate is 4% and the risk premium associated with this share is 6%?

A)$17.93
B)$19.45
C)$31.50
D)$34.73

Question 73

Which of the following is NOT true about the P/E ratio?

A)A comparison of one company with its peers also involves a great deal of subjectivity regarding company-specific characteristics.
B)P/E ratios only work well on companies in the high growth stage of their lifecycle.
C)P/E ratios are uninformative when companies have negative or very small earnings.
D)The volatile nature of earnings implies a great deal of volatility in P/E multiples.

Question 74

Nunavut Beach Resort has a net income of $330,000 on sales of $2,200,000.The firm has total assets of $1,600,000, a book value of shareholders equity of $1,200,000, and a dividend payout ratio of 65%.What is the current market value of their common shares if the required return is 21%?

A)$1.886 million
B)$2.067 million
C)$3.180 million
D)$8.091 million

Question 75

Junkies Corporation has just paid a dividend of $0.90.Dividends are expected to grow at 20% for years one and two, 15% for years three and four, 10% for years five and six, and 5% thereafter.What is the expected dividend for year 10 if the required return is 18%?

A)$2.40
B)$2.52
C)$2.65
D)$2.78

Question 76

Maniac Corporation just paid a dividend of $2 on its current EPS of $6.Its projected net profit margin, asset turnover, and leverage ratio are 12.5%, 2.5, and 0.6, respectively.What is Maniac's required rate of return if the current price is $34.60?

A)12.03%
B)12.39%
C)18.28%
D)19.00%

Question 77

Ontario Ice Corporation has an expected profit margin of 10%, turnover ratio of 3, and a leverage ratio of 0.50.The firm expects an EPS of $3 next year and maintains a retention ratio of 60%.What should the share sell for today if the required return is 15%?

A)$13.33
B)$20.00
C)$26.67
D)$30.00

Question 78

VIP Corporation has just paid a dividend of $1.50.Dividends are expected to grow at 20% for the first three years and 10% for the following two years.What is the expected growth rate for the subsequent years, assuming that the rate would be constant for all subsequent years if the share is selling for $24.86 today and the required return is 17%?

A)-1.07%
B)-1.75%
C)8.00%
D)8.65%

Question 79

Which one of the following is a limitation of the P/E ratio?

A)Easy way to estimate the price of a firm
B)It compares the performance of shares
C)Ignores the magnitude or the sign of the earnings
D)One of the most widely used relative pricing methods

Question 80

Price-earnings (P/E)ratios can be estimated using which of the following?
I.The required rate of return
II.The expected growth rate of dividends
III.The retention ratio

A)I and II only
B)II and III only
C)I and III only
D)I, II, and III