Deck 9: The Valuation of Common Stock

Question 1

A stock's price will tend to fall if
1. the firm's beta declines
2. the firm's beta increases
3. the risk-free rate declines
4. the risk-free rate increases

A)1 and 3
B)1 and 4
C)2 and 3
D)2 and 4

Answer 1

D

Question 2

The expected return depends on future dividends and future price appreciation.

Answer 2

True

Question 3

An increase in the risk-free rate will tend to decrease stock prices.

Answer 3

True

Question 4

The required return includes the risk-free rate and a risk premium.

Question 5

According to the efficient market hypothesis, purchasing low P/S stocks should produce superior investment results.

Question 6

The efficient market hypothesis suggests that the current prices of stocks reflect what the investment community believes the stocks are worth.

Question 7

The dividend-growth valuation model employs current dividends, future dividend growth, and the required return.

Question 8

The risk-adjusted required rate of return includes
1. the firm's earnings
2. the firm's beta coefficient
3. the treasury bill rate (i.e., the risk-free rate)

A)1 and 2
B)1 and 3
C)2 and 3
D)all of the above

Question 9

The dividend-growth model includes both the current and past years' dividends.

Question 10

According to the efficient market hypothesis, purchasing companies with high cash flow should produce superior investment results.

Question 11

The dividend-growth model requires that dividends grow annually at the same rate.

Question 12

A P/E ratio depends on
1. the firm's dividends
2. the price of the stock
3. the firm's per-share earnings

A)1 and 2
B)1 and 3
C)2 and 3
D)all of the above

Question 13

If the required rate of return is 10 percent and the stock pays a fixed $5 dividend, its value is

A)$100
B)$75
C)$50
D)$25

Question 14

A higher beta decreases the required rate of return.

Question 15

Value investors tend to prefer stocks with low price to sales and price to book ratios.

Question 16

The PEG ratio multiplies a stock's earnings, price, and growth rate.

Question 17

According to the dividend-growth model, the valuation of common stock depends on
1. the firm's dividends
2. investors' required rate of return
3. the prior year's dividends

A)1 and 2
B)1 and 3
C)2 and 3
D)all of the above

Question 18

According to the efficient market hypothesis, purchasing high P/E stock should not produce superior investment results.

Question 19

If the anticipated return exceeds the required rate of return, the investor should buy the stock.

Question 20

High P/E stocks should be preferred because they pay larger dividends.

Question 21

Investors may use P/E and price/sales ratios to value stocks. If this analysis is used, which of the following is desirable?

A)a high P/E and a low price/sales ratio
B)a high P/E and a high price/sales ratio
C)a low P/E and a low price/sales ratio
D)a low P/E and a high price/sales ratio

Question 22

If the financial markets were not efficient,

A)all investors would profit
B)prices indicate the proper valuation of securities
C)prices would adjust rapidly
D)an investor may consistently outperform the market

Question 23

As an investor you have a required rate of return of 14 percent for investments in risky stocks. You have analyzed three risky firms and must decide which (if any)to purchase. Your information is

a. What is your valuation of each stock using the dividend-growth model? Which (if any)should you buy?
b. If you bought Stock A, what is your implied rate of return?
c. If your required rate of return were 10 percent, what should be the price necessary to induce you to buy Stock A?

Question 24

Presently, Stock A pays a dividend of $2.00 a share, and you expect the dividend to grow rapidly for the next four years at 20 percent. Thus the dividend payments will be
       Year      Dividend
         1        $1.20
         2         1.44
         3         1.73
         4         2.07

After this initial period of super growth, the rate of increase in the dividend should decline to 8 percent. If you want to earn 12 percent on investments in common stock, what is the maximum you should pay for this stock?

Question 25

Higher required returns

A)decrease stock prices
B)are required by the efficient market hypothesis
C)increase dividends
D)are associated with higher dividends

Question 26

The price to sales ratio may be a preferred analytical tool if

A)the firm is not generating cash
B)the firm is not generating earnings
C)the P/E ratio is too high
D)the dividend-growth model suggests the stock is undervalued

Question 27

You know the following concerning a common stock:

If you want to earn 10 percent, should you buy this stock? What is the maximum price you should be willing to pay for the stock?

Question 28

If the ratio of price to book exceeds 1.0,

A)the stock is overvalued
B)the firm's assets are understated
C)the price of the stock is greater than the accounting value of the firm
D)the accounting value of the firm is greater than the market value of the firm

Question 29

Two stocks each pay a $1 dividend that is growing annually at 8 percent. Stock A has a beta of 1.3; stock B's beta is 0.8.

a. Which stock is more volatile?

b. If treasury bills yield 6 percent and you expect the market to rise by 12 percent, what is your risk-adjusted required rate of return?

c. Using the dividend-growth model, what is the maximum amount you would be willing to pay for each stock?

d. Why are your valuations different?

Question 30

If you purchase TrisCorp stock at $71 a share and the firm pays a $5.20 dividend which is expected to grow at 7.5 percent, what is the implied annual rate of return on the investment?

Question 31

The risk-free rate of return is 8 percent; the expected rate of return on the market is 12 percent. Stock X has a beta coefficient of 1.3, an earnings and dividend-growth rate of 7 percent, and a current dividend of $2.40. If the stock is selling for $35, what should you do?

Question 32

Your broker recommends that you purchase XYZ Inc. at $60. The stock pays a $2.40 dividend which (like its per-share earnings)is expected to grow annually at 8 percent. If you want to earn 12 percent on your funds, is this a good buy?

Question 33

A low price to sales ratio suggests

A)the firm is generating cash
B)the firm has no earnings
C)the stock valuation is too high
D)the stock may be undervalued

Question 34

The use of price to book ratios to select stocks suggests that

A)high price to book stocks are undervalued
B)low price to book stocks are overvalued
C)a stock should be purchased if it is selling near its historic high price to book ratio
D)a stock should be purchased if it is selling near its historic low price to book ratio

Question 35

The use of P/E ratios to select stocks suggests that

A)high P/E stocks should be purchased
B)low P/E ratio stocks are overvalued
C)a stock should be purchased if it is selling near its historic low P/E
D)a stock should be purchased if it is selling near its historic high P/E