Deck 8: Stock Valuation

Question 1

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

Answer 1

True

Question 2

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

Answer 2

False

Question 3

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

Answer 3

True

Question 4

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

Question 5

List the key variables that affect the P/E ratio and explain the relationship between each variable and the P/E ratio.

Question 6

P/E ratios could rise even as earnings fall if

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

Question 7

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

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

Question 8

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

Question 9

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

Question 10

Which of the following contributes to high P/E ratios

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

Question 11

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

Question 12

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

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

Question 13

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

Question 14

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 15

High P/E ratios can be expected when investors expect

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

Question 16

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

Question 17

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

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

Question 18

The value of a stock is a function of

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

Question 19

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

Question 20

Which of the following variables affect the P/E ratio?
I)capital structure of a firm
II)amount of dividends paid
III)inflation rate
IV)earnings rate of growth

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

Question 21

The greater the perceived risk of an asset, the lower the expected rate of return.

Question 22

The intrinsic value of an asset equals the present value of all future cash flows at a given discount rate.

Question 23

Which of the following are key inputs to determining the value of an asset?
I)the required rate of return
II)future cash flows
III)current stock price
IV)timing of future cash flows

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

Question 24

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

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

Question 25

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

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

Question 26

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

Question 27

The major forces behind earnings per share are

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

Question 28

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

Question 29

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

Question 30

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

Question 31

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

Question 32

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 of common stock 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 of common stock for next year?

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

Question 33

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

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

Question 34

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

Question 35

Whisper numbers are

A) officially published forecast numbers provided by company management.
B) the official released estimates prepared by financial analysts.
C) generally less accurate than the released estimates by analysts.
D) generally higher than the released analysts' forecasts.

Question 36

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 stocks are as follows.: ABC .8 , 10%; DEF 1, 12%; GHI 1.2 , 13%, and JKL 2, 22%.Which of these stocks should not be purchased?

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

Question 37

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

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

Question 38

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 one share of common stock in Markhem Enterprises be selling for in the market?

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

Question 39

The common stock 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) $36,032
C) $48,327
D) $60,053

Question 40

The required rate of return denotes the minimum rate of return an investor should expect.

Question 41

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

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

Question 42

An investor should purchase a stock when

A) the market price exceeds the intrinsic value.
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 is greater than the justified price.

Question 43

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 common stock of Michelak's, how much should you pay to purchase each share of stock?

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

Question 44

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 45

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

Question 46

The subjective approach to determining a required rate of return for a stock includes
I)the rate of return on a long-term bond.
II)a risk premium for the perceived business risk of the asset.
III)a risk premium for assuming the risk of the market.
IV)the desired rate of return of the individual investor.

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

Question 47

Overall, professional analysts have an outstanding record of predicting changes in market direction before they happen.

Question 48

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

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

Question 49

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

Question 50

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

Question 51

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

Question 52

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

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

Question 53

The intrinsic value of a zero-growth stock is simply the capitalized value of its annual dividends.

Question 54

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 55

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

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

Question 56

Which of the following characteristics appeal to so-called value investors?
I)high P/E ratios.
II)low debt to equity ratios
III)high cash flow relative to price
IV)high book value relative to market price.

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

Question 57

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 58

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

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

Question 59

Explain how the time value of money concept is used in stock valuation.

Question 60

The rate of growth can exceed the required return during the variable-growth period without invalidating the variable growth dividend valuation model.

Question 61

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

Question 62

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 stock is currently selling for $63.60 a share.What is the rate of return on this stock?

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

Question 63

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

Question 64

WaterCo is a manufacturer of boat parts and has been in business only a few years.Its board of directors decided to start paying a dividend to help boost the attractiveness of its stock.The dividend will be $0.50 per share next year.After that dividends will increase by 4 percent per year.The company has a beta of 1.6.The market rate of return is 8% and the T-bill rate is 3%.Should you purchase shares in this firm at the current market price of $6.98 per share?

Question 65

The variable-growth dividend valuation model

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

Question 66

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 stock to you if you require a 9% rate of return on this investment?

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

Question 67

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

Question 68

ABC Company stock 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 stock.This change in the required rate of return

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

Question 69

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

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

Question 70

Neither the P/E approach nor the dividends-and-earnings approach rely on dividends as the key input into the valuation of a stock.

Question 71

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

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

Question 72

In general, the higher the retention ratio

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

Question 73

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

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

Question 74

What is the required rate of return on a common stock 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 stock price is $8.59?

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

Question 75

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

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

Question 76

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

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

Question 77

Which of the following statements concerning the constant-growth dividend valuation model is (are)correct?
I)One simple method of estimating the dividend growth rate is to analyze the historical pattern of dividends.
II)The expected total return equals the return from capital gains plus the return from dividends paid.
III)The model is applicable to growth firms with initially high growth rates.
IV)The intrinsic value calculated using this method can change from one investor to another if their risk-return payoffs differ.

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

Question 78

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

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

Question 79

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

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

Question 80

The common stock of Peachtree Paper, Inc., is currently selling for $40 a share.A dividend of $2.00 per share was just paid.You are estimating that this dividend will grow at a constant rate of 10%.
(a)Using the constant growth DVM model, what is your required rate of return if $40 is a reasonable trading price? (Show all work.)
(b)If Peachtree Papers is a new company that produces a relatively unknown product, is the constant growth model a good valuation method for a potential investor to use? Justify your answer.