Deck 13: Equity Valuation

Question 1

Stockholders of Dog's R Us Pet Supply expect a 12% rate of return on their stock.Management has consistently been generating a ROE of 15% over the last 5 years but now believes that ROE will be 12% for the next five years.Given this the firm's optimal dividend payout ratio is now ______.

A) 0%
B) 100%
C) between 0% and 50%
D) between 50% and 100%

Answer 1

B

Question 2

A firm cuts its dividend payout ratio.As a result you know that the firm's _______.

A) return on assets will increase
B) earnings retention ratio will increase
C) earnings growth rate will fall
D) stock price will fall

Answer 2

B

Question 3

A stock has an intrinsic value of $15 and an actual stock price of $13.50.You know that this stock ________.

A) has a Tobin's Q value < 1
B) will generate a positive alpha
C) has an expected return less than its required return
D) has a beta > 1

Answer 3

B

Question 4

If a firm increases its plowback ratio this will probably result in a(n)_______ P/E ratio.

A) higher
B) lower
C) unchanged
D) unable to determine

Question 5

The value of internet companies is based primarily on _____.

A) current profits
B) Tobin's q
C) growth opportunities
D) replacement cost

Question 6

The price-to-sales ratio is probably most useful for firms in which phase of the industry life cycle?

A) Start up phase
B) Consolidation
C) Maturity
D) Relative decline

Question 7

The accounting measure of a firm's equity value generated by applying accounting principles to asset and liability acquisitions is called ________.

A) book value
B) market value
C) liquidation value
D) Tobin's q

Question 8

P/E ratios tend to be _______ when inflation is ______.

A) higher; higher
B) lower; lower
C) higher; lower
D) they are unrelated

Question 9

The constant growth dividend discount model (DDM)can be used only when the ___________.

A) growth rate is less than or equal to the required return
B) growth rate is greater than or equal to the required return
C) growth rate is less than the required return
D) growth rate is greater than the required return

Question 10

New-economy companies generally have higher _______ than old-economy companies.

A) book value per share
B) P/E multiples
C) profits
D) asset values

Question 11

Bill,Jim and Shelly are all looking to buy the same stock that pays dividends.Bill plans on holding the stock for one year.Jim plans on holding the stock for three years.Shelly plans on holding the stock until she retires in 10 years.Which one of the following statements is correct?

A) Bill will be willing to pay the most for the stock because he will get his money back in one year when he sells.
B) Jim should be willing to pay three times as much for the stock as Bill because his expected holding period is three times as long as Bill's.
C) Shelly should be willing to pay the most for the stock because she will hold it the longest and hence she will get the most dividends.
D) All three should be willing to pay the same amount for the stock regardless of their holding period.

Question 12

A firm has current assets which could be sold for their book value of $10 million.The book value of its fixed assets is $60 million but they could be sold for $95 million today.The firm has total debt at a book value of $40 million but interest rate changes have increased the value of the debt to a current market value of $50 million.This firm's market to book ratio is ________.

A) 1.83
B) 1.50
C) 1.35
D) 1.46

Question 13

Which one of the following is a common term for the market consensus value of the required return on a stock?

A) Dividend payout ratio
B) Intrinsic value
C) Market capitalization rate
D) Plowback ratio

Question 14

Which one of the following is equal to the ratio of common shareholders' equity to common shares outstanding?

A) Book value per share
B) Liquidation value per share
C) Market value per share
D) Tobin's Q

Question 15

If a stock is correctly priced then you know that ____________.

A) the dividend payout ratio is optimal
B) the stock's required return is equal to the growth rate in earnings and dividends
C) the sum of the stock's expected capital gain and dividend yield is equal to the stock's required rate of return
D) the present value of growth opportunities is equal to the value of assets in place

Question 16

A firm that has an ROE of 12% is considering cutting its dividend payout.The stockholders of the firm desire a dividend yield of 4% and a capital gain yield of 9%.Given this information which of the following statement(s)is/are correct?
I)All else equal the firm's growth rate will accelerate after the payout change
II)All else equal the firm's stock price will go up after the payout change
III)All else equal the firm's P/E ratio will increase after the payout change

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

Question 17

Which one of the following statements about market and book value is correct?

A) All firms sell at a market to book ratio above 1.
B) All firms sell at a market to book ratio greater than or equal to 1.
C) All firms sell at a market to book ratio below 1.
D) Most firms have a market to book ratio above 1, but not all.

Question 18

An underpriced stock provides an expected return which is ____________ the required return based on the capital asset pricing model (CAPM).

A) less than
B) equal to
C) greater than
D) greater than or equal to

Question 19

__________ is the amount of money per common share that could be realized by breaking up the firm,selling its assets,repaying its debt,and distributing the remainder to shareholders.

A) Book value per share
B) Liquidation value per share
C) Market value per share
D) Tobin's Q

Question 20

Earnings yields tend to _______ when Treasury yields fall.

A) fall
B) rise
C) remain unchanged
D) fluctuate wildly

Question 21

Firm A is high risk and Firm B is low risk.Everything else equal,which firm would you expect to have a higher P/E ratio?

A) Firm A
B) Firm B
C) Both would have the same P/E if they were in the same industry
D) There is not any necessary linkage between risk and P/E ratios

Question 22

Suppose that in 2009 the expected dividends of the stocks in a broad market index equaled $240 million when the discount rate was 8% and the expected growth rate of the dividends equaled 6%.Using the constant growth formula for valuation,if interest rates increase to 9% the value of the market will change by _____.

A) -10%
B) -20%
C) -25%
D) -33%

Question 23

Flanders,Inc.has expected earnings of $4 per share for next year.The firm's ROE is 8% and its earnings retention ratio is 40%.If the firm's market capitalization rate is 15%,what is the present value of its growth opportunities?

A) -$6.33
B) $0
C) $20.34
D) $26.67

Question 24

A firm is planning on paying its first dividend of $2 after two years.Then dividends are expected to grow at 6% per year indefinitely.The stock's required return is 14%.What is the intrinsic value of a share today?

A) $25.00
B) $16.87
C) $19.24
D) $20.99

Question 25

Weyerhaeuser Incorporated has a balance sheet which lists $70 million in assets,$45 million in liabilities and $25 million in common shareholders' equity.It has 1,000,000 common shares outstanding.The replacement cost of its assets is $85 million.Its share price in the market is $49.Its book value per share is _________.

A) $16.67
B) $25.00
C) $37.50
D) $40.83

Question 26

The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%.Its expected ROE is 12% and its expected EPS is $5.00.If the firm's plow-back ratio is 60%,its P/E ratio will be _________.

A) 7.14
B) 14.29
C) 16.67
D) 22.22

Question 27

Rose Hill Trading Company is expected to have EPS in the upcoming year of $6.00.The expected ROE is 18.0%.An appropriate required return on the stock is 14%.If the firm has a plowback ratio of 70%,its intrinsic value should be _________.

A) $20.93
B) $69.77
C) $128.57
D) $150.00

Question 28

Rose Hill Trading Company is expected to have EPS in the upcoming year of $8.00.The expected ROE is 18.0%.An appropriate required return on the stock is 14%.If the firm has a plowback ratio of 70%,its dividend in the upcoming year should be _________.

A) $1.12
B) $1.44
C) $2.40
D) $5.60

Question 29

Annie's Donut Shops,Inc.has expected earnings of $3.00 per share for next year.The firm's ROE is 18% and its earnings retention ratio is 60%.If the firm's market capitalization rate is 12%,what is the value of the firm excluding any growth opportunities?

A) $25.00
B) $50.00
C) $83.33
D) $208

Question 30

Grott and Perrin,Inc.has expected earnings of $3 per share for next year.The firm's ROE is 20% and its earnings retention ratio is 70%.If the firm's market capitalization rate is 15%,what is the present value of its growth opportunities?

A) $20
B) $70
C) $90
D) $115

Question 31

The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%.Its expected ROE is 12% and its expected EPS is $5.00.If the firm's plow-back ratio is 50%,its P/E ratio will be _________.

A) 8.33
B) 12.50
C) 19.23
D) 24.15

Question 32

A preferred share of Coquihalla Corporation will pay a dividend of $8.00 in the upcoming year,and every year thereafter,i.e.,dividends are not expected to grow.You require a return of 7% on this stock.Using the constant growth DDM to calculate the intrinsic value,a preferred share of Coquihalla Corporation is worth _________.

A) $13.50
B) $45.50
C) $91.00
D) $114.29

Question 33

Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming year.Dividends are expected to grow at 8% per year.The riskfree rate of return is 4% and the expected return on the market portfolio is 14%.Investors use the CAPM to compute the market capitalization rate,and the constant growth DDM to determine the value of the stock.The stock's current price is $84.00.Using the constant growth DDM,the market capitalization rate is _________.

A) 9%
B) 12%
C) 14%
D) 18%

Question 34

You are considering acquiring a common share of Sahali Shopping Center Corporation that you would like to hold for one year.You expect to receive both $1.25 in dividends and $35 from the sale of the share at the end of the year.The maximum price you would pay for a share today is __________ if you wanted to earn a 12% return.

A) $31.25
B) $32.37
C) $38.47
D) $41.32

Question 35

Eagle Brand Arrowheads has expected earnings of $1.25 per share and a market capitalization rate of 12%.Earnings are expected to grow at 5% per year indefinitely.The firm has a 40% plowback ratio.By how much does the firm's ROE exceed the market capitalization rate?

A) 0.5%
B) 1.0%
C) 1.5%
D) 2.0%

Question 36

Brevik Builders has an expected ROE of 25%.Its dividend growth rate will be __________ if it follows a policy of paying 30% of earning in the form of dividends.

A) 5.0%
B) 15.0%
C) 17.5%
D) 45.0%

Question 37

Gagliardi Way Corporation has an expected ROE of 15%.If it pays out 30% of it earnings as dividends,its dividend growth rate will be _____.

A) 4.5%
B) 10.5%
C) 15.0%
D) 30.0%

Question 38

Each of two stocks,A and B,are expected to pay a dividend of $7 in the upcoming year.The expected growth rate of dividends is 6% for both stocks.You require a return of 10% on stock A and a return of 12% on stock

A) will be higher than the intrinsic value of stock B
B) Using the constant growth DDM, the intrinsic value of stock A _________.
B) will be the same as the intrinsic value of stock B
C) will be less than the intrinsic value of stock B
D) more information is necessary to answer this question

Question 39

Ace Ventura,Inc.has expected earnings of $5 per share for next year.The firm's ROE is 15% and its earnings retention ratio is 40%.If the firm's market capitalization rate is 10%,what is the present value of its growth opportunities?

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

Question 40

You wish to earn a return of 11% on each of two stocks,A and

A) will be higher than the intrinsic value of stock B
B) Stock A is expected to pay a dividend of $3 in the upcoming year while stock B is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends for both stocks is 4%. Using the constant growth DDM, the intrinsic value of stock A _________.
B) will be the same as the intrinsic value of stock B
C) will be less than the intrinsic value of stock B
D) more information is necessary to answer this question

Question 41

Value stocks are more likely to have a PEG ratio _____.

A) less than one
B) equal to one
C) greater than one
D) less than zero

Question 42

Sanders,Inc.,paid a $4.00 dividend per share last year and is expected to continue to pay out 60% of its earnings as dividends for the foreseeable future.If the firm is expected to generate a 13% return on equity in the future,and if you require a 15% return on the stock,the value of the stock is _________.

A) $26.67
B) $35.19
C) $42.94
D) $59.89

Question 43

A firm has PVGO of 0 and a market capitalization rate of 12%.What is the firm's P/E ratio?

A) 12.00
B) 8.33
C) 10.25
D) 18.55

Question 44

Everything equal,which variable is negatively related to intrinsic value of a company?

A) D₁
B) D₀
C) g
D) k

Question 45

Ace Frisbee Corporation produces a good that is very mature in their product life cycles.Ace Frisbee Corporation is expected to pay a dividend in year 1 of $3.00,a dividend in year 2 of $2.00,and a dividend in year 3 of $1.00.After year 3,dividends are expected to decline at the rate of 2% per year.An appropriate required return for the stock is 8%.Using the multistage DDM,the stock should be worth __________ today.

A) $13.07
B) $13.58
C) $18.25
D) $18.78

Question 46

Assuming all other factors remain unchanged,__________ would increase a firm's price/earnings ratio.

A) an increase in the dividend payout ratio
B) a reduction in investor risk aversion
C) an expected increase in the level of inflation
D) an increase in the yield on treasury bills

Question 47

Generally speaking,as the firm progresses through the industry life cycle you would expect the PVGO to ________ as a percent of share price.

A) increase
B) decrease
C) stay the same
D) no typical pattern can be expected

Question 48

A firm's earnings per share increased from $10 to $12,its dividends increased from $4.00 to $4.40,and its share price increased from $80 to $100.Given this information,it follows that _________.

A) the stock experienced a drop in its P/E ratio
B) the company had a decrease in its dividend payout ratio
C) both earnings and share price increased by 20%
D) the required rate of return increased

Question 49

Interior Airline is expected to pay a dividend of $3 in the upcoming year.Dividends are expected to grow at the rate of 10% per year.The risk-free rate of return is 4% and the expected return on the market portfolio is 13%.The stock of Interior Airline has a beta of 4.00.Using the constant growth DDM,the intrinsic value of the stock is _________.

A) $10.00
B) $22.73
C) $27.78
D) $41.67

Question 50

Cache Creek Manufacturing Company is expected to pay a dividend of $4.20 in the upcoming year.Dividends are expected to grow at the rate of 8% per year.The riskfree rate of return is 4% and the expected return on the market portfolio is 14%.Investors use the CAPM to compute the market capitalization rate on the stock,and the constant growth DDM to determine the intrinsic value of the stock.The stock is trading in the market today at $84.00.Using the constant growth DDM and the CAPM,the beta of the stock is _________.

A) 1.4
B) 0.9
C) 0.8
D) 0.5

Question 51

Todd Mountain Development Corporation is expected to pay a dividend of $3.00 in the upcoming year.Dividends are expected to grow at the rate of 8% per year.The risk-free rate of return is 5% and the expected return on the market portfolio is 17%.The stock of Todd Mountain Development Corporation has a beta of 0.75.Using the constant growth DDM,the intrinsic value of the stock is _________.

A) 4.00
B) 17.65
C) 37.50
D) 50.00

Question 52

Caribou Gold Mining Corporation is expected to pay a dividend of $4 in the upcoming year.Dividends are expected to decline at the rate of 3% per year.The risk-free rate of return is 5% and the expected return on the market portfolio is 13%.The stock of Caribou Gold Mining Corporation has a beta of -0.50.Using the CAPM,the return you should require on the stock is _________.

A) 2%
B) 5%
C) 8%
D) 9%

Question 53

Lifecycle Motorcycle Company is expected to pay a dividend in year 1 of $2.00,a dividend in year 2 of $3.00,and a dividend in year 3 of $4.00.After year 3,dividends are expected to grow at the rate of 7% per year.An appropriate required return for the stock is 12%.Using the multistage DDM,the stock should be worth __________ today.

A) $63.80
B) $65.13
C) $67.95
D) $85.60

Question 54

Westsyde Tool Company is expected to pay a dividend of $2.00 in the upcoming year.The risk-free rate of return is 6% and the expected return on the market portfolio is 12%.Analysts expect the price of Westsyde Tool Company shares to be $29 a year from now.The beta of Westsyde Tool Company's stock is 1.20.Using a one-period valuation model,the intrinsic value of Westsyde Tool Company stock today is _________.

A) $24.29
B) $27.39
C) $31.13
D) $34.52

Question 55

Todd Mountain development Corporation is expected to pay a dividend of $2.50 in the upcoming year.Dividends are expected to grow at the rate of 8% per year.The risk-free rate of return is 5% and the expected return on the market portfolio is 12%.The stock of Todd Mountain Development Corporation has a beta of 0.75.Using the CAPM,the return you should require on the stock is _________.

A) 7.25%
B) 10.25%
C) 14.75%
D) 21.00%

Question 56

Generally speaking the higher a firm's ROA the _________ the dividend payout ratio and the _________ the firm's growth rate of earnings.

A) higher; lower
B) higher; higher
C) lower; lower
D) lower; higher

Question 57

A company with an expected earnings growth rate which is greater than that of the typical company in the same industry,most likely has _________________.

A) a dividend yield which is greater than that of the typical company
B) a dividend yield which is less than that of the typical company
C) less risk than the typical company
D) less sensitivity to market trends than the typical company

Question 58

Westsyde Tool Company is expected to pay a dividend of $1.50 in the upcoming year.The risk-free rate of return is 6% and the expected return on the market portfolio is 14%.Analysts expect the price of Westsyde Tool Company shares to be $29 a year from now.The beta of Westsyde Tool Company's stock is 1.20.Using the CAPM,an appropriate required return on Westsyde Tool Company's stock is _________.

A) 8.0%
B) 10.8%
C) 15.6%
D) 16.8%

Question 59

Caribou Gold Mining Corporation is expected to pay a dividend of $6 in the upcoming year.Dividends are expected to decline at the rate of 3% per year.The risk-free rate of return is 5% and the expected return on the market portfolio is 13%.The stock of Caribou Gold Mining Corporation has a beta of -0.50.Using the constant growth DDM,the intrinsic value of the stock is _________.

A) $50.00
B) $100.00
C) $150.00
D) $200.00

Question 60

Firms with higher expected growth rates tend to have P/E ratios that are ___________ the P/E ratios of firms with lower expected growth rates.

A) higher than
B) equal to
C) lower than
D) There is not necessarily any linkage between risk and P/E ratios

Question 61

Firm A has a stock price of $35 and 60% of the value of the stock is in the form of PVGO.Firm B also has a stock price of $35 but only 20% of the value of Stock B is in the form of PVGO.We know that _________.
I)Stock A will give us a higher return than Stock B
II)an investment in Stock A is probably riskier than an investment in Stock B
III)Stock A has higher forecast earnings growth than Stock B

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

Question 62

A stock is priced at $45 per share.The stock has earnings per share of $3.00 and a market capitalization rate of 14%.What is the stock's PVGO?

A) $23.57
B) $15.00
C) $19.78
D) $21.34

Question 63

The free cash flow to the firm is reported as $205 million.The interest expense to the firm is $22 million.If the tax rate is 35% and the net debt of the firm increased by $25,what is the market value of the firm if the FCFE grows at 2% and the cost of equity is 11%?

A) $2,168 billion
B) $2,397 billion
C) $2,565 billion
D) $2,998 billion

Question 64

The free cash flow to the firm is $300 million in perpetuity,the cost of equity equals 14% and the WACC is 10%.If the market value of the debt is $1.0 billion,what is the value of the equity using the free cash flow valuation approach?

A) $1 billion
B) $2 billion
C) $3 billion
D) $4 billion

Question 65

A firm reports EBIT of $100 million.The income statement shows depreciation of $20 millions.If the tax rate is 35% and total capital expenditures and increases in working capital total $10 million,what is the free cash flow to the firm?

A) $57
B) $65
C) $75
D) $95

Question 66

A firm increases its dividend plowback ratio.All else equal you know that _____________.

A) earnings growth will increase and the stock's P/E will increase
B) earnings growth will decrease and the stock's P/E will increase
C) earnings growth will increase and the stock's P/E will decrease
D) earnings growth will increase and the stock's P/E may or may not increase

Question 67

Transportation stocks currently provide an expected rate of return of 15%.TTT,a large transportation company,will pay a year-end dividend of $3 per share.If the stock is selling at $60 per share,what must be the market's expectation of the constant growth rate of TTT dividends?

A) 5%
B) 10%
C) 20%
D) None of the above

Question 68

If a firm has a free cash flow equal to $50 million and that cash flow is expected to grow at 3% forever,what is the total firm value given a WACC of 9.5%?

A) $679 million
B) $715 million
C) $769 million
D) $803 million

Question 69

ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock.
At what P/E ratio would you expect ART to sell?

A) 8.33
B) 11.43
C) 14.29
D) 15.25

Question 70

A firm has a stock price of $54.75 per share.The firm's earnings are $75 million and the firm has 20 million shares outstanding.The firm has an ROE of 15% and a plowback of 65%.What is the firm's PEG ratio?

A) 1.50
B) 1.25
C) 1.10
D) 1.00

Question 71

A firm is expected to produce earnings next year of $3.00 per share.It plans to reinvest 25% of its earnings at 20%.If the cost of equity if 11%,what should be the value of the stock?

A) $27.27
B) $50.00
C) $66.67
D) $70.00

Question 72

The EBIT of a firm is $300,the tax rate is 35%,the depreciation is $20,capital expenditures are $60 and the increase in net working capital is $30.What is the free cash flow to the firm?

A) $85
B) $125
C) $185
D) $305

Question 73

ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock.
At what price would you expect ART to sell?

A) $25.00
B) $34.29
C) $42.86
D) $45.67

Question 74

The free cash flow to the firm is reported as $405 million.The interest expense to the firm is $76 million.If the tax rate is 35% and the net debt of the firm increased by $50,what is the free cash flow to the equity holders of the firm?

A) $406 million
B) $454 million
C) $505 million
D) $553 million

Question 75

The free cash flow to the firm is reported as $198 million.The interest expense to the firm is $15 million.If the tax rate is 35% and the net debt of the firm increased by $20 million,what is the market value of the firm if the FCFE grows at 3% and the cost of equity is 14%?

A) $1,893 billion
B) $2,497 billion
C) $2,585 billion
D) $3,098 billion

Question 76

The free cash flow to the firm is reported as $275 million.The interest expense to the firm is $60 million.If the tax rate is 35% and the net debt of the firm increased by $33,what is the free cash flow to the equity holders of the firm?

A) $269 million
B) $296 million
C) $305 million
D) $327 million

Question 77

What is the present value of growth opportunities for ART?

A) $8.57
B) $9.29
C) $14.29
D) $16.29

Question 78

A firm has an earnings retention ratio of 40%.The stock has a market capitalization rate of 15% and an ROE of 18%.What is the stock's P/E ratio?

A) 12.82
B) 7.69
C) 8.33
D) 9.46

Question 79

What price do you expect ART shares to sell for in 4 years?

A) $53.96
B) $44.95
C) $41.68
D) $39.76

Question 80

A common stock pays an annual dividend per share of $1.80.The risk-free rate is 5 percent and the risk premium for this stock is 4 percent.If the annual dividend is expected to remain at $1.80 per share,what is the value of the stock?

A) $17.78
B) $20.00
C) $40.00
D) None of the above