Deck 7: Equity Valuation

Question 1

Alpine Ski Equipment has 2 million preferred shares issued at a par value of $40.The preferred shares are currently selling at $33.25 per share and the required rate is 8.42 percent.What is the dividend rate?
a) 7.00%
b) 8.42%
c) 9.00%
d) 10.13%

Answer 1

a,Dividend rate = ($33.25*8.42%)/$40 = 7%

Question 2

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%

Answer 2

d,10/70 = 16.66%

Question 3

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.

Answer 3

B

Question 4

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

A) Always have voting rights.
B) Dividends must be paid in entirety before the common shareholders can receive any payments.
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

Montreal Growers Inc.issued 1 million preferred shares at a par 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 6

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 7

The 1.2 million preferred shares of Mighty Machines Ltd.,which pay a dividend rate of 6.5 percent on a stated value of $40,are currently worth $42,000,000.What is the risk premium associated with these preferred shares if the risk-free rate is 4.25 percent?
a) 1.97%
b) 2.25%
c) 2.57%
d) 3.18%

Question 8

The value of a common stock 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

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.

Question 10

What are the sources of uncertainties 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 11

A bond and a preferred share_________________________

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

Question 12

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 percent.The market value of the preferred shares is ____________ if the required rate of return is 8 percent.
a) $3,125,000
b) $2,500,000
c) $2,000,000
d) $34,380,000 million

Question 13

The value of a stock 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 14

Determine the market price of a $50 par value preferred share that pays annual dividends based on a 4 percent dividend rate when the market rate is 5%?
a) $50
b) $40
c) $35
d) $60

Question 15

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 percent?
a) 5.00%
b) 6.00%
c) 7.2%
d) 11.11%

Question 16

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 17

Which of the following statements is TRUE?

A) Preferred shares will trade at a discount from par value when market rates are less than the dividend rate.
B) Preferred shares will trade at a premium when the market rate exceeds the dividend rate.
C) Preferred shares will trade at par when the dividend rate does not equal the market rate.
D) The market prices of preferred shares increase when market rates decline, and vice versa.

Question 18

In 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 19

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 20

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.

Question 21

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 percent,what is the implied risk premium?
a) 4.00%
b) 4.50%
c) 5.00%
d) 5.50%

Question 22

The 800,000 preferred shares of Fantastic Services have a 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 percent and the risk premium is 3.65 percent?
a) 7.40%
b) 7.25%
c) 6.80%
d) 6.25%

Question 23

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 24

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 25

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 par value of $85 and the risk premium is 4.5 percent,what is the implied risk-free rate?
a) 4.00%
b) 4.50%
c) 5.00%
d) 5.50%

Question 26

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 27

Use the following two statements to answer this question:
I)The 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 28

Infinity Inc.has 750,000 preferred shares outstanding,which pay a dividend rate of 5.25 percent.Currently,the market value of these preferred shares is $22.5 million and the short-term government T-bills yield is 5 percent.What is the par value of these shares if investors require a risk premium of 3.75 percent?
a) $7.14
b) $18.00
c) $30.00
d) $50.00

Question 29

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 30

How much would you pay for a share of stock 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 stock is 13 percent.
a) $60.50
b) $55.50
c) $53.54
d) $49.59

Question 31

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 32

How much would you pay for a share of stock 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 stock is 13 percent.
a) $60.50
b) $55.50
c) $53.54
d) $49.59

Question 33

You paid $20 for one share of HyperTension Inc.today.What is the expected one-year holding period return if the stock 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 34

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 35

Which of the following is TRUE about the implicit assumption of the 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 36

The Beautiful Mind Company's preferred stock is selling for $30 per share.What is the expected dividend of year four if the required rate of return is 7.5 percent?
a) $2.00
b) $2.25
c) $3.00
d) $3.25

Question 37

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 38

The rate of return required by 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 39

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 40

Which of the following is a FALSE statement about the 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 41

Gadgets Inc.just paid a dividend of $1.55.It expects its earnings and dividends to decline at a rate of 3 percent per year indefinitely.What is the value of the stock today if the required return is 12.5 percent?
a) $9.70
b) $10.00
c) $16.32
d) $16.81

Question 42

The common stock of Atlantic Fishing Ltd.currently sells for $48 per share.The firm has a constant dividend growth rate of 6 percent.If the required rate of return is 15 percent,what is the expected dividend yield on the stock?
a) 6.00%
b) 8.49%
c) 9.00%
d) 15.00%

Question 43

BC Corporation common stock has just paid a dividend of $2.20 per share.Its dividend is expected to grow at a rate of 5 percent per year indefinitely.The current stock price is $30 and the risk premium associated with this stock is 8.7 percent.What is the implied risk-free rate?
a) 3.63%
b) 3.70%
c) 4.00%
d) 4.42%

Question 44

Jack had an investment return of -24 percent on a stock that he bought for $100 a year ago.What is the sale price of the stock if he received a dividend of $1.75 during the year?
a) $72.75
b) $74.25
c) $76.00
d) $77.75

Question 45

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 percent.What is the present value of growth opportunities if the risk premium is 8.4 percent?
a) $1.67
b) $8.10
c) $14.40
d) $20.83

Question 46

Toronto Skates Inc.'s common stock is 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 percent.What is the dividend growth rate if the risk premium on comparable companies is 6.2 percent?
a) 2.22%
b) 2.40%
c) 3.12%
d) 3.54%

Question 47

Charlotte purchased a share for $50 a year ago.She received $2.40 in dividends and sold the stock for $52.If the inflation rate over the year was 2.6 percent,her exact real rate of return is
a) 6.04%
b) 8.8%
c) 11.4%
d) 16.28%

Question 48

Zigzag Corporation's common stock is selling for $22 per share in the market.Zigzag's EPS is expected to be $2 next year,and the required rate of return is 12 percent.What is the present value of growth opportunities per share?
a) $5.33
b) $16.67
c) $20.00
d) $38.67

Question 49

According to the DDM,if a firm increases its retention rate what happens to the firm's share price assuming no dividend growth and 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 50

The stock of Townships Ski Resorts Inc.just paid a dividend of $0.78.What is the expected capital gains yield if the stock is selling for $28.25 today and the required rate of return is 15 percent?
a) 13.62%
b) 12.30%
c) 11.91%
d) 10.73%

Question 51

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 stock price if the required return is 13.1 percent?
a) $8.55
b) $9.35
c) $9.57
d) $10.37

Question 52

Toronto Skates Inc.is paying dividends on a regular basis with a constant growth rate.The dividend last year was $ 1.00 and this year is $1.25.If the required rate of return is 12%,what is the price of the stock?
a) $10.42
b) $8.33
c) 5.00
d) Cannot be calculated

Question 53

BC Electrics Inc.pays a constant dividend of $2 every year.What will the stock sell for three years from now if the required rate of return is 9 percent?
a) $22.22
b) $21.30
c) $25.70
d) $28.78

Question 54

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 percent indefinitely.What is today's stock price if the required return is 12.5 percent?
a) $4.62
b) $7.33
c) $7.70
d) $11.55

Question 55

Toronto Skates Inc.is offering a dividend of $1 next year and the stock sells for $20.If the required rate of return is 8 percent,what is the capital growth rate?
a) 5%
b) 13%
c) 3%
d) 12.5%

Question 56

Suppose Delightful Inc.'s present value of growth opportunities 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 57

Prairies Oil Sands Inc.is expected to pay a dividend of $1 in one year.If the dividend growth rate is 2 percent forever and the required return is 10 percent,what should the stock be sold for five years from now?
a) $13.53
b) $13.80
c) $14.08
d) $14.62

Question 58

Analysts announced estimated earnings per share of $4 for the coming year for Toronto Skates Inc.The company plans not to pay any dividends for the next three years.For the subsequent two years,the company plans on retaining 50 percent of its earnings,and then 25 percent of its earnings from that point forward.Retained earnings will be invested in projects with an expected return of 20 percent per year.If the required rate of return is 12 percent,then the price is:
a) $48.48
b) $67.30
c) $57.50
d) $59.09

Question 59

Atlantic Fishing Ltd.common stock has just paid a dividend of $1.80 per share and is selling for $34.48 each.The firm expects its dividend to grow at a constant rate of 6.3 percent a year.What is the risk premium associated with the stock if the risk-free rate is 4.25 percent?
a) 7.27%
b) 7.60%
c) 11.52%
d) 11.85%

Question 60

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 stock is selling for $30 today?
a) 8.26%
b) 8.43%
c) 8.60%
d) 8.92%

Question 61

Ontario Ice Corporation has an expected profit margin of 10 percent,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 percent.What should the stock sell for today if the required return is 15 percent?
a) $13.33
b) $20.00
c) $26.67
d) $30.00

Question 62

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 63

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 percent?
a) $2.40
b) $2.52
c) $2.65
d) $2.78

Question 64

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,and the subsequent dividends are expected to grow at a constant rate of 5 percent per year.What is the stock price today if the risk-free rate is 4 percent and the risk premium associated with this stock is 6 percent?
a) $17.93
b) $19.40
c) $31.50
d) $34.73

Question 65

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 66

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 percent,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 67

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 percent per year indefinitely.What is the firm's current stock price if the required rate of return is 13%?
a) $30.33
b) $24.25
c) $19.24
d) $17.73

Question 68

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 69

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 has 500,000 shares outstanding with a current market value of $5.What is the firm's present value of growth opportunities if the required rate of return is 10.08 percent?
a) $0.77
b) $0.84
c) $0.86
d) $0.90

Question 70

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

Question 71

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 stocks
C) Ignores the magnitude or the sign of the earnings
D) One of the most widely used relative pricing methods

Question 72

Suppose a firm has just reported an EPS of $2.50 and expects to maintain a dividend payout ratio of 40 percent.If the firm's price-earnings ratio is 9.3 and its return on equity is 12 percent,what is its required rate of return?
a) 13.80%
b) 11.5%
c) 13.35%
d) 12%

Question 73

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 if the stock is selling for $24.86 today and the required return is 17 percent?
a) -1.07%
b) -1.75%
c) 8.00%
d) 8.65%

Question 74

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 growth rate of this company?
a) 6.67%
b) 11.11%
c) 4.44%
d) 0%

Question 75

Suppose a firm's price/earnings ratio is 16.It has just paid a dividend of $1.80 per share to maintain a 45 percent payout ratio.What is the firm's current market price if its return on equity is 12 percent?
a) $68.22
b) $67.46
c) $66.54
d) $65.78

Question 76

DDM Company has an expected profit margin of 15 percent,turnover ratio of 2,and a leverage ratio of 0.5.The firm had an EPS of $2 and paid a dividend of $1.05 per share.What is DDM's sustainable growth rate?
a) 8.125%
b) 7.875%
c) 7.125%
d) 6.875%

Question 77

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 percent?
a) 2.33%
b) 3.50%
c) 4.67%
d) 7.00%

Question 78

Suppose a firm has just reported an EPS of $2.50 and expects to maintain a dividend payout ratio of 40 percent.What is the firm's price-earnings ratio if its return on equity is 12 percent and the required return is 11.5 percent?
a) 11.50
b) 9.30
c) 7.20
d) 5.97

Question 79

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 80

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 equity of $1,200,000,and a dividend payout ratio of 65 percent.What is the firm's current market value if the required return is 21 percent?
a) $1.886 million
b) $2.067 million
c) $3.180 million
d) $8.091 million