Deck 17: Security Valuation and Selection

Question 1

Price/earnings ratios are ____ for firms with ____ expected earnings and ____ expected required rates of return.

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

Answer 1

higher; higher; lower

Question 2

Factors that fundamentalists examine to determine future stock price movements include:
I.Company conditions
II.Industry conditions
III.Economic & market conditions
IV.Supply/demand relationships

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

Answer 2

I, II, and III

Question 3

If the stock market is semi-strong efficient, which of the following statements is correct?

A) All stocks should have the same expected returns; however, they may have different realized returns.
B) In equilibrium, stocks and bonds should have the same expected returns.
C) Investors can outperform the market if they have access to information which has not yet been publicly revealed.
D) If the stock market has been performing strongly over the past several months, stock prices are more likely to decline than increase over the next several months.
E) None of the above statements is correct.

Answer 3

Investors can outperform the market if they have access to information which has not yet been publicly revealed.

Question 4

Beefcake Burgers' stock has a current market value of $80.65.The company just paid a dividend equal to $3.50 per share, which is expected to grow at a constant rate of 6 percent forever into the future.What is the rate of return required by Beefcake's marginal investors?

A) 10.3%
B) 6.0%
C) 10.6%
D) 15.0%
E) There is not enough information to answer this question.

Question 5

Which of the following statements is correct?

A) A stock is said to be in equilibrium when investors at the margin think its expected rate of return is equal to its required rate of return.
B) According to the Efficient Markets Hypothesis, stock prices are best predicted by use of sophisticated statistical techniques such as regression analysis.
C) The more efficient markets are, in an EMH sense, the easier it is for sophisticated investors to profit by analyzing data that companies have released to the public.
D) The more efficient markets are, in an EMH sense, the more dangerous it would be for an investor to pick stocks at random as opposed to picking them on the basis of a careful analysis.
E) The EMH would predict that one can "beat the market" by analyzing publicly available data, if the analyst is efficient.

Question 6

Government spending, which is primarily supported by the government's ability to tax individuals and businesses, is called ____.

A) Deficit spending
B) Fiscal policy
C) Monetary policy
D) Gross domestic product
E) Business cycle

Question 7

Technical analysts would argue that the stock market is ____ form efficient.

A) Weak
B) Semistrong
C) Strong
D) None of the above, because most technicians would argue the stock market is not efficient.

Question 8

The practice of evaluating the information contained in financial statements, industry reports, and economic factors to determine the intrinsic value of a firm is called

A) Asset valuation.
B) Technical analysis.
C) Price theory.
D) Fundamental analysis.
E) Industry analysis.

Question 9

____ occurs when the government spends more than it collects in taxes.

A) Deficit spending
B) Fiscal policy
C) Monetary policy
D) Gross domestic product
E) Business cycle

Question 10

Which of the following economic indicators is not considered a leading indicator?

A) Average workweek, production.
B) Average length of unemployment.
C) Money supply, M2.
D) New orders of manufacturers.
E) Stock prices.

Question 11

Ace Fly Rod Company expects the next dividend it pays, which will be in one year, to be $3.In the following year, the dividend is expected to be $4.50, and then the dividends are expected to grow at 10 percent annually thereafter.The appropriate discount rate for the company is 18 percent.What should be the market price of the stock?

A) $59.68
B) $57.58
C) $50.21
D) $46.17
E) $43.43

Question 12

What are the stages of a typical industry life cycle?

A) Introductory stage, expansionary or contractionary stage (depending on the business cycle), mature stage.
B) Speculative, expanding growth, declining growth.
C) If the industry is cyclical then it will not follow a life cycle because it expands and contracts with the business cycle.
D) Introductory stage, Expansion stage, Mature stage.
E) Introductory stage, Expansion stage, Stable stage.

Question 13

Industries that tend to be directly related to business cycles such that they perform best during expansions and worst during contractions are called ____.

A) Defensive industries
B) Industry life cycles
C) Countercyclical industries
D) Growth industries
E) Cyclical industries

Question 14

The means by which the Federal Reserve influences economic conditions in the United States is called ____.

A) Deficit spending
B) Fiscal policy
C) Monetary policy
D) Gross domestic product
E) Business cycle

Question 15

What is the expected stock price of company who has $5.00 earnings per share, a dividend payout ratio of 0.8, and a P/E ratio of 12?

A) $48.00
B) $60.00
C) $12.00
D) $9.60
E) There is not enough information to answer this question.

Question 16

All of the following variables must be estimated when using the dividend discount model for stock valuation except the

A) Future dividends.
B) Growth rate of the company.
C) Risk free rate.
D) Appropriate required rate of return.

Question 17

Hurricane Shutters Inc.paid a dividend of $1.30 yesterday.The next dividend will be in one year and is expected to be $1.50.After that, dividends are expected to grow at a constant 15 percent forever.The discount rate for Hurricane Shutters Inc.is 25 percent.What should be the market price of the stock?

A) $17.25
B) $15.00
C) $13.20
D) $13.80
E) $18.75

Question 18

Titanium World Inc., which is a firm that makes specialized golf clubs, plans to pay a dividend of $2 per share at the end of this year; the following year's dividend is expected to be $3 per share; the dividend the year after is expected to be $5; and, after that point, dividends should increase at a constant rate of 10 percent each year forever.The appropriate discount rate for Titanium World is 15 percent.What is the per share value of Titanium World's stock?

A) $70.19
B) $110.00
C) $62.89
D) $79.62
E) $80.72

Question 19

Florida Sports Magazine is a publicly traded company.The next dividend will be paid in one year and is expected to be $1.25 per share.Dividends are expected to grow at 10 percent a year for the next three years, and then grow at 8 percent a year thereafter.The appropriate discount rate for investing in this firm is 15 percent.What should be the current stock price?

A) $21.27
B) $10.76
C) $22.40
D) $17.33
E) $18.75

Question 20

Financial statement analysis should be included in investment analysis because

A) A firm's business conditions can be compared with similar firms to determine whether its current operations are average or above or below average.
B) We can predict earnings and dividends by forecasting the future financial conditions.
C) We can use the accounting statements and information regarding current and forecasted business conditions to form expectations regarding the risk of the firm's future operations.
D) Only a and b are valid reasons.
E) a, b and c are all valid reasons.

Question 21

Davis Brothers Incorporated is an apparel manufacturer that paid a $1.50 dividend yesterday.Analysts expect dividends to grow at a constant 20 percent per year for the next four years.From that point forward, dividends are expected to grow at a constant rate of 12 percent forever.The discount rate for a firm of this risk is 15 percent.What should be the current stock price?

A) $65.96
B) $58.23
C) $103.68
D) $73.07
E) $106.79

Question 22

Using the following financial data, determine the maximum dividends per share that can be paid to stockholders before the firm's value would be threatened.Base your answer on the economic value added model.

A) $1.20
B) $0.90
C) $0.60
D) $0.36
E) $0.24

Question 23

Pet Rock Quarries, Inc.is a publicly traded company with 200,000 shares of common stock outstanding.The stock currently sells for $50.00 a share.They had net income of $4,000,000.What is the company's P/E ratio?

A) 20.0
B) 50.0
C) 2.5
D) 2.0
E) There is not enough information to answer this question.

Question 24

Use the following financial data to determine the maximum total dividends that can be paid to stockholders before the firm's value would be threatened.Base your answer on the economic value added model.

A) $920,000
B) $1,920,000
C) $2,100,000
D) $2,352,000
E) $3,920,000

Question 25

The ____ includes all the goods and services produced in the economy during a specific time where value of the goods and services is not adjusted for inflation.

A) real GDP
B) nominal GDP
C) real GNP
D) nominal GNP

Question 26

Ace Incorporated has just paid a dividend of $4.00 per share.They have a retention ratio of 20 percent.They have a P/E ratio of 14.What should be the current price of the stock?

A) $56.00
B) $11.20
C) $70.00
D) $46.67
E) There is not enough information to answer this question.

Question 27

If the industry P/E ratio normally varies from 15 to 20, which of the following prices is most appropriate for a company that has an EPS equal to $3?

A) $57.60
B) $40.00
C) $188.20
D) $43.20
E) Not enough information is given to answer this question.

Question 28

Since its inception five years ago, Companioni Gyms has not paid a dividend to its common stockholders, and it does not expect to pay a dividend for the next five years.Beginning six years from today, however, Companioni Gyms expects to pay a $2 dividend, which, from that point on, will increase by 10 percent per year forever.Stocks with similar risks have a required rate of return equal to 15 percent.What should be the market price of Companioni's common stock?

A) $19.89
B) $22.87
C) $17.29
D) $44.00
E) There is not enough information to answer this question.

Question 29

What is the expected price for the stock of a company that just paid a dividend of $3.00? The company has a dividend payout ratio of 50 percent, discount rate of 25 percent, and a P/E of 10.

A) $60.00
B) $30.00
C) $12.00
D) $45.00
E) $22.50

Question 30

Acme Corporation stock currently sells for $22.08 per share.The last dividend paid was $1.00 per share.The next dividend will be paid in one year and is expected to be $1.50; the following year's dividend will be $2.50; and, in the third year dividends are expected to begin growing at a constant rate.If the appropriate discount rate for Acme is 20 percent, at what constant rate does the market expect dividends to grow in Year 3 and beyond?

A) 10.0%
B) 15.0%
C) 8.0%
D) 20.0%
E) 12.5%

Question 31

Using the following financial data, determine the maximum dividends per share that can be paid to stockholders before the firm's value would be threatened.Base your answer on the economic value added model.

A) $1.07
B) $1.14
C) $1.20
D) $2.28
E) $2.40

Question 32

Using the following financial data, determine the maximum dividends per share that can be paid to stockholders before the firm's value would be threatened.Base your answer on the economic value added model.

A) $0.15
B) $0.85
C) $1.55
D) $1.79
E) $2.60

Question 33

Using the following financial data, determine the maximum dividends per share that can be paid to stockholders before the firm's value would be threatened.Base your answer on the economic value added model.

A) $1.15
B) $0.92
C) $0.90
D) $0.72
E) $0.24

Question 34

Using the following financial data, determine the maximum dividends per share that can be paid to stockholders before the firm's value would be threatened.Base your answer on the economic value added model.

A) $0.50
B) $0.70
C) $2.00
D) $2.30
E) $3.10

Question 35

MTB Surfboards has a P/E of 20.The discount rate for this firm is 30 percent.They had earnings of $2,000,000 and 100,000 shares of common stock outstanding.What should be the current price of the stock?

A) $120.00
B) $60.00
C) $600.00
D) $400.00
E) $200.00

Question 36

Candy Apple Cakes' stock has a current market value of $40.50.The company just paid a dividend equal to $1.50 per share, which is expected to grow at a constant rate forever into the future.If Candy Apple's marginal investors require a rate of return equal to 12 percent, what is the rate at which dividends are expected to grow in the future?

A) 8.3%
B) 12.0%
C) 4.0%
D) 8.0%
E) There is not enough information to answer this question.

Question 37

Big Joe's Burgers has a P/E ratio of 12 and a beta equal to 3.The risk-free rate is 8 percent and the return to the market has been 14 percent.The firm has an EPS of $5.00.What should be the current market price of Big Joe's stock?

A) $120.00
B) $96.00
C) $44.40
D) $60.00
E) $55.20

Question 38

F Minus Notes is a publicly traded company.The last dividend paid was $4 per share.Dividends are paid annually, and they are expected to increase 5 percent per year for the next five years, then increase 10 percent per year thereafter.The discount rate associated with F Minus Notes common stock is 20 percent.What should be the current price of F Minus Notes stock?

A) $36.21
B) $33.13
C) $47.55
D) $50.72
E) $31.59

Question 39

Wheathouse Bakery just paid a dividend of $2.50.They expect the dividends to grow at 15 percent per year for next three years, and then they expect the dividends to remain constant forever.The appropriate discount rate for this firm is 20 percent.What should be the current market price of the stock?

A) $15.69
B) $17.50
C) $17.89
D) $19.01
E) $22.16

Question 40

Using the following financial data, determine the maximum total dividends that can be paid to stockholders before the firm's value would be threatened.Base your answer on the economic value added model.

A) $1,170,000
B) $1,120,000
C) $820,000
D) $570,000
E) $220,000

Question 41

Economists define a recession as a contraction in the economy in at least three out of the last five quarters.

Question 42

Increased deficit spending by the government is likely to result in

A) higher than normal interest rates.
B) no change in the interest rate.
C) lower than normal interest rates.
D) lower expected inflation.

Question 43

When the economy is in a recession, by definition, all sectors of the economy must be experiencing a downturn, or contraction.

Question 44

Fundamental analysts attempt to find the intrinsic value of a firm by evaluating information contained in financial statements, industry reports, and economic forecasts.

Question 45

Technical analysts often are called chartists because they depend solely on charts and graphs to determine stock market trends.

Question 46

Fundamental analysts primarily base their investment decisions on analyses of supply and demand relationships that influence trends in price movements in stocks and general financial market conditions.

Question 47

Many investors use screening techniques to find one of two kinds of stocks.One kind is stocks of firms that exhibit sales and earnings growth rates that significantly exceed the industry averages.Another kind is stocks of firms that are mispriced, especially those that are undervalued.What are these two types of stocks called?

A) preferred stocks and common stocks
B) growth stocks and value stocks
C) advancing stocks and declining stocks
D) efficient stocks and inefficient stocks

Question 48

The ____ includes all the goods and services produced in the economy during a specific time where value of the goods and services is adjusted for inflation.

A) real GDP
B) nominal GDP
C) real GNP
D) nominal GNP

Question 49

Which of the following measures is included in the index of lagging indicators?

A) Loans to commerce and industry
B) Manufacturing and trade sales
C) Index of consumer expectations
D) Industrial production

Question 50

According to the Dow Theory, which one of the following is not one of the types of market movements that are possible?

A) A short-term movement.
B) An intermediate trend.
C) A broad trend.
D) All of the above types of market movements are possible.

Question 51

The EVA of a firm will be positive when

A) WACC > IRR
B) WACC = IRR
C) WACC < IRR
D) IRR > 0

Question 52

Technical analysis is the examination of the supply/demand relationships for securities to determine trends in price movements of stocks or financial markets.

Question 53

When the Federal Reserve wants to slow down the economy that is growing at an unsustainable rate, the Federal reserve can

A) decrease interest rates by increasing the money supply.
B) increase interest rates by increasing the money supply.
C) increase interest rates by decreasing the money supply.
D) decrease interest rates by decreasing the money supply.

Question 54

When economists measure the aggregate economy and say that it is either expanding or contracting, they are indicating the direction of the current business cycle.

Question 55

A business cycle is the measure of all the goods and services produced in the economy during a specific time period.

Question 56

Which of the following measures is included in the index of leading indicators?

A) prime rate at banks
B) average length of unemployment
C) money supply
D) manufacturing and trade sales

Question 57

Generally speaking, the P/E multiples are higher for firms with ____ expected growth rates and ____ expected required rates of return.

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

Question 58

The economic activity in the United States generally is measured by the gross domestic product (GDP).

Question 59

Which of the following measures is included in the index of coincident indicators?

A) Average workweek production
B) Prime rate at banks
C) New private building permits
D) Industrial production

Question 60

Fundamental analysis is used to try to find the intrinsic value of a firm, which actually is the "true", or economic, value.

Question 61

The dividend discount model (DDM) can only be used to value a company's stock if it is expected that the company will pay a dividend that grows at a constant rate in the future.

Question 62

The fiscal policy of the United States is formulated and carried out by the Federal Reserve.

Question 63

When there is deficit spending in the United States, the amount of goods and services that is imported exceed the amount that is exported.

Question 64

An investor who uses the P/E ratio approach to value a firm's common stock would simply multiply the most recently reported earnings per share (EPS) by the current dividend per share to determine the value.

Question 65

Economic measures that tend to mirror, or move concurrent with, business cycles are called coincident indicators.

Question 66

Fiscal policy refers to government spending, which is supported by the government's ability to tax businesses and individuals.

Question 67

According to the economic value added (EVA) method, a firm should be considered attractive only if it can generate sufficient income to pay for its existing capital.

Question 68

Industries that are comprised of companies that tend to be directly related to business cycles are generally referred to as cyclical industries.

Question 69

The industry life cycle follows various stages of growth with respect to the product of competitive conditions within the industry.

Question 70

Generally, composite indexes rather than individual indexes are used to indicate the general movement of the economy because combinations of multiple measures provide better gauges of the general pattern than individual measures that contain spurious movements that are difficult to interpret.

Question 71

Industries comprised of companies that tend to be directly related to business cycles are generally referred to as defensive industries.

Question 72

From an investor's standpoint, the purpose of financial statement analysis is to determine the attractiveness of an investment by identifying the strengths and weaknesses of the firm and projecting how the firm will do in the future.

Question 73

Individuals who prefer investments that offer current income (i.e., dividends) probably should purchase stocks that are in the mature stage of their industry life cycle.Such investors most likely would avoid companies that are in the introductory stage of their life cycle.

Question 74

For the most part, lagging economic indicators are not very useful for investment analysis because they represent measures that tend to lag movements in the general economy.

Question 75

Because financial statement analysis is based on examination of accounting statements, which often do not represent economic earnings, they should not be included in investment analysis.

Question 76

When the economy is in a recession, the Federal Reserve generally attempts to increase business activity by easing credit via lower interest rates, which is accomplished by decreasing reserves (money supply).

Question 77

The monetary policy of the United States is formulated and carried out by the Federal Reserve.

Question 78

Industries generally go through life cycles similar to the human life cycle⎯in the first years of an industry's life growth is substantial, yet operations are somewhat unstable, while in its later years, the industry has attained greater stability, but growth slows and perhaps even declines.

Question 79

Even though industries might be at different stages in their industry life cycle and the progress of their paces vary, all industries will eventually reach the mature stage.

Question 80

The fiscal policy of the United States is dominated by deficit spending, which means the government spends more than it collects in taxes.