Deck 10: Common Stock Valuation Lessons for All Investors

Question 1

The zero-growth dividend model:

A) gives the highest value for a common stock.
B) is the most accurate model to use.
C) is equivalent to the valuation model for preferred stock.
D) assumes the highest required return possible.

Answer 1

C

Question 2

Discounted cash flow techniques used in valuing common stock are based on:

A) future value analysis.
B) present value analysis.
C) the CAPM.
D) the APT.

Answer 2

B

Question 3

Which of the following is a problem using the dividend discount model to value common stock?

A) The model does not account for the risk of the stock.
B) The model does not consider the present value of the dividends.
C) The model does not consider that dividends may not be paid
D) The model does not account for small dividends.

Answer 3

C

Question 4

WWW Company currently (t = 0) earns $4.00 per share, and has a payout of 40 percent. Dividends are expected to grow at a constant rate of 4 percent per year. The required rate of return is 15 percent. The price of this stock would be estimated at

A) $57.14.
B) $22.86.
C) $15.13.
D) $24.69.

Question 5

The dividend model that is most appropriate for a young company that pays small dividends now but is expected to increase dividends in a few years is the:

A) zero-growth model.
B) constant growth model.
C) expansion growth model.
D) multiple growth model.

Question 6

Analysts often use a ________% rule in security valuation in recognition of the fact that estimating a security's value is an inexact process.

A) 5
B) 10
C) 15
D) 20

Question 7

Which of the following is not one of the reasons two investors both using the constant growth version of the DDM on the same stock might arrive at different estimates of the stock's value?

A) They used different expected returns.
B) They used different growth rates of dividends.
C) They used different required returns.
D) They assume a different payout ratio.

Question 8

Infinite growth is a problem with the dividend discount model because:

A) The expected stream of dividends is infinite
B) At reasonably high discount rates, such as 12 percent, dividends received in the distant future (40 or 50 years from now) are worth very little today
C) Dividend growth rates eventually become very small
D) The statement is incorrect - infinite growth is not a problem with the dividend discount model because at reasonably high discount rates, such as 12 percent, dividends received in the distant future are worth very little today

Question 9

Based on PSR rule of thumb, if PSR is less than 1, the stock is:

A) over-priced
B) a candidate for short-sale
C) a bargain
D) about to default

Question 10

Which of the following situations indicates a signal to buy a stock?

A) IV > CMP
B) IV < CMP
C) IV = CMP
D) Impossible to determine.

Question 11

The constant growth dividend model uses the:

A) historical growth rate in dividends.
B) historical growth rate in earnings.
C) estimated growth rate in dividends.
D) estimated growth rate in earnings.

Question 12

XYZ Company has expected earnings of $3.00 for next year and usually retains 40 percent for future growth. Its dividends are expected to grow at a rate of 10 percent indefinitely. If an investor has a required rate of return of 15 percent, what price would he be willing to pay for XYZ stock?

A) $12.50
B) $25.00
C) $30.00
D) $36.00

Question 13

The constant growth rate model of the DDM implies that:

A) earnings are not relevant to stock prices.
B) the payout ratio remains fixed.
C) the stock price grows at the same rate as dividends.
D) the growth rate in dividends equates to zero (i.e., dividends remain a "constant" dollar amount over time).

Question 14

Which of the following statements regarding intrinsic value and market price is true?

A) If intrinsic value is greater than the current market price, the stock should be avoided or, if already held, sold.
B) If intrinsic value is less than the current market price, the stock is undervalued.
C) If intrinsic value is equal to the current market price, the stock is correctly valued.
D) If the intrinsic value is greater than the current market price, the stock is considered speculative.

Question 15

The estimated value of common stock is the:

A) present value of all expected cash flows.
B) present value of all capital gains.
C) future value of all dividend payments.
D) present value of all dividend payments.

Question 16

All of the following are interchangeable terms except for:

A) discount rate
B) coupon rate
C) required rate of return
D) capitalization rate

Question 17

Seaside Toys currently earns $2.00 per share and currently pays $1.00 per share in dividends. It is expected to have a constant growth rate of 5 percent per year. The required rate of return is 15 percent. What is the intrinsic value of this stock?

A) $6.67
B) $7.00
C) $10.00
D) $10.50

Question 18

Under the multiple growth model, at least ------ different growth rates are used.

A) two
B) three
C) four
D) five

Question 19

What is the estimated value of a stock with a required rate of return of 12 percent, a projected constant growth rate of dividends of 7 percent and expected dividend of $2.50?

A) $60
B) $15
C) $150
D) $5

Question 20

Relative valuation measures commonly used by market participants today include:

A) P/E ratio, Price/Book Value, and Sales/Price ratios
B) Earnings per Share ratio
C) Discounted Cash Flow
D) Residual Income Valuation

Question 21

Which of the following changes will likely lead to a higher P/E, assuming other factors are equal?

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

Question 22

Which of the following statements regarding P/E ratios is true?

A) Generally, the riskier the stock, the higher the P/E ratio.
B) In recent years, the small capitalization stocks had the highest P/E ratios.
C) As interest rates increase, P/E ratios are expected to decline.
D) Higher growth prospects often lead to lower P/E ratios.

Question 23

Several analysts and empiricists recommend investing in stocks with what kind of price to book value ratios?

A) low.
B) equal to one.
C) high.
D) equal to zero.

Question 24

Which of the following statements concerning price to book value is true?

A) There is an inverse relationship between price to book values and market prices.
B) It is calculated as the ratio of price to the book value of assets.
C) There is supporting evidence that stocks with low price to book values significantly outperform the market.
D) Price to book value ratios for many stocks range from 5.5 to 10.5.

Question 25

Under the P/E model, stock price is a product of:

A) EPS and DPS
B) P/E ratio and EPS
C) EPS and required return
D) P/E ratio and required return

Question 26

A company has a price to sales ratio of 1.0, annual sales of $1 billion and 100 million shares of common stock outstanding. Its stock price is:

A) $10
B) $20
C) $17.52
D) $22.00

Question 27

The price/sales ratio indicates:

A) the amount of risk in the firm's operations.
B) what the market is willing to pay for a firm's revenues.
C) the price advantage a company has for its brand names.
D) what the analysts see as the breakup value of the firm.

Question 28

If all investors use the constant growth dividend model to value the same stock, they will all arrive at the same estimate of value.

Question 29

Book value is:

A) the same as market value.
B) a more accurate valuation technique than the dividend models.
C) the accounting value of the firm as reflected in the financial statements.
D) the same as liquidation value.

Question 30

Generally speaking, if interest rates fall and other factors remain constant, the P/E ratio of most companies company will:

A) become negative.
B) increase.
C) decrease.
D) become more volatile.

Question 31

Which of the following variables has an inverse relationship with the P/E ratio?

A) payout ratio
B) expected growth rate of dividends
C) expected growth rate of earnings
D) required rate of return

Question 32

There are many ways to measure Earnings Per Share.

Question 33

A relatively new valuation technique that emphasizes the difference between a firm's operating profits and its cost of capital is called:

A) the discounted dividend model.
B) the capital asset pricing model.
C) economic value added model.
D) the market capitalization model.

Question 34

Value stocks, such as those considered the Dogs of the Dow, will generally have:

A) no dividend payments
B) a low P/E ratio
C) a low payout ratio
D) a high required return

Question 35

A firm has net income of $1 million with 250,000 shares outstanding with a total market value of $8 million. What is its P/E ratio?

A) 4
B) 8
C) 16
D) 32

Question 36

Which of the following models incorporates debt financing, including both the repayment and interest on existing debt as the sale of new debt, as well as preferred stock financing?

A) FCFE model
B) FCFF model
C) constant growth rate model
D) multiple growth rate model

Question 37

Economic value added is the difference between:

A) operating profits and cost of capital.
B) operating profits and cost of equity.
C) net profits and cost of capital.
D) net profits and cost of equity.

Question 38

Relatively small changes in inputs used in DDM can change the estimated value by large percentage amounts.

Question 39

A major difference between the dividend discount model (DDM) and the free cash flow to equity model (FCFE) is that the FCFE:

A) accounts for potential capital gains and the DDM does not.
B) measures what a firm could pay out in dividends and the DDM measures what is actually paid.
C) measures both dividend growth and stability and the DDM only measures the dividend growth.
D) bases its calculations on future value techniques while the DDM uses present value calculations.

Question 40

It is recommended that investors interested in the EVA approach should seek companies that have a return of capital in excess of ------- because this will likely exceed the cost of capital and the company is, therefore, adding value.

A) 10
B) 20
C) 30
D) 40

Question 41

If the growth rate in dividends is greater than the required rate of return, the price found under the constant growth model will be negative.

Question 42

Declining interest rates in the market should send P/E ratios, on average, higher.

Question 43

Why have dividends historically been important in the valuation of common stock?

Question 44

What variables must be estimated to use the dividend discount model? The P/E model?

Question 45

You calculate the intrinsic value of a stock to be $27. You check The Wall Street Journal and find the actual price to be $30. What could differ in your analysis and the market's valuation? If you are confident about your analysis, should you buy or not?

Question 46

EVA analysis reflects an emphasis on risk-adjusted return on capital.

Question 47

If the intrinsic value of stock is greater than the current stock price, the stock is overvalued and should be sold short.

Question 48

What are the implications for the usefulness of the P/E ratio if a company's earnings are very low (like a few cents) or negative?

Question 49

Relative valuation methods tend to be more sophisticated, more formal and less intuitive than discounted cash flow techniques.

Question 50

S&P's Outlook reports intrinsic value for stocks based on a combination of relative valuation and discounted cash flow analysis.

Question 51

The financial newscaster comments that the Stock X is overvalued at an earnings multiple of 60. What could cause a P/E this high?

Question 52

Unlike discounted cash flow techniques, relative valuation does not require comparatively strong assumptions about the inputs that lead to an estimate of stock value.

Question 53

Under the zero-growth dividend model, expected dividends are the same as current dividends.

Question 54

The higher the payout ratio, the higher the P/E is expected to be, other things being equal. However, other things might not be equal. Give an example of something that might not be equal and how it would affect the P/E.

Question 55

A number of companies that formerly experienced rapid growth were unable to sustain high growth rates. These companies included Cisco, Dell, Yahoo, and Google.

Question 56

Morningstar reports a "fair value" for stocks based on a relative valuation analysis.

Question 57

Companies with significant intangible assets on their balance sheets may receive a slightly lower P/E ratio versus companies with assets.

Question 58

The "New Economy" stocks of the 1990s, such as the experience of eToys, proved conclusively that old valuation principles do not apply today.

Question 59

You would expect a lower PSR for a retail company than for a biotechnology company.

Question 60

Other things equal, the higher the required return, the lower the P/E.

Question 61

Often "high-flyer" stocks have high P/E ratios, yet some analysts seek low P/E stocks. Are high or low P/E ratios more reliable as tools for valuation of stocks?

Question 62

Brotech Unlimited sells at $40 per share, and its latest 12 month earnings were $8 per share, of which $3.20 per share were paid as dividends.
(a) What is Brotech's current P/E ratio?
(b) If Brotech's earnings are expected to grow by 9 percent per year, what is the projected price for next year assuming that the P/E ratio remains constant?
(c) If you had a required rate of return of 15 percent, expected the dividend payout ratio to remain constant, and dividends to grow at a rate of 9 percent, would you buy this stock? Explain your answer.

Question 63

The Crazy Horse Corporation's stock is trading at $75. The firm paid out $2.20 in dividends during the last year. If the payout ratio of the firm is 45 percent, what is its price earnings ratio?

Question 64

Bronco Inc.'s common stock is currently selling for $42 and paying a dividend of $3. If the investors expect dividends to double in 8 years, what is the required rate of return for Western Inc?

Question 65

A. T. Edwards paid an annual dividend of $1.25 last year. Investors expect the dividends to grow at a rate of 6 percent per year over the foreseeable future. If the required rate of return for this stock is 12 percent, what is its intrinsic value today?

Question 66

Contemporary Casuals, Inc., (CCI) has a beta of 1.15, an expected dividend of $2.30, and an expected dividend growth rate of 5 percent for the foreseeable future. The S&P500 expected return is 18 percent, and the Treasury bill rate is 6 percent.
(a) Calculate the required return on Contemporary stock.
(b) Calculate the price of Contemporary stock.

Question 67

Why did investors favor large cap stocks in the mid to late 1990s?

Question 68

The current market price of the stock of a company, Stryker Ltd. is $30 per share. The dividends for the next year are expected to be $4.00 per share and the investor is confident that the selling price of the stock will be $35 at the end of one year. What is the implied rate of return assuming dividends are growing at a constant rate?