Equity Valuation Models

Multiple Choice Questions 1. ________ is equal to the total market value of the firm's common stock divided by (the replacement cost of the firm's assets less liabilities). A. Book value per share B. Liquidation value per share . !arket value per share D. "obin's # $. %one of the above. Book value per share is assets minus liabilities divided by number of shares. Liquidation value per share is the amount a shareholder &ould receive in the event of bankruptcy. !arket value per share is the market price of the stock.

Difficulty: Easy

'. (i)h *+$ ratios tend to indicate that a company &ill _______, ceteris paribus. A. )ro& quickly B. )ro& at the same speed as the avera)e company . )ro& slo&ly -. not )ro& $. none of the above .nvestors pay for )ro&th/ hence the hi)h *+$ ratio for )ro&th firms/ ho&ever, the investor should be sure that he or she is payin) for e0pected, not historic, )ro&th.

Difficulty: Easy

1121

3. _________ is equal to (common shareholders' equity+common shares outstandin)). A. Book value per share B. Liquidation value per share . !arket value per share -. "obin's # $. none of the above Book value per share is assets minus liabilities divided by number of shares. Liquidation value per share is the amount a shareholder &ould receive in the event of bankruptcy. !arket value per share is the market price of the stock.

Difficulty: Easy

4. ________ are analysts &ho use information concernin) current and prospective profitability of a firms to assess the firm's fair market value. A. redit analysts B. 5undamental analysts . 6ystems analysts -. "echnical analysts $. 6pecialists 5undamentalists use all public information in an attempt to value stock (&hile hopin) to identify undervalued securities).

Difficulty: Easy

112'

7. "he _______ is defined as the present value of all cash proceeds to the investor in the stock. A. dividend payout ratio B. intrinsic value . market capitali8ation rate -. plo&back ratio $. none of the above "he cash flo&s from the stock discounted at the appropriate rate, based on the perceived riskiness of the stock, the market risk premium and the risk free rate, determine the intrinsic value of the stock.

Difficulty: Easy

9. _______ is the amount of money per common share that could be reali8ed by breakin) up the firm, sellin) the assets, repayin) the debt, and distributin) the remainder to shareholders. A. Book value per share B. Liquidation value per share . !arket value per share -. "obin's # $. %one of the above Book value per share is assets minus liabilities divided by number of shares. Liquidation value per share is the amount a shareholder &ould receive in the event of bankruptcy. !arket value per share is the market price of the stock.

Difficulty: Easy

1123

:. 6ince 1;77, "reasury bond yields and earnin)s yields on stocks &ere _______. A. identical B. ne)atively correlated C. positively correlated -. uncorrelated "he earnin)s yield on stocks equals the e0pected real rate of return on the stock market, &hich should be equal to the yield to maturity on "reasury bonds plus a risk premium, &hich may chan)e slo&ly over time. "he yields are plotted in 5i)ure 11.1.

Difficulty: Easy

1. (istorically, *+$ ratios have tended to be _________. A. hi)her &hen inflation has been hi)h B. lo&er &hen inflation has been hi)h . uncorrelated &ith inflation rates but correlated &ith other macroeconomic variables -. uncorrelated &ith any macroeconomic variables includin) inflation rates $. none of the above *+$ ratios have tended to be lo&er &hen inflation has been hi)h, reflectin) the market's assessment that earnin)s in these periods are of <lo&er quality<, i.e., artificially distorted by inflation, and &arrantin) lo&er *+$ ratios.

Difficulty: Easy

;. "he ______ 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 capitali8ation rate -. plo&back rate $. none of the above "he market capitali8ation rate, &hich consists of the risk2free rate, the systematic risk of the stock and the market risk premium, is the rate at &hich a stock's cash flo&s are discounted in order to determine intrinsic value.

Difficulty: Easy

1124

1=. "he _________ is the fraction of earnin)s reinvested in the firm. A. dividend payout ratio B. retention rate . plo&back ratio -. A and E. B and >etention rate, or plo&back ratio, represents the earnin)s reinvested in the firm. "he retention rate, or (1 2 plo&back) ? dividend payout.

Difficulty: Easy

11. "he @ordon model A. is a )enerali8ation of the perpetuity formula to cover the case of a )ro&in) perpetuity. B. is valid only &hen g is less than k. . is valid only &hen k is less than g. D. A and B. $. A and . "he @ordon model assumes constant )ro&th indefinitely. !athematically, ) must be less than k/ other&ise, the intrinsic value is undefined.

Difficulty: Easy

1'. Aou &ish to earn a return of 13B on each of t&o stocks, C and A. 6tock C is e0pected to pay a dividend of D3 in the upcomin) year &hile 6tock A is e0pected to pay a dividend of D4 in the upcomin) year. "he e0pected )ro&th rate of dividends for both stocks is :B. "he intrinsic value of stock C ______. A. cannot be calculated &ithout kno&in) the market rate of return B. &ill be )reater than the intrinsic value of stock A . &ill be the same as the intrinsic value of stock A D. &ill be less than the intrinsic value of stock A $. none of the above is a correct ans&er. *E= ? -1+(k2))/ )iven k and ) are equal, the stock &ith the lar)er dividend &ill have the hi)her value.

Difficulty: Easy

1127

13. Aou &ish to earn a return of 11B on each of t&o stocks, and -. 6tock is e0pected to pay a dividend of D3 in the upcomin) year &hile 6tock - is e0pected to pay a dividend of D4 in the upcomin) year. "he e0pected )ro&th rate of dividends for both stocks is :B. "he intrinsic value of stock ______. A. &ill be )reater than the intrinsic value of stock B. &ill be the same as the intrinsic value of stock C. &ill be less than the intrinsic value of stock -. cannot be calculated &ithout kno&in) the market rate of return $. none of the above is a correct ans&er. *E= ? -1+(k2))/ )iven k and ) are equal, the stock &ith the lar)er dividend &ill have the hi)her value.

Difficulty: Easy

14. Aou &ish to earn a return of 1'B on each of t&o stocks, A and B. $ach of the stocks is e0pected to pay a dividend of D' in the upcomin) year. "he e0pected )ro&th rate of dividends is ;B for stock A and 1=B for stock B. "he intrinsic value of stock A _____. A. &ill be )reater than the intrinsic value of stock B B. &ill be the same as the intrinsic value of stock B C. &ill be less than the intrinsic value of stock B -. cannot be calculated &ithout kno&in) the rate of return on the market portfolio. $. none of the above is a correct statement. *E= ? -1+(k2))/ )iven that dividends are equal, the stock &ith the hi)her )ro&th rate &ill have the hi)her value.

Difficulty: Easy

1129

17. Aou &ish to earn a return of 1=B on each of t&o stocks, and -. $ach of the stocks is e0pected to pay a dividend of D' in the upcomin) year. "he e0pected )ro&th rate of dividends is ;B for stock and 1=B for stock -. "he intrinsic value of stock _____. A. &ill be )reater than the intrinsic value of stock B. &ill be the same as the intrinsic value of stock C. &ill be less than the intrinsic value of stock -. cannot be calculated &ithout kno&in) the rate of return on the market portfolio. $. none of the above is a correct statement. *E= ? -1+(k2))/ )iven that dividends are equal, the stock &ith the hi)her )ro&th rate &ill have the hi)her value.

Difficulty: Easy

19. $ach of t&o stocks, A and B, are e0pected to pay a dividend of D7 in the upcomin) year. "he e0pected )ro&th rate of dividends is 1=B for both stocks. Aou require a rate of return of 11B on stock A and a return of '=B on stock B. "he intrinsic value of stock A _____. A. &ill be )reater than the intrinsic value of stock B B. &ill be the same as the intrinsic value of stock B . &ill be less than the intrinsic value of stock B -. cannot be calculated &ithout kno&in) the market rate of return. $. none of the above is true. *E= ? -1+(k2))/ )iven that dividends are equal, the stock &ith the lar)er required return &ill have the lo&er value.

Difficulty: Easy

112:

1:. $ach of t&o stocks, and -, are e0pected to pay a dividend of D3 in the upcomin) year. "he e0pected )ro&th rate of dividends is ;B for both stocks. Aou require a rate of return of 1=B on stock and a return of 13B on stock -. "he intrinsic value of stock _____. A. &ill be )reater than the intrinsic value of stock B. &ill be the same as the intrinsic value of stock . &ill be less than the intrinsic value of stock -. cannot be calculated &ithout kno&in) the market rate of return. $. none of the above is true. *E= ? -1+(k2))/ )iven that dividends are equal, the stock &ith the lar)er required return &ill have the lo&er value.

Difficulty: Easy

11. .f the e0pected >F$ on reinvested earnin)s is equal to k, the multista)e --! reduces to A. E= ? ($0pected -ividend *er 6hare in Aear 1)+k B. E= ? ($0pected $*6 in Aear 1)+k . E= ? ("reasury Bond Aield in Aear 1)+k -. E= ? (!arket return in Aear 1)+k $. none of the above .f >F$ ? k, no )ro&th is occurrin)/ b ? =/ $*6 ? -*6

Difficulty: Moderate

1;. Lo& "ech ompany has an e0pected >F$ of 1=B. "he dividend )ro&th rate &ill be ________ if the firm follo&s a policy of payin) 4=B of earnin)s in the form of dividends. A. 9.=B B. 4.1B . :.'B -. 3.=B $. none of the above 1=B C =.9= ? 9.=B.

Difficulty: Easy

1121

'=. !usic -octors ompany has an e0pected >F$ of 14B. "he dividend )ro&th rate &ill be ________ if the firm follo&s a policy of payin) 9=B of earnin)s in the form of dividends. A. 4.1B B. 7.9B . :.'B -. 9.=B $. none of the above 14B C =.4= ? 7.9B.

Difficulty: Easy

'1. !edtronic ompany has an e0pected >F$ of 19B. "he dividend )ro&th rate &ill be ________ if the firm follo&s a policy of payin) :=B of earnin)s in the form of dividends. A. 3.=B B. 9.=B . :.'B D. 4.1B $. none of the above 19B C =.3= ? 4.1B.

Difficulty: Easy

''. (i)h 6peed ompany has an e0pected >F$ of 17B. "he dividend )ro&th rate &ill be ________ if the firm follo&s a policy of payin) 7=B of earnin)s in the form of dividends. A. 3.=B B. 4.1B C. :.7B -. 9.=B $. none of the above 17B C =.7= ? :.7B.

Difficulty: Easy

112;

'3. Li)ht onstruction !achinery ompany has an e0pected >F$ of 11B. "he dividend )ro&th rate &ill be _______ if the firm follo&s a policy of payin) '7B of earnin)s in the form of dividends. A. 3.=B B. 4.1B C. 1.'7B -. ;.=B $. none of the above 11B C =.:7 ? 1.'7B.

Difficulty: Easy

'4. Clink ompany has an e0pected >F$ of 17B. "he dividend )ro&th rate &ill be _______ if the firm follo&s a policy of plo&in) back :7B of earnin)s. A. 3.:7B B. 11.'7B . 1.'7B -. 17.=B $. none of the above 17B C =.:7 ? 11.'7B.

Difficulty: Easy

'7. "hink "ank ompany has an e0pected >F$ of '9B. "he dividend )ro&th rate &ill be _______ if the firm follo&s a policy of plo&in) back ;=B of earnin)s. A. '.9B B. 1=B C. '3.4B -. ;=B $. none of the above '9B C =.;= ? '3.4B.

Difficulty: Easy

1121=

'9. Bubba @umm ompany has an e0pected >F$ of ;B. "he dividend )ro&th rate &ill be _______ if the firm follo&s a policy of plo&in) back 1=B of earnin)s. A. ;=B B. 1=B . ;B D. =.;B $. none of the above ;B C =.1= ? =.;B.

Difficulty: Easy

':. A preferred stock &ill pay a dividend of D'.:7 in the upcomin) year, and every year thereafter, i.e., dividends are not e0pected to )ro&. Aou require a return of 1=B on this stock. Gse the constant )ro&th --! to calculate the intrinsic value of this preferred stock. A. D=.':7 B. D':.7= . D31.1' -. D79.'7 $. none of the above '.:7 + .1= ? ':.7=

Difficulty: Moderate

'1. A preferred stock &ill pay a dividend of D3.==in the upcomin) year, and every year thereafter, i.e., dividends are not e0pected to )ro&. Aou require a return of ;B on this stock. Gse the constant )ro&th --! to calculate the intrinsic value of this preferred stock. A. D33.33 B. D=..': . D31.1' -. D79.'7 $. none of the above 3.== + .=; ? 33.33

Difficulty: Moderate

11211

';. A preferred stock &ill pay a dividend of D1.'7 in the upcomin) year, and every year thereafter, i.e., dividends are not e0pected to )ro&. Aou require a return of 1'B on this stock. Gse the constant )ro&th --! to calculate the intrinsic value of this preferred stock. A. D11.79 B. D;.97 . D11.1' D. D1=.4' $. none of the above 1.'7 + .1' ? 1=.4'

Difficulty: Moderate

3=. A preferred stock &ill pay a dividend of D3.7= in the upcomin) year, and every year thereafter, i.e., dividends are not e0pected to )ro&. Aou require a return of 11B on this stock. Gse the constant )ro&th --! to calculate the intrinsic value of this preferred stock. A. D=.3; B. D=.79 C. D31.1' -. D79.'7 $. none of the above 3.7= + .11 ? 31.1'

Difficulty: Moderate

31. A preferred stock &ill pay a dividend of D:.7= in the upcomin) year, and every year thereafter, i.e., dividends are not e0pected to )ro&. Aou require a return of 1=B on this stock. Gse the constant )ro&th --! to calculate the intrinsic value of this preferred stock. A. D=.:7 B. D:.7= . D94.1' -. D79.'7 E. none of the above :.7= + .1= ? :7.==

Difficulty: Moderate

1121'

3'. A preferred stock &ill pay a dividend of D9.== in the upcomin) year, and every year thereafter, i.e., dividends are not e0pected to )ro&. Aou require a return of 1=B on this stock. Gse the constant )ro&th --! to calculate the intrinsic value of this preferred stock. A. D=.9= B. D9.== . D9== -. D7.4= E. none of the above 9.== + .1= ? 9=.==

Difficulty: Moderate

33. Aou are considerin) acquirin) a common stock that you &ould like to hold for one year. Aou e0pect to receive both D1.'7 in dividends and D3' from the sale of the stock at the end of the year. "he ma0imum price you &ould pay for the stock today is _____ if you &anted to earn a 1=B return. A. D3=.'3 B. D'4.11 . D'9.7' -. D':.7= $. none of the above .1= ? (3' 2 * H 1.'7) + */ .1=* ? 3' 2 * H 1.'7/ 1.1=* ? 33.'7/ * ? 3=.'3.

Difficulty: Moderate

11213

34. Aou are considerin) acquirin) a common stock that you &ould like to hold for one year. Aou e0pect to receive both D=.:7 in dividends and D19 from the sale of the stock at the end of the year. "he ma0imum price you &ould pay for the stock today is _____ if you &anted to earn a 1'B return. A. D'3.;1 B. D14.;9 . D'9.7' -. D':.7= $. none of the above .1' ? (19 2 * H =.:7) + */ .1'* ? 19 2 * H =.:7/ 1.1'* ? 19.:7/ * ? 14.;9.

Difficulty: Moderate

37. Aou are considerin) acquirin) a common stock that you &ould like to hold for one year. Aou e0pect to receive both D'.7= in dividends and D'1 from the sale of the stock at the end of the year. "he ma0imum price you &ould pay for the stock today is _____ if you &anted to earn a 17B return. A. D'3.;1 B. D'4.11 C. D'9.7' -. D':.7= $. none of the above .17 ? ('1 2 * H '.7=) + */ .17* ? '1 2 * H '.7=/ 1.17* ? 3=.7=/ * ? '9.7'.

Difficulty: Moderate

11214

39. Aou are considerin) acquirin) a common stock that you &ould like to hold for one year. Aou e0pect to receive both D3.7= in dividends and D4' from the sale of the stock at the end of the year. "he ma0imum price you &ould pay for the stock today is _____ if you &anted to earn a 1=B return. A. D'3.;1 B. D'4.11 . D'9.7' -. D':.7= E. none of the above .1= ? (4' 2 * H 3.7=) + */ .1=* ? 4' 2 * H 3.7=/ 1.1* ? 47.7=/ * ? 41.39.

Difficulty: Moderate

*aper $0press ompany has a balance sheet &hich lists D17 million in assets, D4= million in liabilities and D47 million in common shareholders' equity. .t has 1,4==,=== common shares outstandin). "he replacement cost of the assets is D117 million. "he market share price is D;=.

3:. Ihat is *aper $0press's book value per shareJ A. D1.91 B. D'.9= C. D3'.14 -. D9=.:1 $. none of the above D47!+1.4! ? D3'.14.

Difficulty: Moderate

11217

31. Ihat is *aper $0press's market value per shareJ A. D1.91 B. D'.9= . D3'.14 -. D9=.:1 E. none of the above "he price of D;=.

Difficulty: Easy

3;. Ihat is *aper $0press's replacement cost per shareJ A. D1.91 B. D'.9= C. D73.7: -. D9=.:1 $. none of the above D117! 2 4=!+1.4! ? D73.7:.

Difficulty: Moderate

4=. Ihat is *aper $0press's "obin's qJ A. 1.91 B. '.9= . 73.7: -. 9=.:1 $. none of the above D;=+ 73.7: ? 1.91

Difficulty: Moderate

11219

41. Fne of the problems &ith attemptin) to forecast stock market values is that A. there are no variables that seem to predict market return. B. the earnin)s multiplier approach can only be used at the firm level. C. the level of uncertainty surroundin) the forecast &ill al&ays be quite hi)h. -. dividend payout ratios are hi)hly variable. $. none of the above. Althou)h some variables such as market dividend yield appear to be stron)ly related to market return, the market has )reat variability and so the level of uncertainty in any forecast &ill be hi)h.

Difficulty: Easy

4'. "he most popular approach to forecastin) the overall stock market is to use A. the dividend multiplier. B. the a))re)ate return on assets. . the historical ratio of book value to market value. D. the a))re)ate earnin)s multiplier. $. "obin's #. "he earnin)s multiplier approach is the most popular approach to forecastin) the overall stock market.

Difficulty: Easy

6ure "ool ompany is e0pected to pay a dividend of D' in the upcomin) year. "he risk2free rate of return is 4B and the e0pected return on the market portfolio is 14B. Analysts e0pect the price of 6ure "ool ompany shares to be D'' a year from no&. "he beta of 6ure "ool ompany's stock is 1.'7.

1121:

43. "he market's required rate of return on 6ure's stock is _____. A. 14.=B B. 1:.7B C. 19.7B -. 17.'7B $. none of the above 4B H 1.'7(14B 2 4B) ? 19.7B.

Difficulty: Moderate

44. Ihat is the intrinsic value of 6ure's stock todayJ A. D'=.9= B. D'=.== . D1'.1' -. D''.== $. none of the above k ? .=4 H 1.'7 (.14 2 .=4)/ k ? .197/ .197 ? ('' 2 * H ') + */ .197* ? '4 2 */ 1.197* ? '4 / * ? '=.9=.

Difficulty: Difficult

47. .f 6ure's intrinsic value is D'1.== today, &hat must be its )ro&th rateJ A. =.=B B. 1=B . 4B -. 9B E. :B k ? .=4 H 1.'7 (.14 2 .=4)/ k ? .197/ .197 ? '+'1 H )/ ) ? .=:

Difficulty: Difficult

11211

"orque orporation is e0pected to pay a dividend of D1.== in the upcomin) year. -ividends are e0pected to )ro& at the rate of 9B per year. "he risk2free rate of return is 7B and the e0pected return on the market portfolio is 13B. "he stock of "orque orporation has a beta of 1.'.

49. Ihat is the return you should require on "orque's stockJ A. 1'.=B B. 14.9B . 17.9B -. '=B $. none of the above 7B H 1.'(13B 2 7B) ? 14.9B.

Difficulty: Moderate

4:. Ihat is the intrinsic value of "orque's stockJ A. D14.'; B. D14.9= . D1'.33 D. D11.9' $. none of the above k ? 7B H 1.'(13B 2 7B) ? 14.9B/ * ? 1 + (.149 2 .=9) ? D11.9'.

Difficulty: Difficult

1121;

41. !id&est Airline is e0pected to pay a dividend of D: in the comin) year. -ividends are e0pected to )ro& at the rate of 17B per year. "he risk2free rate of return is 9B and the e0pected return on the market portfolio is 14B. "he stock of !id&est Airline has a beta of 3.==. "he return you should require on the stock is ________. A. 1=B B. 11B C. 3=B -. 4'B $. none of the above 9B H 3(14B 2 9B) ? 3=B.

Difficulty: Moderate

4;. 5ools @old !inin) ompany is e0pected to pay a dividend of D1 in the upcomin) year. -ividends are e0pected to decline at the rate of 'B per year. "he risk2free rate of return is 9B and the e0pected return on the market portfolio is 14B. "he stock of 5ools @old !inin) ompany has a beta of 2=.'7. "he return you should require on the stock is ________. A. 'B B. 4B . 9B -. 1B $. none of the above 9B H K2=.'7(14B 2 9B)L ? 4B.

Difficulty: Moderate

112'=

7=. (i)h "ech hip ompany is e0pected to have $*6 in the comin) year of D'.7=. "he e0pected >F$ is 1'.7B. An appropriate required return on the stock is 11B. .f the firm has a plo&back ratio of :=B, the )ro&th rate of dividends should be A. 7.==B B. 9.'7B . 9.9=B -. :.7=B E. 1.:7B 1'.7B C =.: ? 1.:7B.

Difficulty: Easy

71. A company paid a dividend last year of D1.:7. "he e0pected >F$ for ne0t year is 14.7B. An appropriate required return on the stock is 1=B. .f the firm has a plo&back ratio of :7B, the dividend in the comin) year should be A. D1.1= B. D'.1' . D1.:: D. D1.;4 $. none of the above ) ? .177 C .:7 ? 1=.1:7B/ D1.:7(1.1=1:7) ? D1.;4

Difficulty: Moderate

7'. (i)h "ech hip ompany paid a dividend last year of D'.7=. "he e0pected >F$ for ne0t year is 1'.7B. An appropriate required return on the stock is 11B. .f the firm has a plo&back ratio of 9=B, the dividend in the comin) year should be A. D1.== B. D'.7= C. D'.9; -. D'.11 $. none of the above ) ? .1'7 C .9 ? :.7B/ D'.7=(1.=:7) ? D'.9;

Difficulty: Moderate

112'1

73. 6uppose that the avera)e *+$ multiple in the oil industry is '=. -ominion Fil is e0pected to have an $*6 of D3.== in the comin) year. "he intrinsic value of -ominion Fil stock should be _____. A. D'1.1' B. D37.77 C. D9=.== -. D:'.== $. none of the above '= C D3.== ? D9=.==.

Difficulty: Easy

74. 6uppose that the avera)e *+$ multiple in the oil industry is ''. $00on Fil is e0pected to have an $*6 of D1.7= in the comin) year. "he intrinsic value of $00on Fil stock should be _____. A. D33.== B. D37.77 . D93.== -. D:'.== $. none of the above '' C D1.7= ? D33.==.

Difficulty: Easy

77. 6uppose that the avera)e *+$ multiple in the oil industry is 19. !obil Fil is e0pected to have an $*6 of D4.7= in the comin) year. "he intrinsic value of !obil Fil stock should be _____. A. D'1.1' B. D37.77 . D93.== D. D:'.== $. none of the above 19 C D4.7= ? D:'.==.

Difficulty: Easy

112''

79. 6uppose that the avera)e *+$ multiple in the )as industry is 1:. M!* is e0pected to have an $*6 of D7.7= in the comin) year. "he intrinsic value of M!* stock should be _____. A. D'1.1' B. D;3.7= . D93.== -. D:'.== $. none of the above 1: C D7.7= ? D;3.7=.

Difficulty: Easy

7:. An analyst has determined that the intrinsic value of (*# stock is D'= per share usin) the capitali8ed earnin)s model. .f the typical *+$ ratio in the computer industry is '7, then it &ould be reasonable to assume the e0pected $*6 of (*# in the comin) year is ______. A. D3.93 B. D4.44 C. D=.1= -. D''.7= $. none of the above D'=(1+'7) ? D=.1=.

Difficulty: Easy

71. An analyst has determined that the intrinsic value of -ell stock is D34 per share usin) the capitali8ed earnin)s model. .f the typical *+$ ratio in the computer industry is ':, then it &ould be reasonable to assume the e0pected $*6 of -ell in the comin) year is ______. A. D3.93 B. D4.44 . D14.4= D. D1.'9 $. none of the above D34(1+':) ? D1.'9.

Difficulty: Easy

112'3

7;. An analyst has determined that the intrinsic value of .B! stock is D1= per share usin) the capitali8ed earnin)s model. .f the typical *+$ ratio in the computer industry is '', then it &ould be reasonable to assume the e0pected $*6 of .B! in the comin) year is ______. A. D3.94 B. D4.44 . D14.4= -. D''.7= $. none of the above D1=(1+'') ? D3.94.

Difficulty: Easy

9=. Fld #uart8 @old !inin) ompany is e0pected to pay a dividend of D1 in the comin) year. -ividends are e0pected to decline at the rate of 'B per year. "he risk2free rate of return is 9B and the e0pected return on the market portfolio is 14B. "he stock of Fld #uart8 @old !inin) ompany has a beta of 2=.'7. "he intrinsic value of the stock is ______. A. D1=.== B. 133.33 . D'==.== -. D4==.== $. none of the above k ? 9B H K2=.'7(14B 2 9B)L ? 4B/ * ? 1 + K.=4 2 (2.=')L ? D133.33.

Difficulty: Difficult

112'4

91. Lo& 5ly Airline is e0pected to pay a dividend of D: in the comin) year. -ividends are e0pected to )ro& at the rate of 17B per year. "he risk2free rate of return is 9B and the e0pected return on the market portfolio is 14B. "he stock of lo& 5ly Airline has a beta of 3.==. "he intrinsic value of the stock is ______. A. D49.9: B. D7=.== . D79.== -. D9'.7= $. none of the above 9B H 3(14B 2 9B) ? 3=B/ * ? : + (.3= 2 .17) ? D49.9:.

Difficulty: Moderate

9'. 6unshine orporation is e0pected to pay a dividend of D1.7= in the upcomin) year. -ividends are e0pected to )ro& at the rate of 9B per year. "he risk2free rate of return is 9B and the e0pected return on the market portfolio is 14B. "he stock of 6unshine orporation has a beta of =.:7. "he intrinsic value of the stock is _______. A. D1=.:1 B. D17.== . D1:.:7 D. D'7.== $. none of the above 9B H =.:7(14B 2 9B) ? 1'B/ * ? 1.7= + (.1' 2 .=9) ? D'7.

Difficulty: Moderate

112'7

93. Lo& "ech hip ompany is e0pected to have $*6 in the comin) year of D'.7=. "he e0pected >F$ is 14B. An appropriate required return on the stock is 11B. .f the firm has a dividend payout ratio of 4=B, the intrinsic value of the stock should be A. D''.:3 B. D':.7= . D'1.7: D. D31.49 $. none of the above ) ? 14B C =.9 ? 1.4B/ $0pected -*6 ? D'.7=(=.4) ? D1.==/ * ? 1 + (.11 2 .=14) ? D31.49.

Difficulty: Difficult

>isk !etrics ompany is e0pected to pay a dividend of D3.7= in the comin) year. -ividends are e0pected to )ro& at a rate of 1=B per year. "he risk2free rate of return is 7B and the e0pected return on the market portfolio is 13B. "he stock is tradin) in the market today at a price of D;=.==.

94. Ihat is the market capitali8ation rate for >isk !etricsJ A. 13.9B B. 13.;B . 17.9B -. 19.;B $. none of the above k ? 3.7= + ;= H .1=/ k ? 13.;B

Difficulty: Moderate

112'9

97. Ihat is the appro0imate beta of >isk !etrics's stockJ A. =.1 B. 1.= C. 1.1 -. 1.4 $. none of the above k ? 13.;B from 11.94/ 13.; ? 7B H b(13B 2 7B) ? 1.11.

Difficulty: Difficult

99. "he market capitali8ation rate on the stock of 5le0steel ompany is 1'B. "he e0pected >F$ is 13B and the e0pected $*6 are D3.9=. .f the firm's plo&back ratio is 7=B, the *+$ ratio &ill be _________. A. :.9; B. 1.33 C. ;.=; -. 11.11 $. none of the above ) ? 13B C =.7 ? 9.7B/ .7+(.1' 2 .=97) ? ;.=;

Difficulty: Difficult

9:. "he market capitali8ation rate on the stock of 5le0steel ompany is 1'B. "he e0pected >F$ is 13B and the e0pected $*6 are D3.9=. .f the firm's plo&back ratio is :7B, the *+$ ratio &ill be ________. A. :.9; B. 1.33 . ;.=; D. 11.11 $. none of the above ) ? 13B C =.:7 ? ;.:7B/ .'7+(.1' 2 .=;:7) ? 11.11

Difficulty: Difficult

112':

91. "he market capitali8ation rate on the stock of 5ast @ro&in) ompany is '=B. "he e0pected >F$ is ''B and the e0pected $*6 are D9.1=. .f the firm's plo&back ratio is ;=B, the *+$ ratio &ill be ________. A. :.9; B. 1.33 . ;.=; -. 11.11 E. 7= ) ? ''B C =.;= ? 1;.1B/ .1+(.'= 2 .1;1) ? 7=

Difficulty: Difficult

9;. N. . *enney ompany is e0pected to pay a dividend in year 1 of D1.97, a dividend in year ' of D1.;:, and a dividend in year 3 of D'.74. After year 3, dividends are e0pected to )ro& at the rate of 1B per year. An appropriate required return for the stock is 11B. "he stock should be &orth _______ today. A. D33.== B. D4=.9: C. D::.73 -. D99.== $. none of the above alculations are sho&n in the table belo&.

*3 ? D'.74(1.=1) + (.11 2 .=1) ? D;1.44/ *E of *3 ? D;1.44+(1.=1)3 ? D:'.711=/ *F ? D4.;4 H D:'.7; ? D::.73.

Difficulty: Difficult

112'1

:=. $0ercise Bicycle ompany is e0pected to pay a dividend in year 1 of D1.'=, a dividend in year ' of D1.7=, and a dividend in year 3 of D'.==. After year 3, dividends are e0pected to )ro& at the rate of 1=B per year. An appropriate required return for the stock is 14B. "he stock should be &orth _______ today. A. D33.== B. D3;.19 . D77.== -. D99.== E. D4=.91 alculations are sho&n in the table belo&.

*3 ? ' (1.1=) + (.14 2 .1=) ? D77.==/ *E of *3 ? D77+(1.14)3 ? D3:.1'/ *F ? D3.79 H D3:.1' ? D4=.91.

Difficulty: Difficult

112';

:1. Antiquated *roducts orporation produces )oods that are very mature in their product life cycles. Antiquated *roducts orporation is e0pected to pay a dividend in year 1 of D1.==, a dividend of D=.;= in year ', and a dividend of D=.17 in year 3. After year 3, dividends are e0pected to decline at a rate of 'B per year. An appropriate required rate of return for the stock is 1B. "he stock should be &orth ______. A. D1.4; B. D1=.7: . D'=.== -. D''.'' $. none of the above alculations are sho&n belo&.

*3 ? =.17(.;1) + K.=1 2 (2.=')L ? D1.33/ *E of *3 ? D1.33+(1.=1)3 ? D9.1''9/ *F ? D9.1''9 H D'.3:'3 ? D1.4;.

Difficulty: Difficult

1123=

:'. !ature *roducts orporation produces )oods that are very mature in their product life cycles. !ature *roducts orporation is e0pected to pay a dividend in year 1 of D'.==, a dividend of D1.7= in year ', and a dividend of D1.== in year 3. After year 3, dividends are e0pected to decline at a rate of 1B per year. An appropriate required rate of return for the stock is 1=B. "he stock should be &orth ______. A. D;.== B. D1=.7: . D'=.== -. D''.'' $. none of the above alculations are sho&n belo&.

*3 ? 1.==(.;;) + K.1= 2 (2.=1)L ? D;.==/ *E of *3 ? D;+(1.1=)3 ? D9.:911/ *F ? D9.:911 H D3.1=;' ? D1=.7:.

Difficulty: Difficult

11231

:3. onsider the free cash flo& approach to stock valuation. Gtica !anufacturin) ompany is e0pected to have before2ta0 cash flo& from operations of D7==,=== in the comin) year. "he firm's corporate ta0 rate is 3=B. .t is e0pected that D'==,=== of operatin) cash flo& &ill be invested in ne& fi0ed assets. -epreciation for the year &ill be D1==,===. After the comin) year, cash flo&s are e0pected to )ro& at 9B per year. "he appropriate market capitali8ation rate for unlevera)ed cash flo& is 17B per year. "he firm has no outstandin) debt. "he proOected free cash flo& of Gtica !anufacturin) ompany for the comin) year is _______. A. D17=,=== B. D11=,=== . D3==,=== -. D31=,=== $. none of the above alculations are sho&n belo&.

Difficulty: Difficult

1123'

:4. onsider the free cash flo& approach to stock valuation. Gtica !anufacturin) ompany is e0pected to have before2ta0 cash flo& from operations of D7==,=== in the comin) year. "he firm's corporate ta0 rate is 3=B. .t is e0pected that D'==,=== of operatin) cash flo& &ill be invested in ne& fi0ed assets. -epreciation for the year &ill be D1==,===. After the comin) year, cash flo&s are e0pected to )ro& at 9B per year. "he appropriate market capitali8ation rate for unlevera)ed cash flo& is 17B per year. "he firm has no outstandin) debt. "he total value of the equity of Gtica !anufacturin) ompany should be A. D1,===,=== B. D',===,=== . D3,===,=== -. D4,===,=== $. none of the above *roOected free cash flo& ? D11=,=== (see test bank problem 11.:3)/ E= ? 11=,=== + (.17 2 .=9) ? D',===,===.

Difficulty: Difficult

:7. A firm's earnin)s per share increased from D1= to D1', dividends increased from D4.== to D4.1=, and the share price increased from D1= to D;=. @iven this information, it follo&s that ________. A. the stock e0perienced a drop in the *+$ ratio B. the firm had a decrease in dividend payout ratio . the firm increased the number of shares outstandin) -. the required rate of return decreased $. none of the above D1=+D1= ? 1/ D;=+D1' ? :.7.

Difficulty: Moderate

11233

:9. .n the dividend discount model, _______ &hich of the follo&in) are not incorporated into the discount rateJ A. real risk2free rate B. risk premium for stocks C. return on assets -. e0pected inflation rate $. none of the above A, B, and - are incorporated into the discount rate used in the dividend discount model.

Difficulty: Moderate

::. A company &hose stock is sellin) at a *+$ ratio )reater than the *+$ ratio of a market inde0 most likely has _________. A. an anticipated earnin)s )ro&th rate &hich is less than that of the avera)e firm B. a dividend yield &hich is less than that of the avera)e firm . less predictable earnin)s )ro&th than that of the avera)e firm -. )reater cyclicality of earnin)s )ro&th than that of the avera)e firm $. none of the above. 5irms &ith lo&er than avera)e dividend yields are usually )ro&th firms, &hich have a hi)her *+$ ratio than avera)e.

Difficulty: Moderate

:1. Ihich of the follo&in) &ould tend to reduce a firm's *+$ ratioJ A. "he firm si)nificantly decreases financial levera)e B. "he firm increases return on equity for the lon) term C. "he level of inflation is e0pected to increase to double2di)it levels -. "he rate of return on "reasury bills decreases $. %one of the above .n times of hi)h inflation, earnin)s are inflated/ thus, *+$ ratios decline.

Difficulty: Moderate

11234

:;. Fther thin)s bein) equal, a lo& ________ &ould be most consistent &ith a relatively hi)h )ro&th rate of firm earnin)s and dividends. A. dividend payout ratio B. de)ree of financial levera)e . variability of earnin)s -. inflation rate $. none of the above 5irms &ith hi)h )ro&th rates are retainin) most of the earnin)s for )ro&th/ thus, the dividend payout ratio &ill be lo&.

Difficulty: Moderate

1=. A firm has a return on equity of 14B and a dividend payout ratio of 9=B. "he firm's anticipated )ro&th rate is _________. A. 7.9B B. 1=B . 14B -. '=B $. none of the above 14B C =.4= ? 7.9B.

Difficulty: Easy

11. A firm has a return on equity of '=B and a dividend payout ratio of 3=B. "he firm's anticipated )ro&th rate is _________. A. 9B B. 1=B C. 14B -. '=B $. none of the above '=B C =.:= ? 14B.

Difficulty: Easy

11237

1'. 6ales ompany paid a D1.== dividend per share last year and is e0pected to continue to pay out 4=B of earnin)s as dividends for the foreseeable future. .f the firm is e0pected to )enerate a 1=B return on equity in the future, and if you require a 1'B return on the stock, the value of the stock is ________. A. D1:.9: B. D13.== . D19.9: -. D11.9: $. none of the above ) ? 1=B C =.9 ? 9B/ * ? 1 (1.=9) + (.1' 2 .=9) ? D1:.9:.

Difficulty: Moderate

13. Assume that at the end of the ne0t year, Bolton ompany &ill pay a D'.== dividend per share, an increase from the current dividend of D1.7= per share. After that, the dividend is e0pected to increase at a constant rate of 7B. .f you require a 1'B return on the stock, the value of the stock is ________. A. D'1.7: B. D'1.:; . D3=.== -. D31.:1 $. none of the above *1 ? ' (1.=7) + (.1' 2 .=7) ? D3=.==/ *E of *1 ? D3=+1.1' ? D'9.:1/ *E of -1 ? '+1.1' ? 1.:;/ *F ? D'9.:1 H D1.:; ? D'1.7:.

Difficulty: Difficult

11239

14. "he )ro&th in dividends of !usic -octors, .nc. is e0pected to be 1B+year for the ne0t t&o years, follo&ed by a )ro&th rate of 4B+year for three years/ after this five year period, the )ro&th in dividends is e0pected to be 3B+year, indefinitely. "he required rate of return on !usic -octors, .nc. is 11B. Last year's dividends per share &ere D'.:7. Ihat should the stock sell for todayJ A. D1.;; B. D'7.'1 C. D43.:9 -. D11=.== $. none of the above alculations are sho&n belo&.

*7 ? 3.:194 + (.11 2 .=3) ? D49.4744/ *E of *7 ? D49.4744+(1.=1)7 ? D31.9191/ *F ? D1'.144; H D31.93 ? D43.:9

Difficulty: Difficult

1123:

17. "he )ro&th in dividends of AB , .nc. is e0pected to be 17B+year for the ne0t three years, follo&ed by a )ro&th rate of 1B+year for t&o years/ after this five year period, the )ro&th in dividends is e0pected to be 3B+year, indefinitely. "he required rate of return on AB , .nc. is 13B. Last year's dividends per share &ere D1.17. Ihat should the stock sell for todayJ A. D1.;; B. D'7.'1 . D4=.== D. D':.:4 $. none of the above alculations are sho&n belo&.

Difficulty: Difficult

11231

19. "he )ro&th in dividends of CAP, .nc. is e0pected to be 1=B+year for the ne0t t&o years, follo&ed by a )ro&th rate of 7B+year for three years/ after this five year period, the )ro&th in dividends is e0pected to be 'B+year, indefinitely. "he required rate of return on CAP, .nc. is 1'B. Last year's dividends per share &ere D'.==. Ihat should the stock sell for todayJ A. D1.;; B. D'7.'1 . D4=.== -. D11=.== $. none of the above alculations are sho&n belo&.

*7 ? '.1= (1.=') + (.1' 2 .=') ? D'1.79/ *E of *7 ? D'1.79+(1.1')7 ? D19.'1/ *F ? D19.'= H D1.;; ? D'7.'1.

Difficulty: Difficult

1:. .f a firm's required rate of return equals the firm's return on equity, there is no advanta)e to increasin) the firm's )ro&th. 6uppose a no2)ro&th firm had a required rate of return and a >F$ of 1'B and a stock price of D4=. (o&ever, if the firm is able to increase the >F$ to 17B &ith a plo&back ratio of 7=B, &hat is the present value of )ro&th opportunities no&J (Last year's dividends &ere D'.==+share). A. D;.:1 B. D:.:1 . D1=.:1 -. D1'.:1 $. none of the above ) ? =.7= 0 17B ? :.7B/ *= ? ' (1.=:7) + (.1' 2 .=:7) ? D4:.:1/ D4:.:1 2 D4=.== ? D:.:1.

Difficulty: Difficult

1123;

11. .f a firm has a required rate of return equal to the >F$ A. the firm can increase market price and *+$ by retainin) more earnin)s. B. the firm can increase market price and *+$ by increasin) the )ro&th rate. C. the amount of earnin)s retained by the firm does not affect market price or the *+$. -. A and B. $. none of the above. .f required return and >F$ are equal, investors are indifferent as to &hether the firm retains more earnin)s or increases dividends. "hus, retention rates and )ro&th rates do not affect market price and *+$.

Difficulty: Easy

1;. Accordin) to Names "obin, the lon) run value of "obin's # should tend to&ard A. =. B. 1. . '. -. infinity. $. none of the above. Accordin) to "obin, in the lon) run the ratio of market price to replacement cost should tend to&ard 1.

Difficulty: Easy

;=. "he )oal of fundamental analysts is to find securities A. &hose intrinsic value e0ceeds market price. B. &ith a positive present value of )ro&th opportunities. . &ith hi)h market capitali8ation rates. -. all of the above. $. none of the above. "he )oal of analysts is to find an undervalued security.

Difficulty: Easy

1124=

;1. "he dividend discount model A. i)nores capital )ains. B. incorporates the after2ta0 value of capital )ains. C. includes capital )ains implicitly. -. restricts capital )ains to a minimum. $. none of the above. "he --! includes capital )ains implicitly, as the sellin) price at any point is based on the forecast of future dividends.

Difficulty: Moderate

;'. !any stock analysts assume that a mispriced stock &ill A. immediately return to its intrinsic value. B. return to its intrinsic value &ithin a fe& days. . never return to its intrinsic value. D. )radually approach its intrinsic value over several years. $. none of the above. !any analysts assume that mispricin)s may take several years to )radually correct.

Difficulty: Moderate

;3. .nvestors &ant hi)h plo&back ratios A. for all firms. B. &henever >F$ Q k. . &henever k Q >F$. -. only &hen they are in lo& ta0 brackets. $. &henever bank interest rates are hi)h. .nvestors prefer that firms reinvest earnin)s &hen >F$ e0ceeds k.

Difficulty: Easy

11241

;4. Because the --! requires multiple estimates, investors should A. carefully e0amine inputs to the model. B. perform sensitivity analysis on price estimates. . not use this model &ithout e0pert assistance. -. feel confident that --! estimates are correct. E. both A and B. 6mall errors in input estimates can result in lar)e pricin) errors usin) the --!. "herefore, investors should carefully e0amine input estimates and perform sensitivity analysis on the results.

Difficulty: Easy

;7. Accordin) to *eter Lynch, a rou)h rule of thumb for security analysis is that A. the )ro&th rate should be equal to the plo&back rate. B. the )ro&th rate should be equal to the dividend payout rate. . the )ro&th rate should be lo& for emer)in) industries. D. the )ro&th rate should be equal to the *+$ ratio. $. none of the above. A rou)h )uideline is that *+$ ratios should equal )ro&th rates in dividends or earnin)s.

Difficulty: Moderate

;9. 5or most firms, *+$ ratios and risk A. &ill be directly related. B. &ill have an inverse relationship. . &ill be unrelated. -. &ill both increase as inflation increases. $. none of the above. .n the conte0t of the constant )ro&th model, the hi)her the risk of the firm the lo&er its *+$ ratio.

Difficulty: Moderate

1124'

;:. -ividend discount models and *+$ ratios are used by __________ to try to find mispriced securities. A. technical analysts B. statistical analysts C. fundamental analysts -. dividend analysts $. psychoanalysts 5undamental analysts look at the basic features of the firm to estimate firm value.

Difficulty: Easy

;1. Ihich of the follo&in) is the best measure of the floor for a stock priceJ A. book value B. liquidation value . replacement cost -. market value $. "obin's # .f the firm's market value drops belo& the liquidation value the firm &ill be a possible takeover tar)et. .t &ould be &orth more liquidated than as a )oin) concern.

Difficulty: Easy

;;. Iho populari8ed the dividend discount model, &hich is sometimes referred to by his nameJ A. Burton !alkiel B. 5rederick !acaulay . (arry !arko&it8 -. !arshall Blume E. !yron @ordon "he dividend discount model is also called the @ordon model.

Difficulty: Easy

11243

1==. .f a firm follo&s a lo&2investment2rate plan (applies a lo& plo&back ratio), its dividends &ill be _______ no& and _______ in the future than a firm that follo&s a hi)h2reinvestment2 rate plan. A. hi)her, hi)her B. lo&er, lo&er . lo&er, hi)her D. hi)her, lo&er $. .t is not possible to tell. By retainin) less of its income for plo&back, the firm is able to pay more dividends initially. But this &ill lead to a lo&er )ro&th rate for dividends and a lo&er level of dividends in the future relative to a firm &ith a hi)h2reinvestment2rate plan. 5i)ure 11.1 illustrates this )raphically.

Difficulty: Moderate

1=1. "he present value of )ro&th opportunities (*E@F) is equal to .) the difference bet&een a stock's price and its no2)ro&th value per share. ..) the stock's price ...) 8ero if its return on equity equals the discount rate. .E) the net present value of favorable investment opportunities. A. . and .E B. .. and .E C. ., ..., and .E -. .., ..., and .E $. ... and .E All are correct e0cept .. 2 the stock's price equals the no2)ro&th value per share plus the *E@F.

Difficulty: Moderate

11244

1='. Ihich of the follo&in) combinations &ill produce the hi)hest )ro&th rateJ Assume that the firm's proOects offer a hi)her e0pected return than the market capitali8ation rate. A. a hi)h plo&back ratio and a hi)h *+$ ratio B. a hi)h plo&back ratio and a lo& *+$ ratio . a lo& plo&back ratio and a lo& *+$ ratio -. a lo& plo&back ratio and a hi)h *+$ ratio $. %either the plo&back ratio nor the *+$ ratio is related to a firm's )ro&th. "he firm &ill )ro& more rapidly if it retains earnin)s to invest in positive %*E proOects. As for the *+$ ratio's relationship to )ro&th, the )ro&th rate &ill increase as lon) as the proOects' e0pected returns are hi)her than the market capitali8ation rates. .f the e0pected returns are lo&er than the market capitali8ation rates, the )ro&th rate &ill fall.

Difficulty: Moderate

1=3. Lo& *+$ ratios tend to indicate that a company &ill _______, ceteris paribus. A. )ro& quickly B. )ro& at the same speed as the avera)e company C. )ro& slo&ly -. *+$ ratios are unrelated to )ro&th $. none of the above .nvestors pay for )ro&th/ hence a relatively hi)h *+$ ratio for )ro&th firms.

Difficulty: Easy

11247

1=4. $arnin)s mana)ements is A. &hen mana)ement makes chan)es in the operations of the firm to ensure that earnin) do not increase or decrease too rapidly. B. &hen mana)ement makes chan)es in the operations of the firm to ensure that earnin) do not increase too rapidly. . &hen mana)ement makes chan)es in the operations of the firm to ensure that earnin) do not decrease too rapidly. D. the practice of usin) fle0ible accountin) rules to improve the apparent profitability of the firm. $. none of the above. $arnin)s mana)ements is the practice of usin) fle0ible accountin) rules to improve the apparent profitability of the firm.

Difficulty: Easy

1=7. A version of earnin)s mana)ement that became common in the 1;;=s &as A. &hen mana)ement makes chan)es in the operations of the firm to ensure that earnin) do not increase or decrease too rapidly. B. reportin) <pro forma< earnin)s<. . &hen mana)ement makes chan)es in the operations of the firm to ensure that earnin) do not increase too rapidly. -. &hen mana)ement makes chan)es in the operations of the firm to ensure that earnin) do not decrease too rapidly. $. none of the above. A version of earnin)s mana)ement that became common in the 1;;=s &as reportin) <pro forma< earnin)s.

Difficulty: Easy

11249

1=9. @AA* allo&s A. no lee&ay to mana)e earnin)s. B. minimal lee&ay to mana)e earnin)s. C. considerable lee&ay to mana)e earnin)s. -. earnin)s mana)ement if it is beneficial in increasin) stock price. $. none of the above. @AA* allo&s considerable lee&ay to mana)e earnin)s.

Difficulty: Easy

1=:. "he most appropriate discount rate to use &hen applyin) a 5 5$ valuation model is the ___________. A. required rate of return on equity B. IA . risk2free rate -. A or dependin) on the debt level of the firm $. none of the above "he most appropriate discount rate to use &hen applyin) a 5 5$ valuation model is the required rate of return on equity.

Difficulty: Easy

1=1. IA is the most appropriate discount rate to use &hen applyin) a ______ valuation model. A. 5 55 B. 5 5$ . --! -. A or dependin) on the debt level of the firm $. *+$ "he most appropriate discount rate to use &hen applyin) a 5 55 valuation model is the IA .

Difficulty: Easy

1124:

1=;. "he most appropriate discount rate to use &hen applyin) a 5 55 valuation model is the ___________. A. required rate of return on equity B. IA . risk2free rate -. A or dependin) on the debt level of the firm $. none of the above "he most appropriate discount rate to use &hen applyin) a 5 55 valuation model is the IA .

Difficulty: Easy

11=. "he required rate of return on equity is the most appropriate discount rate to use &hen applyin) a ______ valuation model. A. 5 55 B. 5 5$ . --! D. B or $. *+$ "he most appropriate discount rate to use &hen applyin) a 5 5$ valuation model is the required rate of return on equity.

Difficulty: Easy

111. 5 5 and --! valuations should be ____________ if the assumptions used are consistent. A. very different for all firms B. similar for all firms . similar only for unlevered firms -. similar only for levered firms $. none of the above 5 5 and --! valuations should be similar for all firms if the assumptions used are consistent.

Difficulty: Easy

11241

11'. 6iri had a 5 5$ of D1.9! last year and has 3.'! shares outstandin). 6iri's required return on equity is 1'B and IA is ;.1B. .f 5 5$ is e0pected to )ro& at ;B forever, the intrinsic value of 6iri's shares are ____________. A. D91.13 B. D11.9: . D'9.37 -. D14.:9 $. none of the above D1.9!+3.'! ? D=.7= 5 5$ per share/ .7= R 1.=; ? .747/ .747+(.1' 2 .=;) ? 11.9:

Difficulty: Moderate

113. Pero had a 5 5$ of D4.7! last year and has '.'7! shares outstandin). Pero's required return on equity is 1=B and IA is 1.'B. .f 5 5$ is e0pected to )ro& at 1B forever, the intrinsic value of Pero's shares are ____________. A. D1=1.== B. D1=1=.== . D'9.37 -. D14.:9 $. none of the above D4.7!+'.'7! ? D'.== 5 5$ per share/ '.== R 1.=1 ? '.19/ '.19+(.1= 2 .=1) ? 1=1

Difficulty: Moderate

114. 6ee andy had a 5 5$ of D9.1! last year and has '.3'! shares outstandin). 6ee's required return on equity is 1=.9B and IA is ;.3B. .f 5 5$ is e0pected to )ro& at 9.7B forever, the intrinsic value of 6ee's shares are ____________. A. D1=1.== B. D91.'; . D'9.37 -. D14.:9 $. none of the above D9.1!+'.3'! ? D'.9';3 5 5$ per share/ '.9';3 R 1.=97 ? '.1==/ '.1=+(.1=9 2 .=97) ? 91.';

Difficulty: Moderate

1124;

117. 6. .nternational had a 5 5$ of D1''.1! last year and has 1'.43! shares outstandin). 6.'s required return on equity is 11.3B and IA is ;.1B. .f 5 5$ is e0pected to )ro& at :.=B forever, the intrinsic value of 6.'s shares are ____________. A. D1=1.== B. D91.'; C. D'44.4' -. D14.:9 $. none of the above D1''.1!+1'.43! ? D;.1'3 5 5$ per share/ ;.1'3 R 1.=: ? 1=.71/ 1=.71+(.113 2 .=:) ? '44.4'

Difficulty: Moderate

119. (i)hpoint had a 5 5$ of D'49! last year and has 1'3! shares outstandin). (i)hpoint's required return on equity is 1=B and IA is ;B. .f 5 5$ is e0pected to )ro& at 1.=B forever, the intrinsic value of (i)hpoint's shares are ____________. A. D'1.9= B. D1=1 . D'44.4' -. D'19.== $. none of the above D'49!+1'3! ? D'.== 5 5$ per share/ '.== R 1.=1 ? '.19/ '.19+(.1= 2 .=1) ? 1=1

Difficulty: Moderate

11:. 6@A onsultin) had a 5 5$ of D3.'! last year and has 3.'! shares outstandin). 6@A's required return on equity is 13B and IA is 11.7B. .f 5 5$ is e0pected to )ro& at 1.7B forever, the intrinsic value of 6@A's shares are ____________. A. D'1.9= B. D'9.79 . D'44.4' D. D'4.11 $. none of the above D3.'!+3.'! ? D1.== 5 5$ per share/ 1.== R 1.=17 ? 1.=17/ 1.=17+(.13 2 .=17) ? '4.11

Difficulty: Moderate

1127=

111. 6eaman had a 5 5$ of D4.9B last year and has 113.'! shares outstandin). 6eaman's required return on equity is 11.9B and IA is 1=.4B. .f 5 5$ is e0pected to )ro& at 7B forever, the intrinsic value of 6eaman's shares are ____________. A. D3,777.97 B. D377.97 . D37.77 -. D3.77 $. none of the above D4.9B+113.'! ? D4=.939 5 5$ per share/ 4=.939 R 1.=7 ? 4'.99:1/ 4'.99:1+(.119 2 .1=4) ? 3,777.97

Difficulty: Moderate

11;. onsider the free cash flo& approach to stock valuation. 5S@ !anufacturin) ompany is e0pected to have before2ta0 cash flo& from operations of D:7=,=== in the comin) year. "he firm's corporate ta0 rate is 4=B. .t is e0pected that D'7=,=== of operatin) cash flo& &ill be invested in ne& fi0ed assets. -epreciation for the year &ill be D1'7,===. After the comin) year, cash flo&s are e0pected to )ro& at :B per year. "he appropriate market capitali8ation rate for unlevera)ed cash flo& is 13B per year. "he firm has no outstandin) debt. "he proOected free cash flo& of 5S@ !anufacturin) ompany for the comin) year is _______. A. D'7=,=== B. D11=,=== . D3==,=== -. D31=,=== $. none of the above alculations are sho&n belo&.

Difficulty: Difficult

11271

1'=. onsider the free cash flo& approach to stock valuation. 5S@ !anufacturin) ompany is e0pected to have before2ta0 cash flo& from operations of D:7=,=== in the comin) year. "he firm's corporate ta0 rate is 4=B. .t is e0pected that D'7=,=== of operatin) cash flo& &ill be invested in ne& fi0ed assets. -epreciation for the year &ill be D1'7,===. After the comin) year, cash flo&s are e0pected to )ro& at :B per year. "he appropriate market capitali8ation rate for unlevera)ed cash flo& is 13B per year. "he firm has no outstandin) debt. "he total value of the equity of 5S@ !anufacturin) ompany should be A. D1,917,179.7= B. D',4:;,191.;7 . D3,333,333.33 D. D4,199,999.9: $. none of the above *roOected free cash flo& ? D'7=,=== (see test bank problem 11.11;)/ E= ? '7=,=== + (.13 2 .=:) ? D4,199,999.9:.

Difficulty: Difficult

1'1. Boaters Iorld is e0pected to have per share 5 5$ in year 1 of D1.97, per share 5 5$ in year ' of D1.;:, and per share 5 5$ in year 3 of D'.74. After year 3, per share 5 5$ is e0pected to )ro& at the rate of 1B per year. An appropriate required return for the stock is 11B. "he stock should be &orth _______ today. A. D::.73 B. D4=.9: . D1'.19 -. D99.== $. none of the above alculations are sho&n in the table belo&.

*3 ? D'.74 (1.=1) + (.11 2 .=1) ? D;1.44/ *E of *3 ? D;1.44+(1.=1)3 ? D:'.711=/ *F ? D4.;4 H D:'.7; ? D::.73.

Difficulty: Difficult

1127'

1''. 6mart -ra& ompany is e0pected to have per share 5 5$ in year 1 of D1.'=, per share 5 5$ in year ' of D1.7=, and per share 5 5$ in year 3 of D'.==. After year 3, per share 5 5$ is e0pected to )ro& at the rate of 1=B per year. An appropriate required return for the stock is 14B. "he stock should be &orth _______ today. A. D33.== B. D4=.91 . D77.== -. D99.== $. D1'.19 alculations are sho&n in the table belo&.

*3 ? ' (1.1=) + (.14 2 .1=) ? D77.==/ *E of *3 ? D77+(1.14)3 ? D3:.1'/ *F ? D3.79 H D3:.1' ? D4=.91.

Difficulty: Difficult

11273

1'3. Fld 6tyle orporation produces )oods that are very mature in their product life cycles. Fld 6tyle orporation is e0pected to have per share 5 5$ in year 1 of D1.==, per share 5 5$ of D=.;= in year ', and per share 5 5$ of D=.17 in year 3. After year 3, per share 5 5$ is e0pected to decline at a rate of 'B per year. An appropriate required rate of return for the stock is 1B. "he stock should be &orth ______. A. D1':.93 B. D1=.7: . D'=.== -. D''.'' E. 1.4; alculations are sho&n belo&.

*3 ? =.17(.;1) + K.=1 2 (2.=')L ? D1.33/ *E of *3 ? D1.33+(1.=1)3 ? D9.1''9/ *F ? D9.1''9 H D'.3:'3 ? D1.4;.

Difficulty: Difficult

11274

1'4. @oodie orporation produces )oods that are very mature in their product life cycles. @oodie orporation is e0pected to have per share 5 5$ in year 1 of D'.==, per share 5 5$ of D1.7= in year ', and per share 5 5$ of D1.== in year 3. After year 3, per share 5 5$ is e0pected to decline at a rate of 1B per year. An appropriate required rate of return for the stock is 1=B. "he stock should be &orth ______. A. D;.== B. D1=1.7: C. D1=.7: -. D''.'' $. 4:.'3 alculations are sho&n belo&.

*3 ? 1.==(.;;) + K.1= 2 (2.=1)L ? D;.==/ *E of *3 ? D;+(1.1=)3 ? D9.:911/ *F ? D9.:911 H D3.1=;' ? D1=.7:.

Difficulty: Difficult

11277

1'7. "he )ro&th in per share 5 5$ of 6A%M, .nc. is e0pected to be 1B+year for the ne0t t&o years, follo&ed by a )ro&th rate of 4B+year for three years/ after this five year period, the )ro&th in per share 5 5$ is e0pected to be 3B+year, indefinitely. "he required rate of return on 6A% , .nc. is 11B. Last year's per share 5 5$ &as D'.:7. Ihat should the stock sell for todayJ A. D'1.;; B. D37.'1 . D74.9: -. D79.3: E. D43.:9 alculations are sho&n belo&.

*7 ? 3.:194 + (.11 2 .=3) ? D49.4744/ *E of *7 ? D49.4744+(1.=1)7 ? D31.9191/ *F ? D1'.144; H D31.93 ? D43.:9

Difficulty: Difficult

11279

1'9. "he )ro&th in per share 5 5$ of 5FC, .nc. is e0pected to be 17B+year for the ne0t three years, follo&ed by a )ro&th rate of 1B+year for t&o years/ after this five year period, the )ro&th in per share 5 5$ is e0pected to be 3B+year, indefinitely. "he required rate of return on 5FC, .nc. is 13B. Last year's per share 5 5$ &as D1.17. Ihat should the stock sell for todayJ A. D'1.;; B. D'4.4: . D'9.14 D. D':.:4 $. D1;.11 alculations are sho&n belo&.

*7 ? 3.'1(1.=3) + (.13 2 .=3) ? D33.1=/ *E of *7 ? D33.1=+(1.13)7 ? D11.37/ *F ? D11.37 H D;.3; ? D':.:4.

Difficulty: Difficult

1127:

1':. "he )ro&th in per share 5 5$ of B6, .nc. is e0pected to be 1=B+year for the ne0t t&o years, follo&ed by a )ro&th rate of 7B+year for three years/ after this five year period, the )ro&th in per share 5 5$ is e0pected to be 'B+year, indefinitely. "he required rate of return on B6, .nc. is 1'B. Last year's per share 5 5$ &as D'.==. Ihat should the stock sell for todayJ A. D1.;; B. D''.71 . D4=.== D. D'7.'1 $. D':.1' alculations are sho&n belo&.

*7 ? '.1=(1.=') + (.1' 2 .=') ? D'1.79/ *E of *7 ? D'1.79+(1.1')7 ? D19.'1/ *F ? D19.'= H D1.;; ? D'7.'1.

Difficulty: Difficult

1'1. 6tin)y orporation is e0pected have $B." of D1.'! this year. 6tin)y orporation is in the 3=B ta0 bracket, &ill report D133,=== in depreciation, &ill make D:9,=== in capital e0penditures, and have a D'4,=== increase in net &orkin) capital this year. Ihat is 6tin)y's 5 55J A. 1,13;,=== B. 1,'==,=== . 1,='7,=== -. ;'1,=== E. 1:3,=== 5 55 ? $B."(12") H depreciation 2 capital e0penditures 2 increase in %I or 1,'==,===(.:) H 133,=== 2 :9,=== 2 '4,=== ? 1:3,===

Difficulty: Moderate

11271

1';. 5ly Boy orporation is e0pected have $B." of D1==k this year. 5ly Boy orporation is in the 3=B ta0 bracket, &ill report D7',=== in depreciation, &ill make D19,=== in capital e0penditures, and have a D19,=== increase in net &orkin) capital this year. Ihat is 5ly Boy's 5 55J A. 71=,=== B. 4=9,=== . 74',=== -. 7;9,=== $. 91',=== 5 55 ? $B."(12") H depreciation 2 capital e0penditures 2 increase in %I or 1==,===(.:) H 7',=== 2 19,=== 2 19,=== ? 71=,===

Difficulty: Moderate

13=. Lamm orporation is e0pected have $B." of D9.'! this year. Lamm orporation is in the 4=B ta0 bracket, &ill report D1.'! in depreciation, &ill make D1.4! in capital e0penditures, and have a D19=,=== increase in net &orkin) capital this year. Ihat is Lamm's 5 55J A. 9,'==,=== B. 9,19=,=== C. 3,39=,=== -. 3,91=,=== $. 4,9'7,=== 5 55 ? $B."(12") H depreciation 2 capital e0penditures 2 increase in %I or 9,'==,===(.9) H 1,'==,=== 2 1,4==,=== 2 19=,=== ? 3,39=,===

Difficulty: Moderate

1127;

131. >ome orporation is e0pected have $B." of D'.3! this year. >ome orporation is in the 3=B ta0 bracket, &ill report D1:7,=== in depreciation, &ill make D1:7,=== in capital e0penditures, and have no chan)e in net &orkin) capital this year. Ihat is >ome's 5 55J A. ',3==,=== B. 1,:17,=== . 1,;9=,=== D. 1,91=,=== $. 1,437,=== 5 55 ? $B."(12") H depreciation 2 capital e0penditures 2 increase in %I or ',3==,===(.:) H 1:7,=== 2 1:7,=== 2 = ? 1:3,===

Difficulty: Moderate

1129=

Short Answer Questions 13'. -iscuss the @ordon, or constant discounted dividend, model of common stock valuation. .nclude in your discussion the advanta)es, disadvanta)es, and assumptions of the model. "he @ordon model discounts the e0pected dividends for the comin) year by the required rate of return on the stock minus the )ro&th rate. "he )ro&th rate is annual )ro&th in dividends, and is assumed to be a constant annual )ro&th rate indefinitely. Fbviously such an assumption is not likely to be met/ ho&ever, if dividends are e0pected to )ro& at a fairly constant rate for a considerable period of time the model may be used. "he model also assumes a constant rate of )ro&th in earnin)s and in the price of the stock. As a result, the payout ratio must be constant. .n reality, firms have tar)et payout ratios, usually based on industry avera)es/ ho&ever, firms &ill depart from these tar)et ratios in order to maintain the e0pected level of dividends in the event of a decline in earnin)s. .n addition, the constant )ro&th assumes that the firm's return on equity is e0pected to be constant indefinitely. .n )eneral, firm's return on equity (>F$) varies considerably &ith the economic cycle and &ith other variables. 6ome firms, ho&ever, such a public utilities have relatively stable >F$s over time. 5inally, the model requires that the required rate of return be )reater than the )ro&th rate (other&ise the denominator is ne)ative and an undefined firm value results). .n spite of these restrictin) assumptions, the @ordon model is &idely used because the model is easy to use and understand, and, if the assumptions are not )rossly violated, the model may produce a relatively valid valuation assessment. 5eedbackT "he purpose of this question is to ascertain &hether the student understands the @ordon model, the restrictions of the model, and &hy the model continues to be used e0tensively in spite of the restrictin) assumptions.

Difficulty: Moderate

11291

133. "he price+earnin)s ratio, or multiplier approach, may be used for stock valuation. $0plain this process and describe ho& the <multiplier< varies from the one available in the stock market quotation pa)es. "he price earnin)s ratio used for stock valuation should be the predicted price+earnin)s ratio. "hat is, the ratio of the current price of the stock divided by the e0pected earnin)s per share for the comin) year. "hus, the ratio is the stock price as a percenta)e of e0pected earnin)s. All valuation models should be based on &hat the investor is e0pectin) to receive in the comin) period, not upon &hat past investors have received. 6uch a forecasted price+earnin)s ratio is published in Ealue Line. "he analyst+investor can simplistically multiply the value of that published ratio by the forecasted earnin)s per share (also published by Ealue Line), the forecasted earnin)s per share numbers cancel out/ the result bein) the intrinsic value of the stockT *F+e1 C e1 ? *F. 5eedbackT "he purpose of this question is to ascertain &hether the student understands the relative valuation methods.

Difficulty: Moderate

134. -iscuss the relationships bet&een the required rate of return on a stock, the firm's return on equity, the plo&back rate, the )ro&th rate, and the value of the firm. .f the firm earns more on retained earnin)s (equity) than the firm's cost of equity capital (required rate of return), the value of the firm's stock increases/ therefore, the firm should retain more earnin)s, &hich &ill increase the )ro&th rate and increase the value of the firm (share price). .f the firm earns less on retained equity than the required rate of return, and the firm increases the retention rate and the )ro&th rate, the firm decreases firm value, as reflected by share price. .n this scenario, the shareholders &ould prefer that the firm pay out more of earnin)s in dividends, &hich the shareholders could invest at a )reater rate of return than that earned by the firm (>F$). .f the required rate of return equals the >F$, investors are indifferent bet&een the firm's retainin) earnin)s and payin) out dividends. As a result, the retention rate and the )ro&th rate in this scenario have no effect on firm value (stock price). 5eedbackT "his question is desi)ned to ascertain the student's understandin) of these relationships, &hich are important both from the investment and corporate finance perspectives.

Difficulty: Moderate

1129'

137. -escribe the free cash flo& approach to firm valuation. (o& does it compare to the dividend discount model (--!)J "he free cash flo& approach is an alternative to the --!. .t can be used by the firm's mana)ement in capital bud)etin) decisions or in valuin) possible acquisition tar)ets. 5irst the value of the firm as a &hole is estimated. "hen the market value of nonequity claims is subtracted, and the result is the value of the firm's equity. "he value of the firm equals the present value of e0pected cash flo&s, assumin) all2equity financin), plus the net present value of the ta0 shields from debt financin). "he discount rate used for the free cash flo& approach is different from the rate used for the --!. "he free cash flo& approach uses the rate suitable for unlevera)ed equity. "he --! discount rate appropriate for levera)ed equity. "he beta of the firm chan)es as the amount of levera)e chan)es. "he A*! yields different required returns for levera)ed and unlevera)ed firms. 5eedbackT "his question tests the student's a&areness and understandin) of the free cash flo& approach as an alternative to the --!.

Difficulty: Moderate

11293