Deck 20: Mergers

Question 1

Which of the income valuation models is based on the premise that the market value of ordinary shares represents the sum of the expected future dividend flows, to infinity, discounted to present value?

A) Earnings- based model
B) Cash- flow- based model
C) Dividend- based model
D) Share- value- based model

Answer 1

C

Question 2

Calculate the PER for the following company. It is expected to maintain a payout ratio of 40 per cent of earnings. The appropriate discount rate for this risk class is 10 per cent and the expected growth rate in earnings and dividends is 5 per cent.

A) 2.67
B) 8.0
C) 6.67
D) 5.0

Answer 2

B

Question 3

In which situation is it justifiable to use the formula P C1 ? kE - gc

A) Constant cash flow without discounted growth
B) Discounted cash flow with constant growth
C) PER with increasing growth
D) Dividend valuation with constant growth

Answer 3

B

Question 4

For a particular share a dividend of 20p will be paid after 1 year, at which time the share is expected to be sold for 250p. If the risk class justifies a rate of return of 20 per cent, how much should an investor pay for the shares today?

A) 240p
B) 250p
C) 225p
D) 275p

Question 5

Which three of the following could contribute to increases in current working capital, as calculated as part of a cash flow approach?

A) Rise in cash requirements
B) Rise in future earnings
C) Rise in stocks
D) Rise in debtors

Question 6

What should an investor pay for shares in which the rate of return for the risk class is 10 per cent, a dividend of 44p will be paid after 1 year, and the share price after 1 year is expected to be 220p?

A) 270p
B) 224p
C) 214p
D) 240p

Question 7

Which three of the following are examples of companies where income- flow- based methods of valuation are not especially useful?

A) Property investment companies
B) Resource- based companies
C) Investment trusts
D) Manufacturing companies

Question 8

For which one of the following would net asset value be the most inappropriate measure of share value?

A) A property investment company
B) An investment trust
C) A record company
D) An oil production company

Question 9

Which three of the following are most likely to have an effect on a company's growth rate?

A) The proportion of profit retained
B) Market opportunities
C) The value of previous earnings
D) Quality of management

Question 10

Which three of the following are the benefits most likely to be achieved during a takeover?

A) Synergy
B) Lower managerial pay levels
C) Tax benefits
D) Reducing costs

Question 11

Which two of the following statements accurately explain why the companies described cannot easily be valued using income- flow- based methods?

A) The probable reserves of oil companies have a large influence on their valuation.
B) The variable costs of raw materials make it difficult to assess manufacturing company income.
C) The range of shares held makes it relatively simple for a shareholder to assess the income of an investment trust.
D) Property investment companies are primarily valued on the basis of their assets.

Question 12

What is meant by 'golden handcuffs'?

A) Financial incentives to encourage managers to stay with the firm
B) Financial incentives to encourage shareholders to stay with the firm
C) Contractual factors that force effective managers to stay with the firm
D) Financial incentives to encourage suppliers to stay with the firm

Question 13

What is the key difference between Historical PER and Prospective PER?

A) Historical PER uses last year's earnings but Prospective PER focuses on next year's earnings and dividend.
B) Historical PER uses earnings in year 0 but Prospective PER focuses on current earnings.
C) Historical PER uses average past earnings but Prospective PER focuses on current earnings.
D) Historical PER uses earnings in years 1 and 2 but Prospective PER focuses on next year's earnings.

Question 14

How does the growth rate of the average corporations as a whole compare with real GDP plus inflation?

A) Growth < Real GDP plus inflation
B) Growth > Real GDP plus inflation
C) Growth = Real GDP plus inflation
D) Growth = Real GDP plus inflation

Question 15

Which two terms correctly complete the following statement: "The NAV approach to valuation focuses on values, which may be adjusted to reflect values."?

A) fixed asset; future
B) balance sheet; current market
C) fixed asset; discounted values
D) balance sheet; discounted values

Question 16

A company is expected to maintain a payout ratio of 50 per cent of earnings. The appropriate discount rate for this risk class is 15 per cent and the expected growth rate in earnings and dividends is 6 per cent. What is the PER?

A) 3.3
B) 5.5
C) 6.6
D) 4.4

Question 17

Which three of the following are reasons for the valuation of unquoted shares being different from the valuation of quoted shares?

A) The shares may be subject to more risk.
B) The shares always have 'golden handcuffs' and 'earn- out clauses'.
C) There may be a lower quality and quantity of information.
D) The shares are less liquid.

Question 18

Last year a company had earnings per share of 20p. A year ago the share price was 200p. This year's earnings are likely to be 30p, and the share price today is 250p. What is the historical PER?

A) 6.67
B) 10
C) 8.3
D) 12..5

Question 19

In which three of the following situations are asset values particularly useful?

A) When discounted income flow techniques are difficult to apply
B) When a firm is in financial difficulty
C) When used in relation to takeover bids
D) When used in relation to companies that are not primarily valued on the basis of their assets

Question 20

What is the focus of income- flow valuation methods?

A) Past flows attributable to the shareholder
B) Past flows attributable to the company
C) Future flows attributable to the company
D) Future flows attributable to the shareholder

Question 21

What is meant by the term 'intrinsic value' for shares?

A) The discounted value of the owner earnings that can be added to a business
B) The future value of the owner earnings that can be added to a business during its remaining life
C) The discounted value of the owner earnings that can be taken out of a business during its remaining life
D) The future value of the owner earnings that can be taken out of a business during its remaining life

Question 22

Which three of the following are models of income valuation?

A) Cash- flow- based models
B) Earnings- based models
C) Share- value- based models
D) Dividend- based models

Question 23

Which two of the following are factors that explain why many of the most respected investors pay little attention to macroeconomic forecasts when valuing companies?

A) Economists' projections for particular short- term macroeconomic trends are of little significance for long term value.
B) Economists' projections for particular short- term macroeconomic trends are little affected by an individual company's performance.
C) Value is determined more by microeconomic factors affecting the whole industry.
D) Value is determined by income flows to the shareholder over many economic cycles stretching over decades.

Question 24

Which three of the statements describe problems with dividend valuation models?

A) They are highly sensitive to the assumptions.
B) The quality of input data is often poor.
C) They are not dependent on assessment of average risk rates.
D) If g exceeds k_E a nonsensical result occurs.

Question 25

Which three of the following accurately relate to the net asset value approach to valuation?

A) It is less objective than is often supposed.
B) It involves forecasting the level of future dividends.
C) It excludes many non- quantifiable assets.
D) It focuses on balance sheet values.

Question 26

Which two terms correctly complete the following statement: "DVM models are based on the premise that the market value of ordinary shares represents the sum of the , discounted to a ."?

A) expected future dividend flows to infinity; present value
B) expected future dividend flows to infinity; future value
C) expected future dividend flows to the planning horizon; present value
D) expected future dividend flows to the planning horizon; future value

Question 27

Which of the ratios is used to calculate historical PER?

A) Last year's average price per share/Current year's earnings per share
B) Current year's earnings per share/Current year's average price per share
C) Last year's earnings per share/Current year's market average price per share
D) Current market price per share/Last year's earnings per share

Question 28

What is the key difference between historical PER and prospective PER?

A) Prospective PER uses next year's share price; historical PER uses last year's price.
B) Prospective PER uses last year's earnings and the current share price; historical PER uses next year's earnings and the current share price.
C) Prospective PER uses next year's earnings and next year's price; historical PER uses last year's earnings and last year's price.
D) Prospective PER uses next year's earnings and the current share price; historical PER uses last year's earnings and the current share price.

Question 29

Control over a firm permits the possibility of changing the future cash flows. What is the likely result of a high level of control on share price?

A) There is little effect.
B) A share may be more highly valued by the controlling shareholder.
C) Changes in share value are delayed.
D) A share may be valued lower by the controlling shareholder.

Question 30

Control over a firm permits the possibility of changing the future cash flows. Which two of the following are possible results of achieving control on a target company?

A) A share may be less highly valued.
B) It could be valued on the basis of its discounted future cash flows.
C) It could be re- valued on the basis of previous cash flows.
D) A share may be more highly valued.

Question 31

What is the key premise of the dividend growth method of share valuation?

A) The growth in dividends will equal the rate of inflation.
B) There will be constant growth in future dividends to infinity.
C) There will be constant growth in future dividends to the planning horizon.
D) The growth in dividends will equal the rate of increase of the share price.

Question 32

Which three of the following are assets which contribute to a firm's value for shareholders but cannot be objectively measured?

A) Relationships with suppliers
B) The past performance of share values
C) The experience of the management team
D) The skills of the workforce

Question 33

Which three of the following are the most useful pointers when calculating g?

A) Focus on the firm
B) Focus on the economy
C) Evaluate strategy
D) Evaluate the dividend yield

Question 34

Which two of the following are most likely to influence kE ?

A) The proportion of profits retained
B) Adopting a new strategy
C) An increase in inflation
D) Changing the payout ratio

Question 35

The cash flow approach involves a calculation with a number of steps, starting with the pre- interest profits. Which of the following steps would you take first?

A) Take away capital expenditure on fixed assets
B) Take away interest payments
C) Discount back to the present
D) Add depreciation

Question 36

A firm expects to pay dividends of 50p per year to infinity. The rate of return on a share in this risk class is 15 per cent. What is the value of the share to the investor?

A) 666p
B) 333p
C) 200p
D) 400p

Question 37

Based on Warren Buffett's definition of owner earnings, what are the two types of investment?

A) Investment in value- creating growth opportunities beyond the current position
B) Investment to reduce the level of debt repayments
C) Investment in dividends to encourage future shareholders
D) Investment needed to permit the firm to continue to maintain its existing competitive position at the current level of output

Question 38

Which three of the following are included in a calculation of net asset value?

A) Long- term and short- term creditors
B) Share value
C) Stocks, cash and other liquid assets
D) Fixed assets

Question 39

Which three areas are shareholders of firms in financial difficulty most likely to focus on?

A) The break- up value
B) The potential for asset sales
C) Ways of revaluing future cash flows
D) The potential for asset- backed borrowing

Question 40

Which model requires the discounting of the company's future owner earnings which are standard reported earnings after tax plus non- cash charges less the amount of expenditure on plant, machinery, and working capital needed for the firm to maintain its long- term competitive position and its unit volume, and to make investment in all new value- creating projects?

A) Controlled earnings model
B) Owner earnings model
C) Historical price to earnings model
D) Discounted income model

Question 41

Based on the dividend growth model, what price should an investor pay for a share with average annual growth 4 per cent in the future in which the initial dividend is 40p, and the rate of return for the risk class is 10 per cent?

A) 359p
B) 597p
C) 693p
D) 475p

Question 42

Which three of the following factors influence the rate of dividend growth?

A) The rate of return earned on those retained resources
B) The size of the original dividend
C) Rate of return earned on existing assets
D) The quantity of resources retained and reinvested within the business

Question 43

Which of the following best describes typical share prices (in relation to PER) for unquoted firms, as compared with prices for quoted firms?

A) Shares for the two types are roughly equal in price.
B) Shares for unquoted firms are typically sold at significantly higher prices.
C) There is no clear trend between the prices.
D) Shares for unquoted firms are typically sold at significantly lower prices.

Question 44

Which of the following is a key assumption of income- flow valuation methods of share valuation?

A) Current income flow is the only relevant factor.
B) The past is only useful to the extent that it sheds light on the future.
C) Current net income is the only relevant factor.
D) Current income trends give sufficient information to predict future income levels.

Question 45

Why does the stock market often fall after 'good' economic news?

A) Good economic news generally results in a fall in earnings.
B) An increase in earnings generally reduces dividends.
C) The market is predicting the negative effect of the next stage.
D) Investors are confident about future increases in share prices.

Question 46

When finding crude PER, the valuer makes certain assumptions, one being that valuation P0 consists of two parts. What are the two parts?

A) Value of earnings assuming no growth
B) Value of growth in earnings
C) Net value of equity and debt
D) Value of the asset base

Question 47

What are the two key conclusions that Arnold makes about valuation?

A) Valuation is an accurate mathematical process that gives more reliable information than any qualitative assessment.
B) Once you have selected a suitable valuation method, it makes sense to use it consistently and so get fair comparisons.
C) Going through a rigorous process of valuation is more important than arriving at an answer.
D) It makes sense to treat the various valuation methods as complementary rather than rivals.

Question 48

The dividend paid by a company in each year over an 8- year period rises gradually from 50p in the first year of the period to 75p in the final year. What is the average annual growth rate over the period?

A) 0.95%
B) 1.50%
C) 5.20%
D) 0.55%

Question 49

Which of the following is calculated using the ratio d1/E1 ? kE - g

A) Discounted PER
B) Historical PER
C) Prospective PER
D) True PER