Deck 7: Valuing Stocks

Question 1

According to the dividend discount model, the current value of a stock is equal to the:

A)Present value of all expected future dividends
B)Sum of all future expected dividends
C)Next expected dividend, discounted to the present
D)Discounted value of all dividends growing at a constant rate

Answer 1

Present value of all expected future dividends

Question 2

The main purpose of a market-value balance sheet is to:

A)Show an inflated value of the firm
B)Avoid the recording of certain liabilities
C)Value assets and liabilities without GAAP restrictions
D)Improve the credit rating of the firm

Answer 2

Value assets and liabilities without GAAP restrictions

Question 3

Firms having a higher expected return have a higher:

A)Level of expected risk
B)Dividend yield
C)Market value of equity
D)Degree of certainty concerning their returns

Answer 3

Level of expected risk

Question 4

Which of the following statements is correct about a stock currently selling for $50 per share that has a 16 percent expected return and a 10 percent expected capital appreciation?

A)Its expected dividend exceeds the actual dividend
B)Its expected return will exceed the actual return
C)It is expected to pay $3 in annual dividends
D)It is expected to pay $8 in annual dividends Expected return = expected dividend yield + expected capital appreciation
16% = expected dividend yield + 10%
6% = expected dividend yield

Question 5

If the liquidation value of a firm is negative, then:

A)The firm's debt exceeds the market value of assets
B)The firm's debt exceeds the book value of equity
C)The book value of assets exceeds the firm's debt
D)The market value of assets exceeds the firm's debt

Question 6

The book value of a firm's equity is determined by:

A)Multiplying share price by shares outstanding
B)Multiplying share price at issue by shares outstanding
C)The difference between book values of assets and liabilities
D)The difference between market values of assets and liabilities

Question 7

In the calculation of rates of return on common stock, dividends are _______ and capital gains are ______.

A)Guaranteed; not guaranteed
B)Guaranteed; guaranteed
C)Not guaranteed; not guaranteed
D)Not guaranteed; guaranteed

Question 8

Which of the following is inconsistent with a firm that sells for very near book value?

A)Low current earning power
B)No intangible assets
C)High future earning power
D)Low, unstable dividend payment

Question 9

A stock paying $5 in annual dividends sells now for $80 and has an expected return of 14 percent.What might investors expect to pay for the stock one year from now?

A)$82.20
B)$86.20
C)$87.20
D)$91.20 Expected return =

Question 10

How much should you pay for a share of stock that offers a constant growth rate of 10 percent, requires a 16 percent rate of return, and is expected to sell for $50 one year from now?

A)$42.00
B)$45.00
C)$45.45
D)$47.00 The easiest way to solve this problem is to realize:
Expected return = expected dividend yield + expected capital appreciation Then:
)16 = .06 + expected capital appreciation
)10 = expected capital appreciation And
P₁ = 110% of P_o
$50)00 = 1.1P_o

Question 11

Which of the following is least likely to account for an excess of market value over book value of equity?

A)Inaccurate depreciation methods
B)High rate of return on assets
C)The presence of growth opportunities
D)Valuable off-balance sheet assets

Question 12

The expected return on a common stock is composed of:

A)Dividend yield
B)Capital appreciation
C)Both dividend yield and capital appreciation
D)Capital appreciation minus the dividend yield

Question 13

What is the current price of a share of stock for a firm with $5 million in balance-sheet equity, 500,000 shares of stock outstanding, and a price/book value ratio of 4?

A)$2.50
B)$10.00
C)$20.00
D)$40.00 book value per share = $5,000,000/500,000 = $10
If price/book value = 4

Question 14

A firm's liquidation value is the amount:

A)Necessary to repurchase all shares of common stock
B)Realized from selling all assets and repaying debts
C)A purchaser would pay for the firm in bankruptcy
D)Equal to the book value of equity

Question 15

What dividend yield would be reported in the financial press for a stock that currently pays a $1 dividend per quarter and the most recent stock price was $40?

A)2.5 percent
B)4.0 percent
C)10.0 percent
D)15.0 percent $1 dividend per quarter = $4 annually

Question 16

If a stock's P/E ratio is 13.5 at a time when earnings are $3 per year, what is the stock's current price?

A)$4.50
B)$18.00
C)$22.22
D)$40.50 P/E = 13.5X
Then P = 13.5 x $3

Question 17

Firms with valuable intangible assets are more likely to show a(n):

A)Excess of book value over market value of equity
B)High going-concern value
C)Low liquidation value
D)Low P/E ratio

Question 18

Which of the following is a characteristic of secondary markets for common stock?

A)Only low-priced shares are traded in these markets
B)Only high-risk shares are traded in these markets
C)Secondary markets are where corporations borrow funds
D)Secondary-market trades do not provide funds for corporations whose stock is traded

Question 19

How many round lots were traded in a specific stock on a day in which 467,800 shares changed hands?

A)467.8 round lots
B)4,678 round lots
C)467,800 round lots
D)Price must be known to determine round lots

Question 20

If a stock currently sells for $40.00 and has annual earnings per share of $3.00, the P/E multiple is:

A)0.075
B)7.0
C)13.33
D)Not shown above.

Question 21

The g in the constant-growth dividend model refers to:

A)The annual growth rate for dividends
B)The annual growth rate for stock price
C)Both 'a' and 'b' above
D)Neither 'a' nor 'b' above

Question 22

If next year's dividend is forecast to be $5.00, the constant growth rate is 4 percent, and the discount rate is 16 percent, then the current stock price should be:

A)$31.25
B)$40.00
C)$41.67
D)$43.33 P_o =

Question 23

What price would you expect to pay for a stock with 13 percent required rate of return, 4 percent rate of dividend growth, and an annual dividend of $2.50 which will be paid tomorrow?

A)$27.78
B)$30.28
C)$31.10
D)$31.39 P_o = D_o +

Question 24

A payout ratio of 35 percent for a company indicates that:

A)35 percent of dividends are plowed back for growth
B)65 percent of dividends are plowed back for growth
C)65 percent of earnings are paid out as dividends
D)35 percent of earnings are paid out as dividends

Question 25

What constant growth rate in dividends is expected for a stock valued at $32.00 if next year's dividend is forecast at $2.00 and the appropriate discount rate is 13 percent?

A)5.00 percent
B)6.25 percent
C)6.75 percent
D)15.38 percent $32.00 =

Question 26

What is the expected dividend to Be paid in three years if yesterday's dividend was $6.00, dividends are expected to grow at a constant 6 percent annual rate, and the firm has a 10 percent expected return?

A)$6.75
B)$7.15
C)$7.80
D)$9.37 D₃ = D_o x (1 + g)³
= $6.00 (1.06)³

Question 27

A positive value for PVGO suggests that the firm has:

A)A positive return on equity
B)A positive plowback ratio
C)Investment opportunities with superior returns
D)A high rate of constant growth

Question 28

Dividing a stock's earnings per share by the expected rate of return will value the share correctly if no new shares are issued and the dividend yield:

A)Exceeds the required return
B)Equals the required return
C)Is zero
D)is constant

Question 29

The value of common stock will likely decrease if:

A)The investment horizon decreases
B)The growth rate of dividends increases
C)The discount rate increases
D)Dividends are discounted back to the present

Question 30

What is the return on equity for a firm that has a constant dividend growth rate of 7 percent and a dividend payout ratio of 60 percent?

A)2.80 percent
B)4.20 percent
C)11.67 percent
D)17.50 percent 7% = ROE x plowback ratio
= ROE x (1 - .6)
= ROE x .4

Question 31

What is the plowback ratio for a firm that has earnings per share of $12.00 and pays out $4.00 per share as dividends?

A)25.00 percent
B)33.33 percent
C)66.67 percent
D)75.00 percent plowback = 1 - payout ratio
= 1 -

Question 32

When valuing stock with the dividend discount model, the present value of future dividends will:

A)Change depending upon the time horizon selected
B)Remain constant regardless of the time horizon selected
C)Remain constant regardless of growth rate
D)Always equal the present value of the terminal price

Question 33

Common stock can be valued using the perpetuity valuation formula if the:

A)Discount rate is expected to remain constant
B)Dividends are not expected to grow
C)Growth rate in dividends is not constant
D)Investor does not intend to sell the stock

Question 34

What should be the price for a common stock paying $3.50 annually in dividends if the growth rate is zero and the discount rate is 8 percent?

A)$22.86
B)$28.00
C)$42.00
D)$43.75 P_o =

Question 35

A company with a return on equity of 15 percent and a plowback ratio of 60 percent would expect a constant growth rate of:

A)4 percent
B)9 percent
C)21 percent
D)25 percent g = .015 x .60

Question 36

What rate of return is expected from a stock that sells for $30 per share, pays $1.50 annually in dividends, and is expected to sell for $33 per share in one year?

A)5.00 percent
B)10.00 percent
C)14.09 percent
D)15.00 percent Expected Return =

Question 37

What would be the expected price of a stock when dividends are expected to grow at a 25 percent rate for three years, then grow at a constant rate of 5 percent, if the stock's required return is 13 percent and next year's dividend will be $4.00?

A)$61.60
B)$62.08
C)$68.62
D)$79.44 P_o =

Question 38

If the dividend yield for year one is expected to be 5 percent based on the current price of $25, what will the year four dividend be if dividends grow at a constant 6 percent?

A)$1.33
B)$1.49
C)$1.58
D)$1.67 .05 x 25 = 1.25 = Div₁

Question 39

ABC common stock is expected to have extraordinary growth of 20 percent per year for two years, at which time the growth rate will settle into a constant 6 percent.If the discount rate is 15 percent and the most recent dividend was $2.50, what should be the current share price?

A)$31.16
B)$33.23
C)$37.42
D)$47.77 P_o =

Question 40

How is it possible to ignore cash dividends that occur far into the future when using a dividend discount model? Those dividends:

A)Will be paid to a different investor
B)Will not be paid by the firm
C)Have an insignificant present value
D)Ignore the tax consequences of future dividends

Question 41

Which of the following is more likely to be responsible for a firm having low PVGO?

A)ROE exceeds required return
B)Plowback is very high
C)Payout is very high
D)Book value of equity is low

Question 42

Which of the following is least likely to contribute to going concern value?

A)High liquidation value
B)Extra earning power
C)Future investment opportunities
D)Intangible assets

Question 43

Assuming all of the following firms have a required return of 14 percent, which would you expect to have a positive present value of growth opportunities?

A)A firm with a P/E ratio of 9
B)A firm with a P/E ratio of 6
C)A firm with an E/P ratio of 20 percent
D)None of the above firms are expected to have positive PVGO Required return > E/P ratio if PVGO > 0

Question 44

What is the most likely value of the PVGO for a stock with current price of $50, expected earnings of $6 per share, and a required return of 20 percent?

A)$10
B)$20
C)$25
D)$30

Question 45

Which of the following describes a seasoned offering?

A)An IPO of common stock for a well-known firm
B)An IPO that is offered during the best buying season
C)An additional equity issue from a publicly traded firm
D)Any shares traded in the secondary market are seasoned offerings

Question 46

What is the required return for a stock that has a 6% constant growth rate, a price of $25, an expected dividend of $2, and a P/E ratio of 10?

A)5%
B)10%
C)14%
D)22% $25 = 2/(r - .06)

Question 47

What happens to a firm that reinvests its earnings at a rate equal to the firm's required return?

A)Its stock price will remain constant
B)Its stock price will increase by the sustainable growth rate
C)Its stock price will decline unless dividend payout ratio is zero
D)Its stock price will decline unless plowback rate exceeds required return

Question 48

Other things equal, a firm's sustainable growth rate could increase as a result of:

A)Increasing the plowback ratio
B)Increasing the payout ratio
C)Decreasing the return on equity
D)Increasing total assets

Question 49

Which of the following is least assured for firms that plowback a portion of earnings into the firm?

A)Growth in earnings per share
B)Growth in dividends per share
C)Growth in book value of equity
D)Growth in stock price

Question 50

Which of the following is true for a firm having a stock price of $42, and expected dividend of $3, and a sustainable growth rate of 8 percent?

A)It has a required return of 22 percent
B)It has a dividend payout ratio of 37.5 percent
C)It has an ROE of 7.14 percent
D)It has a plowback rate of 7.14 percent $42 = $3/(r - .08)

Question 51

In general, if a firm has positive present value of growth opportunities, then its price-earnings ratio:

A)Is greater than its required rate of return
B)Is less than its required rate of return
C)Equals its required rate of return
D)Will be lower than the industry average

Question 52

What is the expected, constant growth rate of dividends for a stock with a current price of $100, expected dividend payment of $10 per share, and a required return of 16 percent?

A)6.00 percent
B)6.25 percent
C)8.00 percent
D)10.00 percent

Question 53

If a stock's price decreased during the past week, what is the most likely prediction about this week's price change?

A)Price will reverse last week's loss and go up
B)Price will continue last week's decline
C)Price will stand still until new information is released
D)Either direction of price change is equally likely

Question 54

Which of the following best characterizes the difference between growth stocks and income stocks?

A)Growth stocks do not pay dividends
B)Income stocks offer higher rates of return
C)Income stocks are seasoned issues
D)Growth stocks have greater PVGO

Question 55

Investors are willing to purchase stocks having high P/E ratios because:

A)They expect these shares to sell for a lower price
B)They expect these shares to offer higher dividend payments
C)These shares are accompanied by guaranteed earnings
D)They expect these shares to have greater growth opportunities

Question 56

Security prices are said to follow a "random walk," which means that:

A)Stock selection for portfolio composition is unimportant
B)It is impossible to know whether stocks offer higher returns than bonds
C)Investment analysts are unnecessary
D)Successive price changes are unpredictable

Question 57

Which of the following situations accurately describes a growth stock, assuming that each firm has a required return of 12 percent?

A)A firm with PVGO = $0
B)A firm with investment opportunities yielding 10 percent
C)A firm with investment opportunities yielding 15 percent
D)All of the above firms represent growth stocks.

Question 58

What can be expected to happen when stocks having the same expected risk do not have the same expected return?

A)At least one of the stocks becomes temporarily mispriced
B)This is a common occurrence indicating that one stock has more PVGO
C)This cannot happen if the shares are traded in an auction market
D)The expected risk levels will change until the expected returns are equal

Question 59

The terminal value of a share of stock:

A)Is similar to the maturity value of a bond
B)Refers to the share value at the end of the investor's holding period
C)Is the value received by investors upon liquidation of the firm
D)Is the price for shares traded through a dealers' market

Question 60

Dividends that are expected to be paid far into the future have:

A)Great impact on current stock price, due to their expected size
B)Equal impact on current stock price as near-term dividends
C)Lesser impact on current stock price due to discounting
D)No impact on current stock price because they are uncertain

Question 61

How much of a stock's $30 price is reflected in PVGO if it expects to earn $4 per share, has an expected dividend of $2.50, and a required return of 20 percent?

A)$0
B)$6.00
C)$8.00
D)$10.00 P = $4/.2 if all earnings paid as dividends

Question 62

What is meant by the term true depreciation?

A)Depreciation expense as reported on the balance sheet
B)Depreciation expense according to generally accepted accounting principles
C)The amount necessary to overcome deterioration of corporate assets
D)Depreciation expense using only straight-line depreciation methods

Question 63

What proportion of earnings is being plowed back into the firm if the sustainable growth rate is 8 percent and the firm's ROE is 20 percent?

A)8 percent
B)12 percent
C)20 percent
D)40 percent 8% = 20% x plowback

Question 64

What should be the stock value one year from today for a stock that currently sells for $35, has a required return of 15 percent, an expected dividend of $2.80, and a constant dividend growth rate of 7 percent?

A)$37.45
B)$37.80
C)$40.25
D)$43.05

Question 65

If The Globe and Mail lists a stock's dividend as $1, then it is most likely the case that the stock:

A)Pays $1 quarterly, or an estimated $4 annually
B)Pays $0.25 quarterly, or an estimated $1 annually
C)Paid $1 during the past quarter, with no future dividends forecast
D)Paid $1 during the past year, with no future dividends forecast

Question 66

Which of the following is a characteristic of a dealer market, rather than auction market, for common stock?

A)Dealer markets are more likely to be centralized
B)Dealer markets operate as primary, not secondary, markets
C)Dealers may not all offer the same price for the same security
D)Dealer markets specialize in trading income stocks

Question 67

What should be the price of a stock that offers a $4 annual dividend with no prospects of growth, and has a required return of 12.5 percent?

A)$8.50
B)$25.00
C)$32.00
D)$50.00 P = $4/.125

Question 68

What is the minimum amount that shareholders should expect to receive in the event of a complete corporate liquidation?

A)Market value of equity
B)Book value of equity
C)Zero
D)Shareholders may be required to pay to be liquidated

Question 69

Which of the following should increase the firm's sustainable growth rate?

A)Increase the dividend payout ratio
B)Decrease the required return
C)Decrease the ROE
D)Increase the plowback ratio

Question 70

What should be the current price of a share of stock if a $5 dividend was just paid, the stock has a required return of 20 percent, and a constant dividend growth rate of 6 percent?

A)$19.23
B)$25.00
C)$35.71
D)$37.86 P = $5(1.06)/(.20 - .06)
P = 5.30/.14

Question 71

To justify a high P/E ratio, the market must believe one of the following about a firm:

A)It has low growth opportunities
B)It will have constant dividends forever
C)It has high growth opportunities
D)It will use low depreciation to increase earnings

Question 72

According to the constant dividend growth model, a stock price should equal the:

A)Sum of all future dividends
B)Sum of dividends to be received within the investor's holding period
C)Dividend yield plus the constant growth rate
D)Sum of all discounted future dividends

Question 73

What is the value of the expected dividend per share for a stock that has a required return of 16 percent, a price of $45, and a constant growth rate of 12 percent?

A)$1.80
B)$3.60
C)$4.50
D)$7.20 $45 = DIV./(.16 - .12)
$45 x .04 = DIV.

Question 74

What is the expected constant growth rate of dividends for a stock currently priced at $50, that just paid a dividend of $4, and has a required return of 18 percent?

A)3.41 percent
B)5.50 percent
C)9.26 percent
D)12.5 percent $50 = $4(1 + g)/(.18 - g)

Question 75

Reinvesting earnings into a firm will not increase the stock price unless:

A)The new paradigm of stock pricing is maintained
B)True depreciation is less than reported depreciation
C)The firm's dividends are growing also
D)The ROE of new investments exceeds the firm's required return

Question 76

Which of the following values treats the firm as a going concern?

A)Market value
B)Book value
C)Liquidation value
D)Both (b) and (c)

Question 77

The expected return on an equity security is comprised of a:

A)Dividend yield and ROE
B)Current yield and a terminal value
C)Sustainable growth rate and a plowback yield
D)Dividend yield and a capital gains yield

Question 78

What is the value of the expected dividend per share for a stock that has a required return of 16 percent, a price of $45, and a constant growth rate of 10 percent?

A)$2.70
B)$3.60
C)$4.50
D)$7.20 $45 = DIV./(.16 - .10)
$45 x .06 = DIV.

Question 79

What should be the current price of a stock if the expected dividend is $5, the stock has a required return of 20 percent, and a constant dividend growth rate of 6 percent?

A)$19.23
B)$25.00
C)$35.71
D)$37.86 P = 5.00/(.20 - .06)
P = 5.00/.14

Question 80

If stock prices follow a random walk, which of the following statement(s) is(are) correct?

A)Successive stock price changes are not related
B)The history of stock prices cannot be used to predict future returns to investors
C)Both A and B
D)Neither A nor B