Deck 11: Equity Valuation Models

Question 1

The correct strategy for dealing with a security where its price is greater than its value is to short sell the share.

Answer 1

True
Explanation: When considering any investment,the investor will assess the value of the asset,and then compare this value to the current price of the asset.If the asset's value is less than its current price,then the asset is overpriced,and the investor will either leave the asset out of his or her portfolio or seek to short sell the asset at the prevailing market price.Conversely,if the asset's value exceeds its current price,then the asset represents a bargain,and its purchase will increase the net wealth of the investor's portfolio.

Question 2

The horizon value is the project life where constant growth is assumed.

Answer 2

False
Explanation: The PV of the assumed long-term growth rate in FCF is the horizon value.

Question 3

If a share is trading above its P/E multiplier,then it is trading at a discount.

Answer 3

False
Explanation: It is sometimes said by analysts that a particular share is trading above or below its P/E multiple.This statement means that,relative to its level of maintainable earnings and its competitors' P/E ratios,the share's price is too high (i.e.trading above its P/E multiple)or the price is too low (i.e.trading below its P/E multiple).

Question 4

The constant-growth dividend discount model (DDM)can be used only when the ___________.

A)growth rate is less than or equal to the required return
B)growth rate is greater than or equal to the required return
C)growth rate is less than the required return
D)growth rate is greater than the required return

Question 5

An investor expects Gernotti Ltd to pay a dividend of $0.80 next year,after which the investor will sell the share for $9.00.If the cost of capital is 12% p.a. ,what is the current price of the share?

Question 6

If the value of an asset is more than its price,then the asset is said to be overpriced.

Question 7

The correct price of a share with a cost of capital of 25% p.a.that pays $0.28 p.a.dividends in perpetuity is:

Question 8

In the earnings capitalisation model,defining growth involves using the zero growth model,and then subtracting the present value of the growth opportunities.

Question 9

An investor expects Chewy Lewy Ltd to pay a dividend of $0.95 next year,after which the investor expects to sell the share for $12.80.The cost of equity capital is estimated to be 12% p.a.What is the present value of one share in Chewy Lewy Ltd?

Question 10

Brown and Clarke (1993)generally find evidence that investors in the Australian market assign a negative value to the imputation tax credit on ex-dividend dates.

Question 11

Musters Ltd currently pays a dividend of $0.76.One share in Musters Ltd currently costs $14.25.Given a cost of equity capital of 9%,what is the implied constant growth rate?

Question 12

The price of a security is set by:

Question 13

Riskinfoz Ltd currently pays a dividend of $1.30.Riskinfoz Ltd's estimated growth rate is 14.8%.What is the expected dividend in Year 9?

Question 14

The asset backing model of valuation operates by assuming the company is solvent and able to continue as an ongoing concern.

Question 15

The consistent use of real or nominal figures in the calculation of share prices has an enormous effect on the valuation.

Question 16

Most firms exhibit constant rates of growth in their dividend series.

Question 17

An investor expects Tom Fun Ltd to pay a dividend of $0.40 in year 1,$0.75 in year 2 and $.80 in year 3,after which the investor expects to sell the share for $8.95.The cost of equity capital is estimated to be 13.50% p.a.What is the present value of one share in Tom Fun Ltd?

Question 18

The cost of equity capital for a firm can be estimated using an asset pricing model.

Question 19

Lessitz Ltd currently pays a dividend of $0.85.Lessitz Ltd's estimated growth rate is 6.8%.Given a cost of capital of 9.00%,what is the PV of one share in Lessitz Ltd?

Question 20

The market capitalisation rate on the stock of Aberdeen Wholesale Company is 10%.Its expected ROE is 12%,and its expected EPS is $5.If the firm's plowback ratio is 50%,its P/E ratio will be _________.

A)8.33
B)12.5
C)19.23
D)24.15

Question 21

Klister Corporation currently pays dividends of $2.75.The current market price of one share in Klister Corporation is $38.If the growth rate is thought to be 7.5%,what is the implied cost of equity capital?

Question 22

The dividend payout ratio of a firm is 40%.If the cost of equity capital for the firm is 10% p.a.and the corporate tax rate is 30%,calculate the plowback ratio.

Question 23

MSB Ltd has a current share price of $14.55.If MSB has a constant expected growth rate of 5% and is expected to pay a dividend of $0.65 per share,what is MSB's cost of capital?

Question 24

You work for an arm of a major merchant bank specialising in Australian equity stocks.It is company policy to use the earnings capitalisation model for valuation purposes and to calculate EPS forecasts using two approaches;one a random walk (RW)and the other a random walk with $0.05 drift (RWD).The EPS for PF Corporation is currently $0.25,and in the previous year EPS was $0.25.PF Corporation has a current share price of $4.25 and a cost of capital of 12%.Which of the following best represents your recommendation about PF Corporation under each approach?

Question 25

You work for an arm of a major merchant bank specialising in Australian equity stocks.It is company policy to use the earnings capitalisation model for valuation purposes and to calculate EPS forecasts using two approaches: a random walk (RW)and a random walk with $0.05 drift (RWD).The EPS for PF Corporation is currently $0.35,and in the previous year the EPS was $0.32.PF Corporation has a current share price of $4.70 and a cost of capital of 7%.Which of the following best represents your recommendation about PF Corporation under each approach?

Question 26

Company ABC currently pays annual dividends of $0.40,and growth of these dividends is expected to be at 5% p.a.Given a cost of equity capital of 10%,what is the estimated current share price of ABC?

Question 27

If Minion Ltd has a price of $47.50 and current EPS of $3.50,what is Minion's cost of capital?

Question 28

Assume that the current earnings per share of Uschi Ltd is $0.57.Uschi Ltd is not expected to experience any growth.The company has an estimated cost of capital of 15.75%.What is the PV of Uschi Ltd shares?

Question 29

You work for an arm of a major merchant bank specialising in Australian equity stocks.It is company policy to use the earnings capitalisation model for valuation purposes and to calculate EPS forecasts using two approaches;a random walk (RW)and a random walk with $0.05 drift (RWD).The EPS for PF Corporation is currently $0.50,and in the previous year EPS was $0.52.PF Corporation has a current share price of $5.60 and a cost of capital of 8%.Which of the following best represents your recommendation about PF Corporation under each approach?

Question 30

Shares in Anza Ltd are currently trading at a P/E ratio of 17.0.If the current price of Anza Ltd shares is $8.60,what is expected future price of the share?

Question 31

MAB Ltd has just announced its latest dividend at $0.60 per share.If MAB has a constant expected growth rate of 5% and a cost of capital of 7%,which of the following is the best estimate of the value of MAB Ltd's shares?

Question 32

A company has revenues of $170 000,expenses of $45 000 and tax of $37 500.If the company also has a working capital level of $25 000 and the corporate tax rate is 30%,estimate the level of free cash flows for the firm.

Question 33

If a company with a share price of $6 has earnings per share of $0.15,calculate the cost of capital for the firm.

Question 34

Grott and Perrin,Inc.has expected earnings of $3 per share for next year.The firm's ROE is 20%,and its earnings retention ratio is 70%.If the firm's cost of capital is 15%,what is the present value of its growth opportunities?

A)$20
B)$70
C)$90
D)$115

Question 35

A firm has a dividend payout ratio of 20%,annual profit of $20 000 and a market value of equity equal to $150 000.Given a corporate tax rate of 30%,estimate the growth rate in dividends.

Question 36

If shares in Ursula Ltd are currently trading at a P/E ratio of 12.4,what is the implied cost of capital?

Question 37

Generally speaking,the higher a firm's ROA (return on assets),the _________ the dividend payout ratio and the _________ the firm's growth rate of earnings.

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

Question 38

Assume Luna Ltd pays a mixture of both franked and unfranked dividends.The current dividend just paid is $0.80,of which 40% is franked.The expected constant growth rate is 5% and the estimated cost of capital is 9%.Given a corporate tax rate of 30%,what is the present value of one share in Luna Ltd?

Question 39

An investor estimates that a company has a maintainable constant level of EPS of $1.20.The investor also estimates the cost of equity capital to be 14%.New projects adopted for the next three years are expected to generate net returns equal to $4.70,$7.90 and $8.10 in years 1,2 and 3 respectively.What is the present value of one share in this company?

Question 40

Annie's Donut Shops,Inc. ,has just paid a dividend of $3.The firm's ROE is 18%,and its earnings retention ratio is 60%.If the firm's cost of capital is 12%,what is the value of the firm excluding any growth opportunities?

A)$25
B)$50
C)$83.33
D)$208