Deck 8: Stock Valuation

Question 1

Companies with high P/E ratios tend to also have high dividend payout ratios.

Answer 1

False

Question 2

A company's estimated future earnings and its P/E ratio can be used to estimate the stock's future price.

Answer 2

True

Question 3

A decline in earnings that investors expect to be temporary may actually increase a firm's P/E ratio.

Answer 3

True

Question 4

The key to the future financial success of a company lies in the sales growth and the net profit margin.

Question 5

The first step in predicting a stock's future price is to forecast profits.

Question 6

The single most important issue in the stock valuation process is a company's

A)past earnings record.
B)historic dividend growth rate.
C)expected future returns.
D)capital structure.

Question 7

A temporary decline in earnings per share usually results in a temporary reduction of dividends.

Question 8

Which of the following will most directly influence a company's market value?

A)the state of the economy
B)the book value of its assets
C)the use of financial leverage
D)its future cash flows

Question 9

Which of the following will affect the firm's future cash flows?
I.state of the economy
II.state of the industry
III.the firm's recent and current earnings
IV.new products in the firm's pipeline

A)I, II and III only
B)I, II and IV only
C)I, III and IV only
D)I, II, III and IV

Question 10

The common-size income statement expresses every item on the income statement as a percentage of sales.

Question 11

The most important factors influencing a stock's current price are its past earnings and dividends.

Question 12

The value of a stock is a function of

A)future returns.
B)historic dividend growth rate.
C)most recent earnings per share.
D)past returns.

Question 13

Most analysts would not feel comfortable forecasting a firm's future earnings for more than

A)the next quarter.
B)1 to 3 years.
C)4 or 5 years.
D)the next business cycle.

Question 14

List the key variables that affect the P/E ratio and explain the relationship between each variable and the P/E ratio.

Question 15

A stock's value depends on future cash flows.

Question 16

If net income rises, but the number of shares outstanding remains the same, EPS will rise.

Question 17

Which of the following variables affect the P/E ratio?
I.capital structure of a firm
II.amount of dividends to be paid
III.inflation rate
IV.earnings rate of growth

A)I, II and III only
B)I, II and IV only
C)I, III and IV only
D)I, II, III and IV

Question 18

The estimated price of a stock in the future is important because it includes the projected capital gain on the stock.

Question 19

High P/E ratios can be expected when investors expect

A)a high rate of growth in earnings.
B)low earnings.relative to market prices.
C)high interest rates.
D)a bear market.

Question 20

Which of the following contributes to high P/E ratios?

A)high dividend payout ratios
B)high rate of earnings growth
C)periods of high inflation
D)high debt ratios

Question 21

The common stock of Rob's Discount Furniture is currently selling at $65.20 a share.The company adheres to a 60% dividend payout ratio and has a P/E ratio of 19.There are 42,000 shares of stock outstanding.What is the amount of the annual net income for the firm?

A)$42,338
B)$36,032
C)$144,126
D)$72,064

Question 22

The greater the perceived risk of an asset, the lower the expected rate of return.

Question 23

P/E ratios could rise even as earnings fall if

A)earnings fall at a faster rate than stock prices.
B)earnings fall at a slower rate than stock prices.
C)investors expect lower stock prices to be permanent.
D)investors expect lower earnings to be permanent.

Question 24

Over the last year, a firm's earnings per share increased from $1.20 to $1.40, its dividends per share increased from $0.50 to $0.60, and its share price increased from $21 to $24.The firm maintained a relative P/E of 1.10 over the entire time period.Given this information, it follows that the

A)stock experienced an increase in its P/E ratio.
B)company had a decrease in its dividend payout ratio.
C)current P/E of the overall market is 26.4.
D)overall market P/E is declining.

Question 25

The sales forecast depends on factors both internal and external to the firm.

Question 26

A stock will be an attractive investment if the required rate of return exceeds the expected rate of return.

Question 27

Global Warning's EPS for the current year is $2.75 and its current P/E ratio is 50.You have forecasted that EPS will grow by 10% but the P/E ratio will fall to 40.What do you expect the price of a share of GW's stock to be at the end of next year?

A)$110
B)$121
C)$137.50
D)$151.25

Question 28

GLOO stock's P/E ratio is 45 at a time when the market's P/E ratio is 15.GLOO's relative P/E ratio is

A)30.
B)-30.
C)3.
D).33.

Question 29

Columbus Co.'s sales revenue for the most recent quarter was $2.5 million and cost of goods sold was $1.5 million.If sales grow by 15% in the next quarter and all ratios remain the same, gross profit will be

A)$2.25 million.
B)$1.725 million.
C)$1.15 million.
D)$1.375 million.

Question 30

Which of the following will lead to an increase in earnings per share?

A)an increase in the P/E ratio.
B)an increase in the dividend payout ratio.
C)an increase in return on equity if book value per share stays the same.
D)a decrease in the number of shares if return on equity stays the same.

Question 31

If the market multiple is 20.24 and the P/E ratio of a company is 24.5, then the stock's relative P/E is

A)0.83.
B)1.19.
C)1.21.
D)4.26.

Question 32

There is no assurance that the actual rate of return on an asset will be similar to the projected rate of return.

Question 33

The efficient market hypothesis holds that a stock's intrinsic value and market value are essentially the same.

Question 34

The Merry Co.has current annual sales of $350,000 and a net profit margin of 6%.Sales are expected to increase by 5% annually while the profit margin is expected to remain constant.What is the projected after-tax earnings for two years from now?

A)$19,294
B)$22,050
C)$23,100
D)$23,153

Question 35

Which one of the following is a correct equation to calculate earnings per share?

A)(ROA)(book value per share)
B)(profit margin)(total asset turnover)(equity multiplier)(book value per share)
C)(profit margin)(equity multiplier)(book value per share)
D)(profit margin)(book value per share)

Question 36

Even if a company does not officially follow a fixed-dividend policy, dividend payments are

A)extremely difficult to predict.
B)very volatile and subject to economic conditions.
C)fairly stable from one time period to another.
D)directly tied to a company's P/E ratio.

Question 37

Markhem Enterprises is expected to earn $1.34 per share this year.The company has a dividend payout ratio of 40% and a P/E ratio of 18.What should one share of common stock in Markhem Enterprises be selling for in the market?

A)$9.65
B)$14.47
C)$24.12
D)$33.77

Question 38

Which one of the following is is most likely to increase the price of a stock?

A)rapid growth in sales
B)rapid decrease in the company's debt levels
C)rapid growth in earnings
D)rapid increases in bond interest rates

Question 39

The current annual sales of Flower Bud, Inc.are $178,000.Sales are expected to increase by 4% next year.The company has a net profit margin of 5% which is expected to remain constant for the next couple of years.There are 10,000 shares of common stock outstanding.The market multiple is 16.4 and the relative P/E of the firm is 1.21.What is the expected market price per share of common stock for next year?

A)$15.18
B)$17.66
C)$18.37
D)$19.29

Question 40

The major forces behind earnings per share are

A)return on assets and total asset value.
B)gross revenue and the stock price.
C)growth and the number of shares outstanding.
D)net income and the number of shares outstanding.

Question 41

The approach to stock valuation which holds that the value of a share of stock is a function of its future dividends is known as the dividend valuation model (DVM).

Question 42

Both beta and the expected return on the market portfolio incorporate risk into the Capital Asset Pricing Model.

Question 43

The required rate of return denotes the minimum rate of return an investor should expect.

Question 44

The intrinsic value of a stock provides a purchase price for the stock

A)that is reasonable given the associated level of risk.
B)which will assuredly yield the anticipated capital gain.
C)which will guarantee the expected rate of return.
D)that is always below the market value but yet yields the expected rate of return.

Question 45

The risk-free rate of return is 2.2 percent, the expected market return is 11 percent, and the beta for Solstice, Inc.is 1.12.What is Solstice's required rate of return?

A)8.80%
B)12.05%
C)13.20%
D)14.30%

Question 46

The most uncertain value used in the Capital Asset Pricing Model is

A)beta.
B)the risk-free rate.
C)expected return on the market.
D)all are equally uncertain.

Question 47

The growth rate of dividends cannot be permanently greater than the required rate of return.

Question 48

The required rate of return estimated by the Capital Asset Pricing Model is not suitable for use in dividend valuation models.

Question 49

In the Capital Asset Pricing Model, which of the following factors are used to determine the required rate of return?
I.the risk-free interest rate
II.future cash flows
III.expected return on the market portfolio
IV.beta

A)I and II only
B)I, II and III only
C)II, III and IV only
D)I, III and IV only

Question 50

If the annual dividend on a stock never changes, its price will never change.

Question 51

Heather believes that by carefully examining a company's fundamentals and by applying the best valuation models she can identify stocks whose market prices are lower than their intrinsic values.In order for this to be true

A)she needs an accurate estimate of future earnings and dividends.
B)some stocks must be incorrectly priced.
C)betas must be stable over time.
D)P/E ratios for both the stock and the market must be stable over time.

Question 52

One of the easiest aspects of the dividend valuation model (DVM)is specifying the appropriate growth rate for a firm's dividends over time.

Question 53

An investor should purchase a stock when

A)the market price exceeds the intrinsic value.
B)the expected rate of return equals or exceeds the required return.
C)the capital gains rate is less than the required return and no dividends are paid.
D)the market price is greater than the justified price.

Question 54

The dividend valuation model estimates the value of a share of stock as the future value of all dividends.

Question 55

The risk free rate is 2%.The expected rate of return on the market is 12%.Beta and the expected rate of return for four stocks are as follows.: ABC .8 , 10%; DEF 1, 12%; GHI 1.2 , 13%, and JKL 2, 22%.Which of these stocks should not be purchased?

A)ABC
B)DEF
C)GHI
D)JKL

Question 56

Which of the following are key inputs to determining the intrinsic value of an asset?
I.the required rate of return
II.future cash flows
III.current stock price
IV.timing of future cash flows

A)I and II only
B)I and III only
C)I, II and IV only
D)II, III and IV only

Question 57

The intrinsic value of an asset equals the present value of all future cash flows at a given discount rate.

Question 58

The dividend valuation model (DVM)is very sensitive to the growth rate (g)being used, because it affects both the model's numerator and its denominator.

Question 59

Explain how the time value of money concept is used in stock valuation.

Question 60

Which of the following variables used in determining a stock's intrinsic value can be known with the greatest level of confidence?

A)future earnings
B)expected return on the market
C)the risk free rate of return
D)future dividends

Question 61

The constant-growth dividend valuation model is best suited for use with

A)stocks of new or emerging companies.
B)small-cap stocks within growing industries.
C)the stocks of mature, dividend-paying companies.
D)the stocks of cyclical companies.

Question 62

Walpurg, Inc.paid $1.30 as an annual dividend per share last year.The company is expected to increase their annual dividends by 6% each year.How much should you pay to purchase one share of this stock if you require a 9% rate of return on this investment?

A)$45.93
B)$11.44
C)$23.39
D)$22.96

Question 63

What is the required rate of return on a common stock that is expected to pay a $0.75 annual dividend next year if dividends are expected to grow at 2 percent annually and the current stock price is $8.59?

A)8.73%
B)8.91%
C)10.73%
D)11.38%

Question 64

The Hopkinton Company just paid $2.25 as its annual dividend.The dividends have been increasing at a rate of 5% annually and this trend is expected to continue.The stock is currently selling for $63.60 a share.What is the rate of return on this stock?

A)3.60%
B)3.70%
C)8.7%
D)11.8%

Question 65

Lindor Inc.'s $100 par value preferred stock pays a dividend fixed at 8% of par.To earn 12% on an investment in this stock, you need to purchase the shares at a per share price of

A)$9.60.
B)$66.67.
C)$96.00.
D)$150.00.

Question 66

The intrinsic value of a zero-growth stock can be found simply by dividing the dividend by the required rate of return.

Question 67

The dividend valuation model (DVM)cannot accommodate which of the following assumptions?

A)constant dividends
B)a constant growth rate of dividends less than the required rate of return
C)a constant growth rate of dividends greater than the required rate of return
D)dividends growing at a variable rate

Question 68

Michelak's Maritime Industries has relatively stable earnings and pays an annual dividend of $3.00 per share.This dividend has remained constant over the past few years and is expected to remain constant for some time to come.If you want to earn 11% on an investment in the common stock of Michelak's, how much should you pay to purchase each share of stock?

A)$12.50
B)$18.88
C)$20.83
D)$27.27

Question 69

The required rate of return necessary for the dividend valuation model can be estimated using

A)the Capital Asset Pricing Model.
B)comparisons to the rates of return on stocks of similar risk.
C)a subjective assessment of the return required over and above less risky investments such as government bonds.
D)any or all of the above.

Question 70

Newton, Inc.just paid an annual dividend of $0.95.Their dividends are expected to increase by 4% annually.Newton Company stock is selling for $11.54 a share.What is the required rate of return on this stock implied by the dividend-growth model?

A)8.23%
B)12.2%
C)12.6%
D)13.9%

Question 71

John requires a 12% rate of return on EG stock at a time when investors, on average, are requiring an 11% rate of return on the same stock.Which of the following will happen?

A)John will have to pay more for the stock than he was willing to pay.
B)Investors with different required rates of return will pay different prices for the stock.
C)John will not be able to buy the stock unless the price changes.
D)John will buy the stock at a lower price.

Question 72

In applying the variable-growth dividend valuation model to a company's stock, analysts frequently define the growth rate, g, as equal to

A)ROE multiplied by the firm's retention rate.
B)ROE divided by the dividend payout ratio.
C)the dividend payout ratio multiplied by the firm's retention rate.
D)P/E multiplied by the dividend payout ratio.

Question 73

ABC Company stock currently has a market value equivalent to its intrinsic value.Marco perceives that ABC Company is increasing its level of risk and therefore Marco increases his required rate of return on ABC stock.This change in the required rate of return

A)will reduce the intrinsic value of ABC stock to Marco.
B)will increase the intrinsic value of ABC stock to Marco.
C)will change the intrinsic value but the direction of the change cannot be determined.
D)is a signal to Marco that he should buy more ABC Company stock.

Question 74

One stock valuation model holds that the value of a share of stock is a function of its future dividends, and that the dividends will increase at an annual rate which will remain unchanged over time.This stock valuation model is known as the

A)approximate yield model.
B)holding period return model.
C)dividend reinvestment model.
D)constant growth dividend valuation model.

Question 75

When using the constant-growth dividend valuation model, which of the following will lower the value of the stock?

A)an increase in the required rate of return
B)a decrease in the required rate of return
C)an increase in the dividend payout ratio
D)an increase in the growth rate of the dividends

Question 76

The rate of growth can exceed the required return during the variable-growth period without invalidating the variable growth dividend valuation model.

Question 77

A company that wants to maintain both a constant growth rate in dividends and a constant payout ratio will have to

A)grow earnings faster than dividends.
B)increase assets at the same rate as dividends.
C)grow earnings at the same rate as dividends.
D)increase stockholders' equity at the same rate as dividends.

Question 78

The rate of dividend growth can be estimated by multiplying the return on equity rate by the dividend payout ratio.

Question 79

James is willing to settle for a 10% rate of return on EG stock at a time when investors, on average, are requiring an 11% rate of return on the same stock.Which of the following will happen?

A)James will be have to pay more for the stock than he was willing to pay.
B)Investors with different required rates of return will pay different prices for the stock.
C)James will not be able to buy the stock unless the price changes.
D)James will be happy to buy the stock for less than he was willing to pay.

Question 80

One method of estimating the dividend growth rate is to calculate the discount rate that equates today's dividend with the dividend paid several years ago.