Deck 3: Valuation of Shares and Bonds

Question 1

In the formula, ,what does g represent?

A)The dividend at the start of the first period
B)The required rate of return
C)The dividend at the end of the first period
D)The constant growth rate

Answer 1

The constant growth rate

Question 2

What is the required rate of return on a share that is expected to pay a constant dividend of $3.60 in perpetuity and is priced at $27.50?

A)13.09% p.a.
B)10.75% p.a.
C)11.00% p.a.
D)Insufficient information to determine its price

Answer 2

13.09% p.a.

Question 3

Which of the following constitutes a difference between debt and equity?

A)The nature of cash flows underlying the security
B)The right to claim against the assets of the corporation in the case of bankruptcy
C)The life of the security
D)All of the above

Answer 3

All of the above

Question 4

Silo Builders recently paid a dividend of $0.72.Their ordinary shares are currently trading at $18.72 in the market.Silo Builders' shareholders require a return of 8% p.a.What is the implied rate of growth of Silo Builders' dividends?

A)2.00%
B)12.00%
C)0.00%
D)4.00%

Question 5

Which of the following does not constitute a feature of a debt security?

A)The principle will be repaid at the end of a fixed period of time.
B)The holder has first claim against the assets of the firm on the event of liquidation.
C)The holder has a partial ownership interest in the firm.
D)The return is usually contractually fixed for the life of the security.

Question 6

XHZ Ltd has recently paid a dividend of $0.23.This dividend is expected to grow at a constant rate of 3% p.a.The company's equity holders require a return of 11.95% on equity investments.What is XHZ Ltd's current share price?

A)$2.31
B)$2.65
C)$2.57
D)$1.92

Question 7

If you require an 11% rate of return,how much would you pay now for a bond with a face value of $3,000,pays $120 interest each year and matures in 11 years' time? Round your answer to the nearest $10.

A)$810
B)$2,130
C)$1,700
D)$1,950

Question 8

What is the market price (to the nearest dollar)of a 16% p.a.quarterly coupon bond with a face value of $100,five years to go until maturity when the current market yield is 12% p.a.?

A)$173
B)$114
C)$96
D)$86

Question 9

Which of these answers best describes the cost of debt?

A)The discount rate that equates the series of cash inflows (interest and principal)with the current bond price
B)One of the components of the firm's cost of capital
C)The required rate to induce investors to hold the firm's debt
D)All of the above

Question 10

Koromiko Cheese Ltd generated an EPS this year of $1.80 and paid a dividend of $1.00 per share.Koromiko Cheese has recently been able to generate a return of 10.75% p.a.on its (book)equity base.If these numbers are assumed to be fairly stable,what will be Koromiko Cheese's expected future growth rate?

A)5.97%
B)4.78%
C)8.32%
D)9.85%

Question 11

The value of a share is given by the present value of which cash flows?

A)Future dividends only
B)The last dividend and future dividends
C)The current dividend and future dividends
D)The most recent dividend and future dividends

Question 12

What is the price of a share that recently paid a dividend of $0.25,assuming that the dividend is expected to remain unchanged in the future and that the appropriate cost of equity is 12.5% p.a.?

A)$0.50
B)$2.00
C)$1.50
D)$1.00
E)Insufficient information to determine its price

Question 13

Martell Ltd is expected to generate an EPS next year of $0.80 and its shares are currently priced in the marketplace at $13.11.Lannister Ltd is expected to generate an EPS next year of $0.51 and its shares are currently priced in the marketplace at $9.20.Baratheon Ltd is expected to generate an EPS next year of $0.23 and its shares are currently priced in the marketplace at $5.61.Stark Ltd is expected to generate an EPS next year of $0.56 and its shares are currently priced in the marketplace at $8.85.These companies all operate in the same industry,are expected to all have the same growth prospects and all have the same risk.The industry P/E prospective ratio is known to be 17x.Based upon the P/E ratios,which of the following would be the best investment strategy?

A)Buy Lannister and Baratheon shares and sell Stark and Martell shares.
B)Sell Lannister and Baratheon shares and buy Stark and Martell shares.
C)Sell Martell and Lannister shares and buy Stark and Baratheon shares.
D)Buy Martell and Lannister shares and sell Stark and Baratheon shares.

Question 14

Which of the following describes the difference between the returns on debt and equity?

A)The return on debt is adjusted annually throughout the life of the security,whereas the return on equity is fixed.
B)The return on debt is stipulated in the trust deed,whereas the return on equity is varied at the discretion of management.
C)The return on debt is more variable than the return on equity.
D)The return on debt is stipulated in the debt contract,whereas the return on equity is stipulated in the trust deed.

Question 15

When valuing a company's real asset cash flows,which cash flows should be considered? The value of a firm is given by its free cash flows discounted by which of the following?

A)Cash flows from real assets,after reinvestment costs
B)All cash flows
C)Net cash flows from all assets
D)Gross cash flows from real assets

Question 16

What is the market price (to the nearest dollar)of a 12% p.a.quarterly coupon bond with a face value of $100,three years to go until maturity when the current market yield is 8% p.a.?

A)$111
B)$90
C)$100
D)$114

Question 17

What is the required rate of return on a share that is expected to pay a constant dividend of $4.50 in perpetuity and is priced at $47.50?

A)10.31%
B)7.98%
C)11.43%
D)9.47%

Question 18

WineMaster Ltd generated an EPS this year of $0.90 and paid a dividend of $0.30 per share.WineMaster has recently been able to generate a return of 7.75% p.a.on its (book)equity base.If these numbers are assumed to be fairly stable,what will be WineMaster's expected future growth rate?

A)6.45%
B)5.17%
C)8.75%
D)2.33%

Question 19

Jindabyne Brewing Ltd (JBL)recently paid a dividend of $0.72.This dividend is expected to grow at a constant rate of 3% p.a.The company's shareholders require a return of 6% p.a.on their invested capital.Assuming that these figures are accurate what will be JBL's share price in two year's time?

A)$26.23
B)$28.58
C)$24.72
D)$27.44

Question 20

Endeavour Enterprises is expected to pay a dividend of $1.22 at the end of the current year and analysts predict that dividends are expected to grow at a constant rate of 9% p.a.after that.If Endeavour Enterprises' shareholders require a return of 8% p.a.on equity capital provided to the firm what will be its current share price?

A)$100.00
B)- $122.00
C)$122.00
D)Unable to determine using a constant dividend growth model

Question 21

A firm's mix of debt and equity is known as its .

A)Payout ratio
B)Market capitalisation
C)Capital structure
D)Retention ratio

Question 22

The value of a share that pays a constant dividend is equivalent to which of the following?

A)A deferred annuity
B)A perpetuity
C)An annuity due
D)None of the above

Question 23

The value of a firm by calculating the present value of cash flows generated by the firm's productive assets should,theoretically,be the same as:

A)The sum of the present values of the firm's equity and debt securities
B)The value of the firms net assets,as recorded on the balance sheet
C)The most recent price in which the firm's shares were traded,multiplied by the number of shares on issue
D)The present value of the cash flows generated by the firms real assets

Question 24

The P/E ratio is determined by dividing the earnings per share by the price of a share.

Question 25

If a company has earnings per share of $4 and share price of $50,its P/E ratio is 0.08.

Question 26

A convertible note is an example of a(n):

A)Hybrid security
B)Equity security
C)Debt security
D)Ordinary security

Question 27

The constant dividend growth model is superior to the constant dividend model for valuing shares because it of its more realistic assumption regarding company dividend policies.

Question 28

Which of these is the value of a firm's cash flows from real assets after reinvestment costs?

A)Total cash flows
B)Operating cash flows
C)Free cash flows
D)Net cash flows

Question 29

Which of these represents the cash flows generated by a firm's real assets that flow through to debtholders?

A)Expenses
B)Dividends
C)Interest
D)Revenue

Question 30

Wingnut Systems Pty Ltd is expected to pay a dividend of $2.54 at the end of the current year and that dividend is expected to grow at a constant rate of 4% p.a.The company's shareholders require a return of 10% p.a.on their investment.What is Wingnut System's current share price?

A)$44.03
B)$48.15
C)$42.33
D)$46.57

Question 31

One significant difference between debt and equity securities is that the owners of debt securities are entitled to first call on the assets of the issuer in precedence to owners of equity securities in the event of insolvency of a company.

Question 32

Which of these is used to estimate the dividend growth rate (g)?

A)(1- payout ratio)× return on equity
B)(plough back ratio)× return on equity
C)(1- plough back ratio)× return on assets
D)(plough back ratio)× return on assets

Question 33

How does an analyst use P/E ratios to identify underpriced stocks?

Question 34

WaggaWagga Ltd's shares are currently selling for $3.50.If the expected dividend (D₁)is
$0.138 and the current dividend (D₀)is $0.108,what is the rate of return implied by the current share price?

Question 35

If both dividends and capital gains/losses form part of the return a shareholder will receive for investing in shares why are only the dividends taken into account when pricing the share using a constant dividend model or constant dividend growth model?

Question 36

Jindabyne Brewing Ltd (JBL)recently paid a dividend of $0.85.This dividend is expected to grow at a constant rate of 4% p.a.The company's shareholders require a return of 8% p.a.on their invested capital.Assuming that these figures are accurate,what will be JBL's share price in four years' time?

A)$21.25
B)$24.68
C)$22.10
D)$25.86

Question 37

What is the market price of a 12% p.a.semi- annual coupon bond with a face value of $100,two years to go until maturity when the current market yield is 10% p.a.?

A)$100.00
B)$103.55
C)$96.61
D)$103.47

Question 38

When examining the capital structure of a firm,what element(s)would you be most likely to see?

A)Debt securities
B)Equity securities
C)Hybrid securities
D)A mixture of the above

Question 39

Which of these represent the cash flows generated by a firm's real assets that flow through to shareholders?

A)Revenue
B)Interest
C)Expenses
D)Dividends

Question 40

Weta Industries has a P/E ratio of 16.03 and Katipo Company has a P/E ratio of 13.25.As both companies are in the same industry,it is reasonable to assume that Katipo's shares are underpriced.

Question 41

If the equity cost of capital is less than the dividend growth rate,the share value under the constant- dividend growth model will be positive.

Question 42

Since debt holders have first claim upon the assets of a company in the event of liquidation,they will always get their money back whereas shareholders may not.

Question 43

All other things being equal,decreasing the plough back ratio will increase the expected future growth rate.

Question 44

All other things being equal,increasing the payout ratio will decrease the expected future growth rate.

Question 45

The constant dividend model is difficult to rely on in practice because companies rarely maintain constant dividends.

Question 46

The growth rate must be greater than the required rate of return in the constant dividend growth model for the outcome to be realistic.

Question 47

Even though coupon amounts are not always paid yearly,it is not important to consider this when valuing bonds.

Question 48

The constant dividend growth model cannot be used to price the shares of a company when the end of last period dividend is known,but the expected end of this period dividend is not.

Question 49

When valuing shares,it is important to include the last dividend paid as part of the valuation cash flows.

Question 50

Because equity cash flows are generally unstable and the life of equity is indefinite,analysts typically make assumptions about the character of future dividends to be paid by the company when valuing shares.