Deck 11: Equity Valuation

Question 1

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

Answer 1

C

Question 2

Bill, Jim and Shelly are all looking to buy the same shares that pay dividends. Bill plans on holding the shares for one year. Jim plans on holding the shares for three years. Shelly plans on holding the shares until she retires in 10 years. Which one of the following statements is correct?

A)Bill will be willing to pay the most for the shares because he will get his money back in one year when he sells.
B)Jim should be willing to pay three times as much for the shares as Bill because his expected holding period is three times as long as Bill's.
C)Shelly should be willing to pay the most for the shares because she will hold them the longest and hence she will get the most dividends.
D)All three should be willing to pay the same amount for the shares regardless of their holding period.

Answer 2

D

Question 3

Which one of the following statements about market and book value is correct?

A)All firms sell at a market-to-book ratio above 1.
B)All firms sell at a market-to-book ratio greater than or equal to 1.
C)All firms sell at a market-to-book ratio below 1.
D)Most firms have a market-to-book ratio above 1, but not all.

Answer 3

D

Question 4

Gagliardi Way Corporation has an expected ROE of 15%. If it pays out 30% of its earnings as dividends, its dividend growth rate will be ________.

A)4.5%
B)10.5%
C)15.0%
D)30.0%

Question 5

A firm has current assets which could be sold for their book value of $10 million. The book value of its fixed assets is $60 million but they could be sold for $95 million today. The firm has total debt at a book value of $40 million but interest rate changes have increased the value of the debt to a current market value of $50 million. This firm's market to book ratio is ________.

A)1.83
B)1.50
C)1.35
D)1.46

Question 6

A firm that has an ROE of 12% is considering cutting its dividend payout. The shareholders of the firm desire a dividend yield of 4% and a capital gain yield of 9%. Given this information, which of the following statement(s) is/are correct?
I) All else equal, the firm's growth rate will accelerate after the payout change.
II) All else equal, the firm's share price will go up after the payout change.
III) All else equal, the firm's P/E ratio will increase after the payout change.

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

Question 7

Weyerhaeuser Incorporated has a balance sheet which lists $70 million in assets, $45 million in liabilities and $25 million in common shareholders' equity. It has 1 000 000 common shares outstanding. The replacement cost of its assets is $85 million. Its share price in the market is $49. Its book value per share is ________.

A)$16.67
B)$25.00
C)$37.50
D)$40.83

Question 8

If a share is correctly priced then you know that ________.

A)the dividend payout ratio is optimal
B)the share's required return is equal to the growth rate in earnings and dividends
C)the sum of the share's expected capital gain and dividend yield is equal to the share's required rate of return
D)the present value of growth opportunities is equal to the value of assets in place

Question 9

Suppose that in 2009 the expected dividends of the shares in a broad market index equalled $240 million when the discount rate was 8% and the expected growth rate of the dividends equalled 6%. Using the constant growth formula for valuation, if interest rates increase to 9% the value of the market will change by ________.

A)-10%
B)-20%
C)-25%
D)-33%

Question 10

New-economy companies generally have higher ________ than old-economy companies.

A)book value per share
B)P/E multiples
C)profits
D)asset values

Question 11

The market capitalisation rate on the shares of Aberdeen Wholesale Company is 10%. Its expected ROE is 12% and its expected EPS is $5.00. If the firm's plouwback ratio is 50%, its P/E ratio will be ________.

A)8.33
B)12.50
C)19.23
D)24.15

Question 12

You are considering acquiring a common share of Sahali Shopping Centre Corporation that you would like to hold for one year. You expect to receive both $1.25 in dividends and $35 from the sale of the share at the end of the year. The maximum price you would pay for a share today is ________ if you wanted to earn a 12% return.

A)$31.25
B)$32.37
C)$38.47
D)$41.32

Question 13

An underpriced share provides an expected return which is ________ the required return based on the capital asset pricing model (CAPM).

A)less than
B)equal to
C)greater than
D)greater than or equal to

Question 14

Which one of the following is equal to the ratio of common shareholders' equity to common shares outstanding?

A)Book value per share
B)Liquidation value per share
C)Market value per share
D)Tobin's q

Question 15

The accounting measure of a firm's equity value generated by applying accounting principles to asset and liability acquisitions is called ________.

A)book value
B)market value
C)liquidation value
D)Tobin's q

Question 16

Earnings yields tend to ________ when Treasury yields fall.

A)fall
B)rise
C)remain unchanged
D)fluctuate wildly

Question 17

Eagle Brand Arrowheads has expected earnings of $1.25 per share and a market capitalisation rate of 12%. Earnings are expected to grow at 5% per year indefinitely. The firm has a 40% plowback ratio. By how much does the firm's ROE exceed the market capitalisation rate?

A)0.5%
B)1.0%
C)1.5%
D)2.0%

Question 18

Each of two shares, A and B, are expected to pay a dividend of $7 in the upcoming year. The expected growth rate of dividends is 6% for both shares. You require a return of 10% on Share A and a return of 12% on Share B. Using the constant growth DDM, the intrinsic value of Share A ________.

A)will be higher than the intrinsic value of Share B
B)will be the same as the intrinsic value of Share B
C)will be less than the intrinsic value of Share B
D)more information is necessary to answer this question

Question 19

If a firm increases its plowback ratio this will probably result in a(n) ________ P/E ratio.

A)higher
B)lower
C)unchanged
D)Unable to determine

Question 20

________ is the amount of money per common share that could be realised by breaking up the firm, selling its assets, repaying its debt, and distributing the remainder to shareholders.

A)Book value per share
B)Liquidation value per share
C)Market value per share
D)Tobin's q

Question 21

Ace Frisbee Corporation produces a good that is very mature in their product life cycles. Ace Frisbee Corporation is expected to pay a dividend in Year 1 of $3.00, a dividend in Year 2 of $2.00, and a dividend in Year 3 of $1.00. After Year 3, dividends are expected to decline at the rate of 2% per year. An appropriate required return for the shares is 8%. Using the multistage DDM, the shares should be worth ________ today.

A)$13.07
B)$13.58
C)$18.25
D)$18.78

Question 22

Cache Creek Manufacturing Company is expected to pay a dividend of $4.20 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalisation rate on the shares, and the constant growth DDM to determine the intrinsic value of the shares. The shares are trading in the market today at $84.00. Using the constant growth DDM and the CAPM, the beta of the shares is ________.

A)1.4
B)0.9
C)0.8
D)0.5

Question 23

Brevik Builders has an expected ROE of 25%. Its dividend growth rate will be ________ if it follows a policy of paying 30% of earning in the form of dividends.

A)5.0%
B)15.0%
C)17.5%
D)45.0%

Question 24

Interior Airline is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at the rate of 10% per year. The risk-free rate of return is 4% and the expected return on the market portfolio is 13%. The shares of Interior Airline have a beta of 4.00. Using the constant growth DDM, the intrinsic value of the shares is ________.

A)$10.00
B)$22.73
C)$27.78
D)$41.67

Question 25

Caribou Gold Mining Corporation is expected to pay a dividend of $6 in the upcoming year. Dividends are expected to decline at the rate of 3% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The shares of Caribou Gold Mining Corporation have a beta of -0.50. Using the constant growth DDM, the intrinsic value of the shares is ________.

A)$50.00
B)$100.00
C)$150.00
D)$200.00

Question 26

Grott and Perrin Ltd 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 market capitalisation rate is 15%, what is the present value of its growth opportunities?

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

Question 27

Caribou Gold Mining Corporation is expected to pay a dividend of $4 in the upcoming year. Dividends are expected to decline at the rate of 3% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The shares of Caribou Gold Mining Corporation have a beta of -0.50. Using the CAPM, the return you should require on the shares is ________.

A)2%
B)5%
C)8%
D)9%

Question 28

Todd Mountain Development Corporation is expected to pay a dividend of $3.00 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 17%. The shares of Todd Mountain Development Corporation have a beta of 0.75. Using the constant growth DDM, the intrinsic value of the shares is ________.

A)4.00
B)17.65
C)37.50
D)50.00

Question 29

Westsyde Tool Company is expected to pay a dividend of $2.00 in the upcoming year. The risk-free rate of return is 6% and the expected return on the market portfolio is 12%. Analysts expect the price of Westsyde Tool Company shares to be $29 a year from now. The beta of Westsyde Tool Company's shares is 1.20. Using a one-period valuation model, the intrinsic value of Westsyde Tool Company shares today is ________.

A)$24.29
B)$27.39
C)$31.13
D)$34.52

Question 30

Assuming all other factors remain unchanged, ________ would increase a firm's price earnings ratio.

A)an increase in the dividend payout ratio
B)a reduction in investor risk aversion
C)an expected increase in the level of inflation
D)an increase in the yield on treasury bonds

Question 31

Firms with higher expected growth rates tend to have P/E ratios that are ________ the P/E ratios of firms with lower expected growth rates.

A)higher than
B)equal to
C)lower than
D)There is not necessarily any link between risk and P/E ratios

Question 32

Lifecycle Motorcycle Company is expected to pay a dividend in Year 1 of $2.00, a dividend in Year 2 of $3.00, and a dividend in Year 3 of $4.00. After Year 3, dividends are expected to grow at the rate of 7% per year. An appropriate required return for the shares is 12%. Using the multistage DDM, the shares should be worth ________ today.

A)$63.80
B)$65.13
C)$67.95
D)$85.60

Question 33

Westsyde Tool Company is expected to pay a dividend of $1.50 in the upcoming year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. Analysts expect the price of Westsyde Tool Company shares to be $29 a year from now. The beta of Westsyde Tool Company's shares is 1.20. Using the CAPM, an appropriate required return on Westsyde Tool Company's shares is ________.

A)8.0%
B)10.8%
C)15.6%
D)16.8%

Question 34

Firm A is high risk and Firm B is low risk. Everything else equal, which firm would you expect to have a higher P/E ratio?

A)Firm A
B)Firm B
C)Both would have the same P/E if they were in the same industry
D)There is not necessarily any link between risk and P/E ratios

Question 35

Rose Hill Trading Company is expected to have EPS in the upcoming year of $8.00. The expected ROE is 18.0%. An appropriate required return on the shares is 14%. If the firm has a plowback ratio of 70%, its dividend in the upcoming year should be ________.

A)$1.12
B)$1.44
C)$2.40
D)$5.60

Question 36

Value shares are more likely to have a PEG ratio ________.

A)less than one
B)equal to one
C)greater than one
D)less than zero

Question 37

Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming year. Dividends are expected to grow at 8% per year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalisation rate, and the constant growth DDM to determine the value of the shares. The share is currently priced at $84.00. Using the constant growth DDM, the market capitalisation rate is ________.

A)9%
B)12%
C)14%
D)18%

Question 38

A firm's earnings per share increased from $10 to $12, its dividends increased from $4.00 to $4.40, and its share price increased from $80 to $100. Given this information, it follows that ________.

A)the share experienced a drop in its P/E ratio
B)the company had a decrease in its dividend payout ratio
C)both earnings and share price increased by 20%
D)the required rate of return increased

Question 39

Flanders Ltd has expected earnings of $4 per share for next year. The firm's ROE is 8% and its earnings retention ratio is 40%. If the firm's market capitalisation rate is 15%, what is the present value of its growth opportunities?

A)-$6.33
B)$0
C)$20.34
D)$26.67

Question 40

Todd Mountain development Corporation is expected to pay a dividend of $2.50 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 12%. The shares of Todd Mountain Development Corporation have a beta of 0.75. Using the CAPM, the return you should require on the shares is ________.

A)7.25%
B)10.25%
C)14.75%
D)21.00%

Question 41

A firm has a share price of $54.75 per share. The firm's earnings are $75 million and the firm has 20 million shares outstanding. The firm has an ROE of 15% and a plowback of 65%. What is the firm's PEG ratio?

A)1.50
B)1.25
C)1.10
D)1.00

Question 42

The free cash flow to the firm is $300 million in perpetuity, the cost of equity equals 14% and the WACC is 10%. If the market value of the debt is $1.0 billion, what is the value of the equity using the free cash flow valuation approach?

A)$1 billion
B)$2 billion
C)$3 billion
D)$4 billion

Question 43

A firm has PVGO of 0 and a market capitalisation rate of 12%. What is the firm's P/E ratio?

A)12.00
B)8.33
C)10.25
D)18.55

Question 44

Next year's earnings are estimated to be $5.00. The company plans to reinvest 20% of its earnings at 15%. If the cost of equity is 9%, what is the present value of growth opportunities?

A)$9.09
B)$10.10
C)$11.11
D)$12.21

Question 45

Sanders Ltd, paid a $4.00 dividend per share last year and is expected to continue to pay out 60% of its earnings as dividends for the foreseeable future. If the firm is expected to generate a 13% return on equity in the future, and if you require a 15% return on the share, the value of the share is ________.

A)$26.67
B)$35.19
C)$42.94
D)$59.89

Question 46

A firm has an earnings retention ratio of 40%. The shares have a market capitalisation rate of 15% and an ROE of 18%. What is the share's P/E ratio?

A)12.82
B)7.69
C)8.33
D)9.46

Question 47

A share is priced at $45. The share has earnings per share of $3.00 and a market capitalisation rate of 14%. What is the share's PVGO?

A)$23.57
B)$15.00
C)$19.78
D)$21.34

Question 48

ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the shares. At what price would you expect ART to sell?

A)$25.00
B)$34.29
C)$42.86
D)$45.67

Question 49

When Google's share price reached $475 per share Google had a P/E ratio of about 68 and an estimated market capitalisation rate of 11.5%. Google pays no dividends. What percentage of Google's share price was represented by PVGO?

A)92%
B)87%
C)77%
D)64%

Question 50

Firm A has a share price of $35 and 60% of the value of the shares is in the form of PVGO. Firm B also has a share price of $35 but only 20% of the value of Share B is in the form of PVGO. We know that ________.
I) Share A will give us a higher return than Share B
II) an investment in Share A is probably riskier than an investment in Share B
III) Share A has higher forecast earnings growth than Share B

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

Question 51

The EBIT of a firm is $300, the tax rate is 35%, the depreciation is $20, capital expenditures are $60 and the increase in net working capital is $30. What is the free cash flow to the firm?

A)$85
B)$125
C)$185
D)$305

Question 52

The free cash flow to the firm is reported as $205 million. The interest expense to the firm is $22 million. If the tax rate is 35% and the net debt of the firm increased by $25, what is the market value of the firm if the FCFE grows at 2% and the cost of equity is 11%?

A)$2 168 billion
B)$2 397 billion
C)$2 565 billion
D)$2 998 billion

Question 53

The greatest value to an analyst from calculating a share's intrinsic value is ________.

A)how easy it is to come up with accurate model inputs
B)the precision of the value estimate
C)how the process forces analysts to understand the critical variables that have the greatest impact on value
D)how all the different models typically yield identical value results

Question 54

Transportation shares currently provide an expected rate of return of 15%. TTT, a large transportation company, will pay a year-end dividend of $3 per share. If the shares are selling at $60 per share, what must be the market's expectation of the constant growth rate of TTT dividends?

A)5%
B)10%
C)20%
D)None of the above

Question 55

A firm increases its dividend plowback ratio. All else equal you know that ________.

A)earnings growth will increase and the share's P/E will increase
B)earnings growth will decrease and the share's P/E will increase
C)earnings growth will increase and the share's P/E will decrease
D)earnings growth will increase and the share's P/E may or may not increase

Question 56

A company with an expected earnings growth rate which is greater than that of the typical company in the same industry, most likely has ________.

A)a dividend yield which is greater than that of the typical company
B)a dividend yield which is less than that of the typical company
C)less risk than the typical company
D)less sensitivity to market trends than the typical company

Question 57

A firm reports EBIT of $100 million. The income statement shows depreciation of $20 million. If the tax rate is 35% and total capital expenditures and increases in working capital total $10 million, what is the free cash flow to the firm?

A)$57
B)$65
C)$75
D)$95

Question 58

A common share pays an annual dividend per share of $1.80. The risk-free rate is 5 per cent and the risk premium for this share is 4 per cent. If the annual dividend is expected to remain at $1.80 per share, what is the value of the share?

A)$17.78
B)$20.00
C)$40.00
D)None of the above

Question 59

ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the shares. At what P/E ratio would you expect ART to sell?

A)8.33
B)11.43
C)14.29
D)15.25

Question 60

A firm has a share price of $55 per share and a P/E ratio of 75. If you buy the shares at this P/E and earnings fail to grow at all, how long should you expect it to take to just recover the cost of your investment?

A)27 years
B)37 years
C)55 years
D)75 years