Deck 7: Common Stock Valuation

Question 1

A common problem when the sustainable growth rate to estimate a stock's intrinsic value is:

A) disagreement over how to calculate the company's ROE.
B) the use of a discount rate that is greater than payout ratio.
C) the unpredictable nature of dividend payouts
D) sensitivity to year-to-year fluctuations in a company's earnings
E) the need for growth companies to retain a greater proportion of earnings than value companies

Answer 1

D

Question 2

The accounting relationship where the change in book value per share is equal to earnings per share minus dividends per share is called the ____ relationship.

A) Clean surplus
B) Retained earnings
C) Payout
D) Price-payout
E) Price-retention

Answer 2

A

Question 3

The proportion of a firm's net income paid to stockholders is the ____ ratio.

A) Payout
B) Internal
C) Earnings
D) Retention
E) net income

Answer 3

A

Question 4

The market value per share of common stock divided by the firms' equity per share gives the ____ ratio.

A) Market equity
B) Price-value
C) Value-equity
D) Price-book
E) Book-value

Question 5

The measure of cash flow most commonly used in the price-cash flow ratio is:

A) net income plus taxes.
B) net income plus depreciation.
C) net income plus extraordinary expenses.
D) sales minus expenses including taxes.
E) net income minus depreciation.

Question 6

A stock's P/E ratio is its current stock price divided by ________ per share.

A) earnings yield
B) equity per share
C) total equity
D) EBIT
E) earnings

Question 7

The valuation of a company's stock based on the firm's earnings, management, products, etc. is known as _______ analysis.

A) earnings
B) technical
C) corporate
D) fundamental
E) buy-side

Question 8

The net income per share divided by the market price per share is called the

A) Profit margin
B) Profit yield
C) Market yield
D) Income ratio
E) Earnings yield.

Question 9

Which one of the following terms is used to identify the evaluation method that determines the value of a stock by reviewing a firm's financial statement in conjunction with other financial and economic information?

A) technical analysis
B) conceptual analysis
C) prediction valuation
D) fundamental analysis
E) discounted valuation

Question 10

The amount of net income kept by a firm to finance its future growth is known as ____ earnings.

A) Internal
B) Retained
C) bottom line
D) Corporate
E) Operation

Question 11

What is the accounting relationship in which earnings per share minus dividends equal the change in book value per share called?

A) clean surplus relationship
B) economic value added relationship
C) accounting earnings identity
D) payout-retention identity
E) dividend valuation equation

Question 12

Value stocks are defined as stocks with ____________.

A) Low prices
B) Low M/B ratios
C) Low P/E ratios
D) High growth rates
E) High dividends

Question 13

_______ is a financial performance measure based on the ____ between a firm's actual earnings and required earnings.

A) Economic value added; difference
B) Economic value added; summation
C) Economic value added; multiplication
D) Economic value added; division
E) Economic value reduction; difference

Question 14

Stocks with a high P/E ratio are commonly referred to as ______ stocks.

A) Growth
B) Market
C) Value
D) Common
E) Fundamental

Question 15

A model used to value the stock of a company that does not pay dividends is the ____ model

A) Net profit
B) Internal cash flow
C) Internal growth
D) Reinvested growth
E) Residual income

Question 16

_______ is a measure of a stock's risk relative to the overall market.

A) The sustainable growth rate
B) The required return
C) Earnings yield
D) Beta
E) The capital asset price model

Question 17

The percentage of a firm's net income that is reinvested back in the firm is called the _____ ratio.

A) Payout
B) Internal
C) Earnings
D) Retention
E) net income

Question 18

Valuation of a stock as the present value of future cash flows to be received from that stock is accomplished by:

A) technical analysis.
B) price analysis.
C) dividend discount valuation.
D) fundamental analysis.
E) corporate valuation.

Question 19

The model used to value a stock that has a short-term growth rate that varies from its long-term growth rate is called the _____ dividend growth model.

A) Flexible
B) Increasing
C) Two-stage
D) Stepped up
E) Geometric

Question 20

The increase in dividends that can be supported and maintained by a company's earnings is the:

A) capital growth.
B) earnings growth potential.
C) sustainable growth rate.
D) required return.
E) beta.

Question 21

Assuming a return on equity greater than the required return, an increase in the dividend payout ratio will cause a(n) _____ in the sustainable growth rate.

A) increase
B) decrease
C) no change
D) decrease only if the change is temporary
E) increase only if the change is temporary

Question 22

The return on common stock is made up of:

A) a dividend payout and a dividend yield.
B) a capital gains yield and a dividend yield.
C) the present value of the future price.
D) stock yield and capital gains yield.
E) required return and dividend yield.

Question 23

An increase in the sustainable growth rate will cause a(n) ______ in the stock price.

A) increase
B) decrease
C) no change
D) decrease only if the change is temporary
E) increase only if the change is temporary

Question 24

In the constant perpetual growth model, the price of a share of stock will increase each year by the:

A) dividend yield.
B) required return.
C) dividend growth rate.
D) intrinsic value.
E) future value of dividends.

Question 25

The constant perpetual growth model is applicable primarily to those firms who

A) Are relatively new and fast growing
B) Have relatively stable earnings and expect to increase the annual dividend for several years
C) Have recently started paying dividends and expect to increase dividend significantly in the short term
D) Have growth rates that are less than 0.5%
E) Have a long history of constant dividends

Question 26

You wish to purchase a stock and have decided to conduct some fundamental analysis on the company. Which of the following will you most likely review during your analysis?
I) cost structure
II) cash flows
III) management quality
IV) earnings per share

A) I and II
B) I and IV
C) II, III and Iv
D) I, II and IV
E) I, II, III and IV

Question 27

To find a company's PEG ratio and investment manager would:

A) Divide the P/E by the future earnings stream
B) Divide the P/E by expected earnings growth rate
C) Add the growth rate to the P/E
D) Multiple earnings by the P/E
E) Multiply dividend by one plus the dividend growth rate

Question 28

The price-sales ratio helps measure the ability of a firm to generate

A) Net profit
B) Quality cash flows
C) Higher earnings per share
D) Higher cash flow per share
E) Revenue growth

Question 29

Based on the dividend discount model, the current value of a stock will ____ as the discount rate is increased.

A) Remain constant
B) Increase
C) Either remain constant or increase
D) Decrease
E) Either remain constant or decrease

Question 30

An increase in the required return on the stock will cause a(n) _____ in its price.

A) Increase
B) Decrease
C) No change
D) Decrease only if the change is temporary
E) Increase only if the change is temporary

Question 31

Based on the dividend discount model, the current value of a stock will ____ as the discount rate is decreased.

A) Remain constant
B) Increase
C) Either remain constant or increase
D) Decrease
E) Either remain constant or decrease

Question 32

Beta is a commonly used measure of:

A) a stock's dividend yield.
B) capital gains.
C) the risk of a stock.
D) a stock's valuation.
E) sustainable growth.

Question 33

The best stock valuation model to value all stocks is:

A) The constant perpetual growth model.
B) Supernormal growth.
C) The price/sales ratio approach.
D) The price/earnings approach.
E) There is no best model for all situations.

Question 34

The sustainable growth rate for a company is stated as:

A) g = ROE * payout ratio
B) g = ROA * payout ratio
C) g = ROA * (1 - payout ratio)
D) g = ROE * retention ratio
E) g = ROE * (1 - retention ratio)

Question 35

The constant growth model assumes that

A) The dividend payout ratio is constant
B) The dividend payout ration increases at a constant rate
C) Dividend will be paid for a stated number of years
D) Dividends will be paid in perpetuity
E) The dividend growth is equal to the discount rate

Question 36

Assuming a return on equity greater than the required return, a decrease in the dividend payout ratio will cause a(n) _____ in the stock price.

A) increase
B) decrease
C) no change
D) decrease only if the change is temporary
E) increase only if the change is temporary

Question 37

Which of the following is true concerning beta?

A) The beta assigned to the overall market is zero
B) A stock with a beta of 1.2 earns a lower risk premium than does the overall market
C) A stock with a beta of 0.5 has 50% more risk than the overall market
D) A stock with a beta of 1.1 has a risk premium that is greater than the market risk premium
E) The higher the beta, the lower the market risk

Question 38

A decrease in the required return on the stock will cause a(n) _____ in its price.

A) Increase
B) Decrease
C) No change
D) Decrease only if the change is temporary
E) Increase only if the change is temporary

Question 39

Pete and Repete both require a 15% rate of return on Buckeye stock that is currently selling for $20 per share. Both feel that it is appropriate to use the constant growth model to value the stock. They agree that the dividend next year will be $2.00 and will grow at 5% a year for the foreseeable future. Pete plans to buy the stock and hold it for 4 years while Repete plans to buy the stock and hold it for 8 years. Which of the following statements is true?

A) Pete should be willing to pay more for the stock than Repete.
B) Repete should be willing to pay more for the stock than Pete.
C) Neither will be willing to buy the stock.
D) Both should be willing to buy the stock.
E) Insufficient information.

Question 40

Which of the following price valuation ratio is often difficult to use because of accounting changes to the balance sheet?

A) Price/earnings ratio.
B) Price/sales ratio.
C) Price/cash flow ratio.
D) Price/book ratio.
E) None of the above will be affected by accounting procedures.

Question 41

You want to know the value of a firm's equity today in relation to the cost of that equity. Which of the following ratios should you need the most?

A) Price-earnings
B) Price-book
C) Price-sales
D) Price-cash flow
E) Price-asset

Question 42

All else the same, an increase in the riskiness of a stock as measured by its beta will result in a ____ stock price

A) higher
B) lower
C) no change
D) The effect will vary depending on the model used.
E) Insufficient information.

Question 43

All else the same, if a company increases its retention ratio:

A) the sustainable growth rate will increase.
B) the stock price will increase since dividends decline.
C) the company's cash flow will increase.
D) the dividend yield will increase.
E) the sustainable growth rate will decrease.

Question 44

The two-stage dividend growth model assumes the second-stage growth rate is

A) Less than the discount rate
B) Less than or equal to the discount rate
C) Less than, greater than, or equal to the discount rate
D) Less than the first-stage growth rate
E) Greater than the first-stage growth rate

Question 45

A company with a high P/E ratio will have a ____ earnings yield.

A) High
B) Low
C) Constant
D) There is no relationship between P/E and earnings yield.
E) Insufficient information.

Question 46

Which of the following would be the BEST reason to use sustainable growth in a constant perpetual growth model?

A) The sustainable growth rate is the largest rate at which earnings retention is sufficient to maintain the level of dividend growth continuously in the future.
B) In the long run, a company's growth is dictated by the dividends they can sustain.
C) It represents the rate at which a company, given the rate at which earnings grow, can increase dividends without having to sacrifice future earnings growth.
D) It is the growth rate at which retained earnings growth is equal to the rate of capital deprecation.
E) It is the rate at which dividend can grow without cannibalizing future the ROE.

Question 47

Assuming a company's return on equity is less than the required return, which of the following would cause a decrease in the stock price, all else the same?

A) The beta of the stock decreases.
B) The payout ratio decreases.
C) The risk-free rate decreases.
D) The dividends increase.
E) The required return decreases.

Question 48

Which of the following would most likely represent a buying opportunity for a value stock investor?

A) LULU has a P/E of 35 and the company announces continued earnings growth of 20%.
B) ABX with a P/E of 12 announces an increase of 2% in its quarterly EPS.
C) RIMM pays no dividend, has recorded a loss of $0.20 a share and a positive cash flow of $0.28 a share.
D) ED's P/E is 9 compared to the industry average of 15 and its EPS growth is the same as the rest of the industry.
E) None of these represent a buying opportunity for a value stock investor.

Question 49

The retention ratio is equal to:

A) Net income divided by total equity
B) The annual dividend amount divided by the net income
C) Net income divided by the number of shares outstanding
D) 1 - dividend payout ratio
E) 1 + dividend payout ratio

Question 50

The perpetual growth model for valuing stocks is not useful when:

A) the required return is greater than the growth rate.
B) the dividend yield is greater than the capital gains yield.
C) the company is a well-established company.
D) the capital gains yield is greater than the dividend yield.
E) the growth rate is greater than the required return.

Question 51

Assume a stock should be valued with the two-stage dividend growth model. All else the same, a decrease in the length of the first stage dividend growth would:

A) increase the stock price.
B) decrease the stock price.
C) increase the stock price only if the first stage growth was greater than the second stage growth.
D) decrease the stock price only if the first stage growth was greater than the second stage growth.
E) not change the stock price.

Question 52

Which of the following would most likely represent a buying opportunity for a growth stock investor?

A) LULU has a P/E of 35 and the company announces continued earnings growth of 20%.
B) ED with a P/E of 12 announces an increase of 2% in its quarterly dividend.
C) CP's P/E is 9 compared to the industry average of 15 and its EPS growth is the same as the rest of the industry.
D) NT pays no dividend, has recorded a loss of $0.15 a share and a positive cash flow of $0.20 a share.
E) None of these represent a buying opportunity for a growth stock investor.

Question 53

Depreciation is added to net income to calculate cash flow because:

A) depreciation is not a continuing expense.
B) all other expenses are operating expenses while depreciation is a financing expense.
C) depreciation is usually the largest expense for a company.
D) depreciation is a non-cash expense.
E) the amount of depreciation is the result of the accounting method used.

Question 54

Suppose two analysts are evaluating a stock. Analyst A assumes that the required return on the stock is higher than the estimate from Analyst B. All other estimates are the same. The price of the stock calculated by Analyst A will be _____ than the price calculated by Analyst

A) higher
B) lower
C) the same
D) lower only if the stock does not pay a dividend.
E) higher only if the stock does not pay a dividend.

Question 55

Which of the following companies is the best potential candidate for using the perpetual dividend growth model?

A) A company that has just emerged from bankruptcy.
B) A hi-tech firm that began business three years ago.
C) A company formed by the merger of the top two companies in an industry.
D) An internet company.
E) A utility company.

Question 56

Earnings yield is most closely related to the:

A) sustainable growth rate.
B) P/E ratio.
C) beta.
D) P/CF ratio.
E) required return of the stock.

Question 57

Which of the following will increase the P/E ratio, everything else being constant?
I) A decrease in the number of shares outstanding
II) An increase in net income
III) A decrease in the earnings yield
IV) A decrease in the market price per share

A) I.
B) III.
C) II and IV.
D) I and III.
E) I, III and IV.

Question 58

Accelerated depreciation will _____ the cash flow per share in early years when compared to straight-line depreciation and _____ the cash flow per share in the later years.

A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
E) Insufficient information.

Question 59

Which of the following companies would be considered to have quality earnings?

A) The cash flow per share is not significantly larger than earnings per share.
B) The earnings per share show a consistent growth rate.
C) The company lists no unusual or extraordinary items in its income statement.
D) Earnings per share vary by no more than 10 percent per quarter.
E) Earnings per share are larger than the cash flow per share.

Question 60

Earnings quality is important because:

A) high quality earnings may imply better accounting.
B) quality earnings result in a lower required return.
C) quality earnings may better represent cash flow.
D) growth companies exhibit quality earnings.
E) it is difficult to simulate high quality earnings with accounting choices.

Question 61

ABC Inc. is planning on paying an annual dividend of $1.80 per share next year. The company has a policy of increasing the dividend by 3% annually. As far as they know, the company will pay dividends for the foreseeable future. If the required return is 14 percent, what is the current stock price?

A) $18.32
B) $20.77
C) $26.08
D) $24.26
E) $16.36

Question 62

Which one of the following models can be used to value the stock of a non-dividend paying firm?

A) Two-stage growth
B) Residual income
C) Dividend growth
D) Supernormal growth
E) Perpetual dividend growth

Question 63

Which of the following is incorrect description of the term "economic value added"?

A) Abnormal earnings
B) Residual income
C) Value created by a firm's in period t
D) EPS_t - B_{t - 1} * k
E) Excess of required earnings over actual earnings

Question 64

Cage Creations, Inc. is slowly losing its market share. As a result, the company is decreasing its annual dividend by 10% each year and will cease all dividends after 4 more payments. The next dividend is expected to be $0.9 a share. The required return on the stock is 11 percent. What is the current price of the stock?

A) $1.64
B) $2.25
C) $1.19
D) $3.23
E) $2.18

Question 65

You feel a certain stock will pay dividends of $18, $24, and $30 over the next three years. If you require a return of 11 percent, how much should you pay for the stock?

A) $48.21
B) $57.63
C) $59.88
D) $72.00
E) $61.06

Question 66

All else the same, a decrease in the risk-free rate will cause a(n) _____ in stock price in all dividend valuation models.

A) increase
B) decease
C) no change
D) The effect will vary depending on the model used.
E) Insufficient information.

Question 67

Sweet Home Chicago, Inc. stock just paid an annual dividend of $2.10 per share. Dividends are expected to grow at 2.5 percent per year indefinitely, and the required return is 11 percent. What is the current stock price?

A) $29.07
B) $25.32
C) $31.56
D) $23.00
E) $21.43

Question 68

Xavier company paid an annual dividend of $1.36 per share. The dividends are expected to grow at 4 percent per year for 3 more years. If the required return on the stock is 15 percent, what is the price of the stock?

A) $4.82
B) $2.15
C) $3.22
D) $1.32
E) $2.26

Question 69

Baker Corp. just paid a total dividend of $1.40 per share during last year. This annual dividend is expected to grow at 2 percent for 5 more years. If the required return is 9 percent, what is the current price of the stock?

A) $7.75
B) $5.37
C) $5.12
D) $4.19
E) $5.76

Question 70

The arithmetic average dividend growth rate is

A) The compounded rate of growth over a specified time period
B) Easier to compute than the geometric average dividend growth rate
C) The summation of the annual dividend growth rates
D) Generally preferred by most financial analysis as compared to the geometric average growth rate
E) The arithmetic average of the annual dividend growth rates

Question 71

A company plans to pay an annual dividend of $1.30 starting next year for 6 more years and then discontinue all dividends. The dividend is expected to grow at 2.5 percent per year. If you require a return of 11 percent on the stock, what is the most you should be willing to pay?

A) $5.81
B) $7.08
C) $4.12
D) $6.52
E) $5.64

Question 72

A certain stock is expected to pay dividends of $12, $19, $15, and $21 for the next four years. If the required return on the stock is 14 percent, what is the stock price?

A) $47.70
B) $67.00
C) $45.67
D) $49.88
E) $46.67

Question 73

If a firm does not issue dividends, which of the following models would not be applicable?

A) Two-stage growth
B) Free cash flow
C) PEG
D) Residual income
E) Price-Book Ratio

Question 74

A stock is expected to pay a dividend of $25, $35, and $45 each year for the next three years, respectively. If you require a return of 12 percent, how much should you pay for the stock?

A) $85.46
B) $105.00
C) $92.52
D) $82.25
E) $87.18

Question 75

Which of the following is correct for computing a geometric average dividend growth rate?

A) [(1 + D₀) + (1 + D₁) * (1 + D_N)]^{N + 1} - 1
B) [(1 + D₀) * (1 + D₁) * (1 + D_N)]^{N + 1} - 1
C) [(D_N/D₀)]^{1/(N - 1)} - 1
D) [(D_N/D₀)]^{N + 1} - 1
E) [(D_N/D₀)]^N - 1

Question 76

ABC Inc. has announced today that they are going out of business. As of today, no more regular dividends will be paid. The intention of the firm is to pay two liquidating dividends. The first dividend will be paid one year from now in the amount of $20 a share. The second and final dividend will be paid two years from now at an estimated $13 a share. What is the value of this stock to you today if you feel the appropriate discount rate is 16%?

A) $21.14
B) $24.52
C) $26.90
D) $28.45
E) $31.21

Question 77

All else the same, an increase in the risk-free rate will cause a(n) _____ in stock price in all dividend valuation models.

A) increase
B) decease
C) no change
D) The effect will vary depending on the model used.
E) Insufficient information.

Question 78

Xander Inc. stock just paid an annual dividend of $0.80 a share. The dividend is expected to grow at 2 percent annually for the next 3 years. If the required return is 9 percent, what is the stock price?

A) $2.43
B) $2.89
C) $2.35
D) $2.10
E) $2.82

Question 79

Which of the following is correct concerning the net income and cash flow of a firm?

A) The primary difference between the net income and the operating cash flow of a firm is taxes
B) Analysis rely on the net income of a firm and therefore ignore the cash flows
C) High quality earnings exist when the earnings per share is similar in value to the cash flow per share
D) The net income of a firm is unaffected by the depreciation method selected
E) The earnings per share will usually equal the net income per share for most firm

Question 80

In the constant perpetual growth model, the dividend a stock will pay in five years is:

A) D₀ (1 + k)⁵
B) D₀ (1 + g)⁴
C) D₀ (1 + g)⁵
D) D₁ (1 + k)⁵
E) D₁ (1 + g)⁵