Deck 20: An Introduction to Security Valuation

Question 1

Empirical studies have shown that the market factor has increased over time and now accounts for the majority of an individual stock's price variance.

Answer 1

False

Question 2

The importance of an industry's performance on an individual stock's performance varies across industries.

Answer 2

True

Question 3

Growth companies are those firms that consistently earn higher rates of return by assuming greater amounts of risk.

Answer 3

False

Question 4

The three step valuation process consists of 1) analysis of alternative economies and markets, 2) analysis of alternative industries and 3) analysis of industry influences.

Question 5

An example of a relative valuation technique is the Price/Cash Flow ratio.

Question 6

The most difficult part of valuing a bond is determining the required rate of return on this investment.

Question 7

If the estimated value of an asset is greater than the market price, you would want to buy the investment.

Question 8

The price of a bond can be calculated by discounting future coupons over the bonds life by the yield to maturity.

Question 9

The two components that are required in order to carry out asset valuation are 1) the stream of expected cash flows and 2) the required rate of return.

Question 10

The dividend growth models are only meaningful for companies that have a required rate of return that exceeds their dividend growth rate.

Question 11

Given an optimistic economic and stock-market outlook for a country, the investor should underweight the allocation to this country in his/her portfolio.

Question 12

The general economic influences would include inflation, political upheavals, monetary policy, and fiscal policy initiatives.

Question 13

A preferred stock is a perpetuity.

Question 14

In dividend discount models (DDM) with supernormal growth, supernormal growth may continue indefinitely.

Question 15

If the intrinsic value of an asset is greater than the market price, you would want to buy the investment.

Question 16

The required rate of return is determined by 1) the real risk free rate, 2) the expected rate of inflation and 3) liquidity risk.

Question 17

The importance of an industry's performance on an individual stock's performance varies across industries.

Question 18

Fundamentalists typically use the "Bottom-Up Approach" whereas technicians use the "Top-Down Approach" to the valuation process.

Question 19

Discounted cash flow techniques for equity valuation may use one of the following: 1) dividends, 2) Free cash flow or 3) coupons.

Question 20

The growth rate of dividends and profit margin are the main determinants of the P/E ratio.

Question 21

The growth rate of equity earnings without external financing is equal to which of the following?

A) Retention rate plus return on equity.
B) Retention rate minus return on equity.
C) Retention rate divided by return on equity.
D) Retention rate times return on equity.
E) Return on equity divided by retention rate.

Question 22

Which of the following statements regarding fundamental and relative valuation techniques is true?

A) Both techniques require an appropriate estimate of the required rate of return and the growth rate.
B) Both techniques require an estimate of future cash flows and a discount rate.
C) Both techniques require an estimate of future cash flows and a growth rate.
D) Both techniques require an estimate of future cash flows, the required rate of return and a growth estimate.
E) All of the above.

Question 23

The process of fundamental valuation requires estimates of all the following factors, except

A) The time pattern of returns.
B) The economy's real risk-free rate.
C) The risk premium for the asset.
D) The times series of stock prices.
E) The expected rate of inflation.

Question 24

A bond typically pays interest payments every six months equal to the coupon rate times the face value of the bond.

Question 25

The value of preferred stock can be calculated by dividing its dividend by the required rate of return.

Question 26

Growth rates of the (1) labour force, (2) average number of hours worked and (3) labour productivity are the main determinants of a foreign country's

A) Dividend payout ratio.
B) Beta.
C) Real risk free rate.
D) Nominal risk free rate.
E) Risk premium.

Question 27

Which of the following is correct?

A) If estimated value > Market price, you should buy.
B) If estimated value > Market price, you should sell.
C) If estimated value < Market price, you should sell.
D) If estimated value < Market price, you should buy.
E) Choices a and c.

Question 28

The infinite period dividend discount model (DDM) can be used to value a supernormal growth company.

Question 29

Which of the following factors influence an investor's required rate of return?

A) The economy's real risk-free rate (RFR)
B) The expected rate of inflation (I)
C) A risk premium
D) All of the above.
E) None of the above.

Question 30

Which of the following is an underlying assumption of the constant growth dividend discount model (DDM)?

A) Dividends have a constant growth rate
B) The constant growth rate of dividends will continue for an infinite time period
C) The required rate of return is greater than the expected growth rate
D) All of the above.
E) None of the above.

Question 31

Which securities can be valued by dividing the annual dividend by the required rate of return?

A) Low coupon bonds
B) Junk bonds
C) Common stocks
D) Preferred stocks
E) Constant growth common stocks

Question 32

The risk premium is impacted by business risk, financial risk, and liquidity risk.

Question 33

Which of the following is not a consideration in the three-step valuation process?

A) Analysis of alternative economies
B) Analysis of security markets
C) Analysis of alternative industries
D) Analysis of individual companies
E) None of the above (that is, all are considerations in the three-step valuation process)

Question 34

Dividend growth is a function of what?

A) Return on equity.
B) The retention rate.
C) The payout ratio.
D) All of the above.
E) None of the above.

Question 35

What is the P/E ratio is determined by?

A) The required rate of return.
B) The expected dividend payout ratio.
C) The expected growth rate of dividends.
D) Choices a and b
E) All of the above.

Question 36

According to the dividend growth model, if a company were to declare that it would never pay dividends, its value would be

A) Based on earnings.
B) Based on expectations regarding.
C) Higher than similar firms since it could reinvest a greater amount in new projects.
D) Zero.
E) Based on the capital asset pricing model.

Question 37

The real risk free rate depends on the real growth in the economy and for short period by temporary tightness or ease in capital markets.

Question 38

Which of the following is not considered a basic economic force?

A) Fiscal policy
B) Monetary policy
C) Inflation
D) P/E ratio
E) None of the above (that is, all are basic economic forces)

Question 39

The value of a corporate bond can be derived by calculating the present value of the interest payments and the present value of the face value at the bond's

A) Current yield.
B) Coupon rate.
C) Required rate of return.
D) Effective rate.
E) Prime rate.

Question 40

A relative valuation technique is appropriate to consider when you have a good set of comparable entities.

Question 41

Exhibit 20-4
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Davenport Corporation's last dividend was $2.70 and the directors expect to maintain the historic 3% annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 5% for the next three years and the stock will then reach $25 per share.
Refer to Exhibit 20-4. How much should you be willing to pay for the stock if you feel that the 5% growth rate can be maintained indefinitely and you require a 17% return?

A) $22.16
B) $19.28
C) $21.32
D) $23.63
E) $25.46

Question 42

Exhibit 20-1
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
A major retailer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 8 years remaining until maturity. The bonds were issued with a 6.5% coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 4.25%.

-Refer to Exhibit 20-1. What will be the value of these securities in one year if the required return is 7%?

A) $970.14
B) $388.13
C) $1031.15
D) $1035.81
E) $972.52

Question 43

Using the constant growth model, an increase in the required rate of return from 19 to 17% combined with an increase in the growth rate from 11 to 9% would cause the price to

A) Fall more than 2%
B) Fall less than 2%.
C) Remain constant.
D) Rise more than 2%.
E) Rise less than 3%.

Question 44

In 2009, Montpelier Inc. issued a $100 par value preferred stock that pays a 9% annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring a 10% return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?

A) $100
B) $110
C) $75
D) $90
E) $85

Question 45

Exhibit 20-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
A large grocery chain is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 6 years remaining until maturity. The bonds were issued with a 6% coupon rate (paid semiannually) and a par value of $1,000. Because of increased risk the required rate has risen to 10%.
Refer to Exhibit 20-3. What is the current value of these securities?

A) $656.40
B) $899.00
C) $822.70
D) $569.50
E) $962.00

Question 46

Exhibit 20-1
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
A major retailer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 8 years remaining until maturity. The bonds were issued with a 6.5% coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 4.25%.

-Refer to Exhibit 20-1. What is the current value of these securities?

A) $1149.94
B) $433.15
C) $1151.92
D) $860.50
E) $863.35

Question 47

In 2009, Smiths Corp. issued a $50 par value preferred stock that pays a 6% annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring a 7% return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?

A) $42.86
B) $30.00
C) $31.54
D) $33.38
E) $38.37

Question 48

Exhibit 20-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
A large grocery chain is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 6 years remaining until maturity. The bonds were issued with a 6% coupon rate (paid semiannually) and a par value of $1,000. Because of increased risk the required rate has risen to 10%.
Refer to Exhibit 20-3. What will be the value of these securities in one year if the required return declines to 8%?

A) $899.43
B) $862.50
C) $869.88
D) $918.93
E) $946.98

Question 49

Exhibit 20-5
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The National Motor Company's last dividend was $1.25 and the directors expect to maintain the historic 4% annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7% for the next three years and the stock will then reach $25.00 per share.
Refer to Exhibit 20-5. How much should you be willing to pay for the stock if you feel that the 7% growth rate can be maintained indefinitely and you require a 16% return?

A) $11.15
B) $14.44
C) $14.86
D) $18.90
E) $19.24

Question 50

Using the constant growth model, a decrease in the required rate of return from 15 to 13% combined with an increase in the growth rate from 5 to 6% would cause the price to

A) Rise more than 50%.
B) Rise less than 50%.
C) Remain constant.
D) Fall more than 50%.
E) Fall less than 50%.

Question 51

Using the constant growth model, an increase in the required rate of return from 17 to 20% combined with an increase in the growth rate from 8 to 11% would cause the price to

A) Rise more than 3%
B) Rise less than 3%.
C) Remain constant.
D) Fall more than 3%.
E) Fall less than 3%.

Question 52

Ross Corporation paid dividends per share of $1.20 at the end of 1999. At the end of 2009 it paid dividends per share of $3.50. Calculate the compound annual growth rate in dividends.

A) 52.17%
B) 34.28%
C) 23%
D) 19.17%
E) 11.29%

Question 53

Exhibit 20-4
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Davenport Corporation's last dividend was $2.70 and the directors expect to maintain the historic 3% annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 5% for the next three years and the stock will then reach $25 per share.

-Refer to Exhibit 20-4. How much should you be willing to pay for the stock if you require a 17% return?

A) $16.97
B) $22.16
C) $21.32
D) $32.63
E) $23.63

Question 54

Exhibit 20-2
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
A major manufacturer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 7 years remaining till maturity. The bonds were issued with an 8% coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 10%.

-Refer to Exhibit 20-2. What will be the value of these securities in one year if the required return is 6%?

A) $1151.92
B) $972.52
C) $1100.15
D) $900.18
E) $936.72

Question 55

In 2009, Swisten Inc. issued a $150 par value preferred stock that pays an 8% annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring an 15% return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?

A) $80
B) $75
C) $59
D) $95
E) $110

Question 56

Using the constant growth model, an increase in the required rate of return from 14 to 15% combined with an increase in the growth rate from 6 to 7% would cause the price to

A) Rise more than 1%
B) Rise less than 1%.
C) Remain constant.
D) Fall more than 1%.
E) Fall less than 1%.

Question 57

Using the constant growth model, an increase in the required rate of return from 14 to 18% combined with an increase in the growth rate from 8 to 12% would cause the price to

A) Fall more than 4%
B) Fall less than 4%.
C) Rise more than 4%
D) Rise less than 4%.
E) Remain constant.

Question 58

Exhibit 20-5
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
The National Motor Company's last dividend was $1.25 and the directors expect to maintain the historic 4% annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7% for the next three years and the stock will then reach $25.00 per share.

-Refer to Exhibit 20-5. How much should you be willing to pay for the stock if you require a 16% return?

A) $17.34
B) $18.90
C) $19.09
D) $19.21
E) None of the above

Question 59

In 2009, Venus Fly Co. issued a $75 par value preferred stock which pays a 7% annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring a 5% return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?

A) $125
B) $84
C) $91
D) $145
E) $105

Question 60

Exhibit 20-2
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
A major manufacturer is reevaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 7 years remaining till maturity. The bonds were issued with an 8% coupon rate (paid quarterly) and a par value of $1,000. The required rate of return is 10%.

-Refer to Exhibit 20-2. What is the current value of these securities?

A) $900.18
B) $1151.92
C) $972.52
D) $1113.63
E) $904.00

Question 61

Tayco Corporation has just paid dividends of $3 per share. The earnings per share for the company was $4. If you believe that the appropriate discount rate is 15% and the long term growth rate in dividends is 6%, and earnings is 6%, then what is the firm's P/E ratio?

A) 8.33
B) 33.33
C) 44.44
D) 11.11
E) None of the above

Question 62

Exhibit 20-8
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Fast Grow Corporation is expecting dividends to grow at a 20% rate for the next two years. The corporation just paid a $2 dividend and the next dividend will be paid one year from now. After two years of rapid growth dividends are expected to grow at a constant rate of 9% forever.

-Refer to Exhibit 20-8. If the required return is 14%, what is the value of Fast Grow Corporation common stock today?

A) $40.26
B) $42.38
C) $46.70
D) $52.63
E) $62.78

Question 63

Hunter Corporation had a dividend payout ratio of 63% in 2009. The retention rate in 2009 was

A) 37%
B) 63%
C) 50%
D) 0%
E) 100%

Question 64

Exhibit 20-7
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9% per year for the next three years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%.
Refer to Exhibit 20-7. What are the dividends for years 1, 2, and 3?

A) $1.5, $2.0, $2.05
B) $1.64, $1.78, $1.94
C) $1.64, $1.94, $2.24
D) $1.5, $2.40, $3.30
E) $2.07, $2.14, $2.21

Question 65

Exhibit 20-7
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9% per year for the next three years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%.
Refer to Exhibit 20-7. What is the future price of the stock in year 3?

A) $81.75
B) $84.81
C) $92.56
D) $101.85
E) $111.16

Question 66

Exhibit 20-7
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9% per year for the next three years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%.

-Refer to Exhibit 20-7. What is the price of the stock today (P?)?

A) $84.81
B) $87.81
C) $91.09
D) $94.32
E) $97.61

Question 67

What is the value of a preferred stock that has a par value of $100, a required rate of return of 11%, and pays a 7% annual dividend?

A) $63.64
B) $157.14
C) $909.09
D) $1,428.57
E) $2,500.00

Question 68

Micro Corp. just paid dividends of $2 per share. Assume that over the next three years dividends will grow as follows, 5% next year, 15% in year two, and 25% in year 3. After that growth is expected to level off to a constant growth rate of 10% per year. The required rate of return is 15%. Calculate the intrinsic value using the multistage model.

A) $5.56
B) $66.4
C) $49.31
D) $43.66
E) none of the above

Question 69

The beta for the DAK Corporation is 1.25. If the yield on 30 year T-bonds is 5.65%, and the long term average return on the S&P 500 is 11%. Calculate the required rate of return for DAK Corporation.

A) 12.34%
B) 7.06%
C) 13.74%
D) 5.35%
E) 5.65%

Question 70

Exhibit 20-6
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8% per year for the next five years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%.
Refer to Exhibit 20-6. What is the present value today of dividends for years 1 to 5?

A) $4.06
B) $10.28
C) $12.40
D) $14.52
E) $10.0

Question 71

Exhibit 20-6
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8% per year for the next five years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%.
Refer to Exhibit 20-6. What are the dividends for years 1, 2, and 3?

A) $2, $2.08, $2.16
B) $2, $2.05, $2.10
C) $2.16, $2.24, $2.32
D) $2.16, $2.33, $2.52
E) $2.07, $2.14, $2.21

Question 72

What is the value of a 10% semi-annual coupon bond with a par value of $1,000 that matures in 5 years and has a required rate of return of 9%?

A) $1,021.95
B) $1,038.90
C) $1,039.56
D) $1,064.18
E) $1,078.23

Question 73

XCEL Corporation paid a dividend yesterday for $1.50. They expect to pay dividends annually at a constant 6% annual growth rate indefinitely. If the required rate of return on this investment is 12%, what is the current value of this common stock?

A) $1.50
B) $12.50
C) $13.25
D) $25.00
E) $26.50

Question 74

Exhibit 20-8
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Fast Grow Corporation is expecting dividends to grow at a 20% rate for the next two years. The corporation just paid a $2 dividend and the next dividend will be paid one year from now. After two years of rapid growth dividends are expected to grow at a constant rate of 9% forever.
Refer to Exhibit 20-8. Assume that the annual dividend grows at a constant rate of 9% indefinitely instead of the supernormal growth. How much is the stock worth if dividends grow annually at 9%?

A) $40.00
B) $43.60
C) $45.60
D) $47.80
E) $52.40

Question 75

Exhibit 20-6
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8% per year for the next five years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%.

-Refer to Exhibit 20-6. What is the price of the stock today (P?)?

A) $136.29
B) $133.03
C) $120.33
D) $123.43
E) $126.60

Question 76

Exhibit 20-7
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9% per year for the next three years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%.
Refer to Exhibit 20-7. What is the present value today of dividends for years 1 to 3?

A) $4.67
B) $3.08
C) $5.67
D) $4.5
E) $1.53

Question 77

The P/E ratio for BMI Corporation 21, and the P/S ratio is 5.2. The industry P/E ratio is 35 and the industry P/S ratio is 7.5. Based on relative valuation, what is the BMI?

A) undervalued on the basis of relative P/E and relative P/S.
B) overvalued on the basis of relative P/E and undervalued on the basis of relative P/S.
C) undervalued on the basis of relative P/E and overvalued on the basis of relative P/S.
D) overvalued on the basis of relative P/E and relative P/S.
E) none of the above.

Question 78

Exhibit 20-6
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8% per year for the next five years. After that dividends are expected to grow at a normal rate of 5% per year. Assume that the appropriate discount rate is 7%.
Refer to Exhibit 20-6. What is the future price of the stock in year 5?

A) $113.40
B) $122.47
C) $132.27
D) $142.85
E) $154.35