Deck 10: Common Stock Valuation

Question 1

When using the free cash flow to the firm (FCFF)model,which of the following should be used as the discount rate?

A)The required return on equity
B)The before-tax cost of debt
C)The after-tax cost of equity
D)The weighted average cost of capital

Answer 1

D

Question 2

Which of the following is frequently used as a measure of cash flow in the P/CF ratio?

A)Revenue
B)Gross Profit
C)EBITDA
D)Income from continuing operations

Answer 2

C

Question 3

Janice is evaluating a stock that currently pays a dividend of $0.25 per share.She expects this level of dividend to continue indefinitely,and she has determined that 5% is the appropriate required return for the stock.What is the most she should pay for the stock?

A)$1.25 per share
B)$2.50 per share
C)$5.00 per share
D)$7.50 per share

Answer 3

C

Question 4

Charlie is valuing a common stock with forecast dividends as shown below.He thinks that 10% is an appropriate discount rate.What is the most he should pay for the stock?
$\begin{array}{|r|r|c|c|c|}\hline \mathrm{D}_{1} & \mathrm{D}_{2} & \mathrm{D}_{3} & \mathrm{D}_{4} & \text { Later } \\\hline \$ 2.00 & \$ 2.40 & \$ 2.76 & \$ 3.17 & 6 \% \text { growth } \\\hline\end{array}$

A)$60.20
B)$63.25
C)$65.42
D)$84.01

Question 5

Which of the following is not a term used to describe the denominator in the discounted cash flow model?

A)Discount rate
B)Compounding rate
C)Required rate of return
D)Capitalization rate

Question 6

Which of the following is most likely to increase a company's P/E ratio?

A)The company announces a new product,which will increase sales and profits.
B)The company's beta increases.
C)The expected inflation rate increases.
D)Interest rates increase for all borrowers.

Question 7

Which of the following is not one of the steps in using discounted cash flow to value a company?

A)Estimate the amount and timing of the future stream of cash flows
B)Estimate an appropriate discount rate
C)Use a present value model to calculate an intrinsic value
D)Compare the intrinsic value to the relative value metric

Question 8

Which of the following is not used in relative valuation comparisons?

A)The relative value measure from past periods.
B)The relative value measure for the industry under consideration.
C)The relative value measure for a comparable firm.
D)The relative value measure derived from the DCF model.

Question 9

What is used as "earnings" in the price/earnings ratio?

A)The net income shown in the company's most recent annual report
B)Earnings from the firm's last four published quarterly income statements
C)The firm's estimated earnings for the next 12 months
D)All of these definitions of earnings are used by analysts

Question 10

Sam is evaluating a stock that is expected to pay a $1.25 per share dividend at the beginning of next year.He expects the dividend to grow by 10% per year and has determined that 12% is an appropriate required return for the stock.What is the highest amount he should pay for the stock?

A)$1.25
B)$12.50
C)$15.00
D)$62.50

Question 11

Stephen used the dividend discount model to determine that the price of a stock should be $23.50.Stephen checks on the internet and finds the latest price quoted for the stock is $27.00.What should he do?

A)Buy the stock at $27.00
B)Sell the stock at $27.00,or sell short if he does not own it
C)Do nothing,as his estimate of the intrinsic value may be off as much as 15%
D)Buy the stock at $23.50 because that is all it is worth

Question 12

Mr.& Mrs.Jones plan to buy stock to earn the funds needed for their son's college education.They will sell the stock in 7 years to pay tuition.What amount should they use as an estimate for the stock price when they sell in year 7?

A)The discounted value of the dividends for years 1 through 6.
B)The discounted value of all the dividends from year 7 on.
C)The discounted value of all dividends from year 1 on.
D)The price that is currently quoted in the stock market.

Question 13

What is the major difficulty with using discounted cash flow approaches to estimate a stock's intrinsic value?

A)Prices in the stock market move from moment to moment.
B)Small changes to the assumptions of k or g result in major changes in the estimated value.
C)It is extremely unlikely that a stream of cash flows will continue to grow at the same rate.
D)The relative valuation techniques are more accurate approaches.

Question 14

Which of the following increases the price an investor is willing to pay for stock?

A)The investor increases his estimate of the constant growth rate for dividends.
B)The investor decreases his estimate of the constant growth rate for dividends.
C)The investor increases his estimate of the required rate of return.
D)The investor assumes a higher beta for the stock.

Question 15

Which of the following descriptions of the price/earnings ratio is the most accurate?

A)Investors are generally more pessimistic about the prospects for high P/E stocks.
B)Historically,the average P/E for the market as a whole has been approximately 10.
C)Companies with high growth rates generally have higher P/E ratios.
D)All else the same,investors prefer to purchase stocks with relatively high P/E ratios.

Question 16

Carl is evaluating a stock that just paid a dividend of $2.00 per share.He expects this dividend to grow by 4% per year,and he has determined that 11% is the appropriate required return.What is the most he should pay for the stock?

A)$18.18
B)$18.91
C)$28.57
D)$29.71

Question 17

Sometimes analysts use other ratios such as price-to-book or price-to-sales ratio.Which of the following is a weakness of the use of these ratios?

A)Some companies are structured very differently,especially across industries.
B)A price-to-book value less than one cannot be assessed.
C)A high price-to-sales ratio cannot be assessed.
D)The price-to-sales ratio cannot be used for companies that report a net loss.

Question 18

What are two major approaches used to value stocks?

A)Discounted cash flow techniques and absolute valuation techniques
B)Discounted cash flow techniques and relative valuation techniques
C)Compound free cash flow techniques and relative valuation techniques
D)Markowitz diversification techniques and relative valuation techniques

Question 19

Which measure relies on the cash flow remaining after capital expenditures and after interest and principal repayments on debt have been made?

A)Free cash flow to the firm
B)Weighted average cost of capital
C)Economic value added
D)Free cash flow to equity

Question 20

Which factor is least likely to explain why one company has a higher P/E ratio than another?

A)The company has a higher growth rate of earnings.
B)The company has a higher required rate of return.
C)The company has a higher current ratio.
D)The company has a higher return on equity.

Question 21

Economic value added (EVA)indicates the amount by which a company's operating profit exceeds its cost of capital.

Question 22

Riza Corporation's preferred stock has a par value of $100 and a dividend rate of 6%.If the required return on the stock is 8%,its intrinsic value is closest to:

A)$75.
B)$94.
C)$133.
D)$300.

Question 23

Hannett Inc.has a stock price of $40 and just reported earnings of $3 per share.The firm maintains a constant dividend payout of 65% and has an expected return on equity (ROE)of 16%.Based on the constant growth model,Hannett's expected rate of return is closest to:

A)10.50%.
B)10.75%.
C)13.10%.
D)13.50%.

Question 24

Stan expects Terta Corp.to pay its first dividend of $3 in five years.He expects the dividend to grow at 6% thereafter,and his required return on the stock is 9.5%.The largest amount that Stan should pay for the stock is closest to:

A)$54.
B)$60.
C)$68.
D)$86.

Question 25

No one knows with precision which valuation model to apply for any particular stock.

Question 26

The P/E ratio is one of the most widely used measures to assess the financial attractiveness of potential stock investments.

Question 27

Which of the following is a component of the formula used to derive a firm's enterprise value?

A)EBITDA
B)Accounts receivable
C)Bonds
D)Fixed assets

Question 28

Investors will arrive at the same intrinsic valuation for common stocks because valuation is based on an objective approach.

Question 29

Tanex Inc.has a return on assets (ROA)of 12%,a return on equity (ROE)of 15%,and a dividend payout ratio of 60%.Based on the sustainable growth formula,Tanex's estimated growth is:

A)4.8%.
B)6.0%.
C)7.2%.
D)9.0%.

Question 30

If a stock's dividend growth rate or discount rate changes even a small amount,the change in the price calculated by the constant growth model can be very large.

Question 31

Sara estimated the revenue per share for Firm A as $5.50 and estimated the appropriate P/B ratio,P/E ratio,and P/S ratio as 1.9,14.5,and 2.6,respectively.What is the estimated intrinsic value for Firm A?

A)$10.45
B)$79.75
C)$14.30
D)$2.12

Question 32

To estimate the intrinsic value of a security,investors should rely on:

A)the approach that they are most comfortable using.
B)the approach that is easiest to apply and interpret.
C)the approach that generally gives the most conservative value.
D)more than one approach.

Question 33

Seaside Boats currently earns $4.00 per share and has a retention ratio of 75%.It is expected to have a constant growth rate of 5 percent per year.The required rate of return is 15 percent.What is the intrinsic value of this stock?

A)$10
B)$10.50
C)$40
D)$42

Question 34

The required return needed to discount a stock's future cash flows can be determined using the CAPM.

Question 35

The only reliable way to value a common stock is to discount the future flow of dividends at a discount rate appropriate to the riskiness of the company.

Question 36

Historically,the average P/E for the S&P 500 is approximately 16.

Question 37

An increase in interest rates generally reduces P/E ratios and stock prices.

Question 38

Rita has calculated the discounted value of the free cash flows to the firm (FCFFs)for a company that has no preferred stock.What additional adjustment(s)does she have to make to her calculated discounted value to derive an estimate of the firm's stock price?

A)Subtract the value of debt and divide by shares outstanding
B)Add the value of debt and divide by shares outstanding
C)Subtract the value of capital expenditures and divide by shares outstanding
D)Divide by shares outstanding

Question 39

Many analysts prefer to use a relative valuation technique,such as comparing P/E ratios,because these techniques are more grounded in theory than the DCF approaches.

Question 40

Technology stocks generally have P/E ratios that are higher than the market average.

Question 41

The P/B ratio is considered relatively useful for firms with high levels of intangible assets.