Question 1

Which of the income valuation models is based on the premise that the market value of ordinary shares represents the sum of the expected future dividend flows, to infinity, discounted to present value?
A) Earnings- based model
B) Cash- flow- based model
C) Dividend- based model
D) Share- value- based model

Accepted Answer

The dividend-based model, also known as the dividend discount model (DDM), values a stock by calculating the present value of expected future dividends. This model assumes that the market value of ordinary shares represents the sum of expected future dividend flows, discounted to present value.

Question 2

Calculate the PER for the following company. It is expected to maintain a payout ratio of 40 per cent of earnings. The appropriate discount rate for this risk class is 10 per cent and the expected growth rate in earnings and dividends is 5 per cent.
A) 2.67
B) 8.0
C) 6.67
D) 5.0

Accepted Answer

The Price-Earnings Ratio (PER) can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model for a perpetuity with growth). The formula for the model is P = D1 / (k - g), where P is the price, D1 is the expected dividend next year, k is the required rate of return (discount rate), and g is the growth rate. The PER is then P/E, where E is the earnings. Given a payout ratio of 40%, the dividend (D) is 40% of earnings (E). If E is $1 (to simplify calculations), then D1 is $0.40. With k = 10% (or 0.10) and g = 5% (or 0.05), we substitute into the Gordon Growth Model to find P, and then calculate PER as P/E.P = D1 / (k - g) = $0.40 / (0.10 - 0.05) = $0.40 / 0.05 = $8.00.Since E = $1, PER = P/E = $8.00 / $1 = 8.0.

Question 3

In which situation is it justifiable to use the formula P C1 ?   kE - gc
A) Constant cash flow without discounted growth
B) Discounted cash flow with constant growth
C) PER with increasing growth
D) Dividend valuation with constant growth

Accepted Answer

B

Question 4

For a particular share a dividend of 20p will be paid after 1 year, at which time the share is expected to be sold for 250p. If the risk class justifies a rate of return of 20 per cent, how much should an investor pay for the shares today?
A) 240p
B) 250p
C) 225p
D) 275p

Accepted Answer

To calculate the present value of the share, we need to use the formula:

Present Value = Dividend / (1 + rate of return) + Future Value / (1 + rate of return) ^ n

where n is the number of years until the future value is received.

In this case, n = 1 year, and the values are: 
Dividend = 20p 
Future Value = 250p 
Rate of Return = 20%

Plugging these values into the formula, we get:

Present Value = 20p / (1 + 0.20) + 250p / (1 + 0.20) ^ 1 
Present Value = 16.67p + 208.33p 
Present Value = 225p

Therefore, an investor should pay 225p for the shares today.

Question 5

Which three of the following could contribute to increases in current working capital, as calculated as part of a cash flow approach?
A) Rise in cash requirements
B) Rise in future earnings
C) Rise in stocks
D) Rise in debtors

Accepted Answer

The answer of Which three of the following could contribute...

Question 6

What should an investor pay for shares in which the rate of return for the risk class is 10 per cent, a dividend of 44p will be paid after 1 year, and the share price after 1 year is expected to be 220p?
A) 270p
B) 224p
C) 214p
D) 240p

Accepted Answer

The answer of What should an investor pay for shares...

Question 7

Which three of the following are examples of companies where income- flow- based methods of valuation are not especially useful?
A) Property investment companies
B) Resource- based companies
C) Investment trusts
D) Manufacturing companies

Accepted Answer

Income-flow-based methods are less useful for property investment companies, resource-based companies, and investment trusts because their value is often tied to the underlying assets rather than income flows.

Question 8

For which one of the following would net asset value be the most inappropriate measure of share value?
A) A property investment company
B) An investment trust
C) A record company
D) An oil production company

Accepted Answer

Net asset value (NAV) is a measure of the value of a company's assets minus its liabilities, divided by the number of shares. It is commonly used for investment companies, such as property investment companies and investment trusts. However, for a record company or any other company that relies heavily on intangible assets, such as patents or copyrights, NAV would not accurately reflect the company's true value.

Question 9

Which three of the following are most likely to have an effect on a company's growth rate?
A) The proportion of profit retained
B) Market opportunities
C) The value of previous earnings
D) Quality of management

Accepted Answer

The proportion of profit retained affects the amount of capital a company can reinvest in its operations, which can in turn affect growth rate. Market opportunities refer to the potential for expansion and increased sales, which can also impact growth rate. Quality of management influences the strategic decision-making and operational effectiveness of a company, which can also impact growth rate. The value of previous earnings, however, may not necessarily have a direct impact on growth rate as it is a reflection of past performance.

Question 10

Which three of the following are the benefits most likely to be achieved during a takeover?
A) Synergy
B) Lower managerial pay levels
C) Tax benefits
D) Reducing costs

Accepted Answer

The answer of Which three of the following are the...

Question 11

Which two of the following statements accurately explain why the companies described cannot easily be valued using income- flow- based methods?
A) The probable reserves of oil companies have a large influence on their valuation.
B) The variable costs of raw materials make it difficult to assess manufacturing company income.
C) The range of shares held makes it relatively simple for a shareholder to assess the income of an investment trust.
D) Property investment companies are primarily valued on the basis of their assets.

Accepted Answer

A) The probable reserves of oil companies have a large influence on their valuation, as the value of their assets (oil reserves) directly affects their income generation. Therefore, income flow-based methods may not be accurate in valuing these companies.

D) Property investment companies are primarily valued on the basis of their assets (properties), and not necessarily their income generation. Therefore, income flow-based methods may not accurately reflect the value of these companies.

Question 12

What is meant by 'golden handcuffs'?
A) Financial incentives to encourage managers to stay with the firm
B) Financial incentives to encourage shareholders to stay with the firm
C) Contractual factors that force effective managers to stay with the firm
D) Financial incentives to encourage suppliers to stay with the firm

Accepted Answer

Golden handcuffs refer to financial incentives (such as stock options or bonuses) offered by a company to its key employees with the purpose of retaining them for a certain period of time. This is done to prevent them from leaving the firm and working for competitors or starting their own business.

Question 13

What is the key difference between Historical PER and Prospective PER?
A) Historical PER uses last year's earnings but Prospective PER focuses on next year's earnings and dividend.
B) Historical PER uses earnings in year 0 but Prospective PER focuses on current earnings.
C) Historical PER uses average past earnings but Prospective PER focuses on current earnings.
D) Historical PER uses earnings in years 1 and 2 but Prospective PER focuses on next year's earnings.

Accepted Answer

Historical PER uses past earnings, typically from the previous year, while Prospective PER focuses on future earnings, specifically the next year's earnings and dividend.

Question 14

How does the growth rate of the average corporations as a whole compare with real GDP plus inflation?
A) Growth < Real GDP plus inflation
B) Growth > Real GDP plus inflation.
C) Growth = Real GDP plus inflation
D) Growth = Real GDP plus inflation.

Accepted Answer

The answer of How does the growth rate of the...

Question 15

Which two terms correctly complete the following statement: "The NAV approach to valuation focuses on values, which may be adjusted to reflect values."?
A) fixed asset; future
B) balance sheet; current market
C) fixed asset; discounted values
D) balance sheet; discounted values

Accepted Answer

The NAV (Net Asset Value) approach to valuation focuses on the balance sheet values, which may be adjusted to reflect current market values.

Question 16

A company is expected to maintain a payout ratio of 50 per cent of earnings. The appropriate discount rate for this risk class is 15 per cent and the expected growth rate in earnings and dividends is 6 per cent. What is the PER?
A) 3.3
B) 5.5
C) 6.6
D) 4.4

Accepted Answer

The answer of A company is expected to maintain a...

Question 17

Which three of the following are reasons for the valuation of unquoted shares being different from the valuation of quoted shares?
A) The shares may be subject to more risk.
B) The shares always have 'golden handcuffs' and 'earn- out clauses'.
C) There may be a lower quality and quantity of information.
D) The shares are less liquid.

Accepted Answer

Unquoted shares are subject to more risk as compared to quoted shares. In addition, there may be a lower quality and quantity of information available for unquoted shares due to less transparency in financial reporting. Lastly, unquoted shares are less liquid and may have longer holding periods, leading to differences in valuation compared to more liquid quoted shares. However, the existence of "golden handcuffs" and "earn-out clauses" is not a universal characteristic of unquoted shares and is not a primary reason for differences in valuation.

Question 18

Last year a company had earnings per share of 20p. A year ago the share price was 200p. This year's earnings are likely to be 30p, and the share price today is 250p. What is the historical PER?
A) 6.67
B) 10
C) 8.3
D) 12..5

Accepted Answer

The answer of Last year a company had earnings per...

Question 19

In which three of the following situations are asset values particularly useful?
A) When discounted income flow techniques are difficult to apply
B) When a firm is in financial difficulty
C) When used in relation to takeover bids
D) When used in relation to companies that are not primarily valued on the basis of their assets

Accepted Answer

Asset values are particularly useful in situations where discounted income flow techniques are difficult to apply due to unpredictable future incomes, when a firm is in financial difficulty as assets might need to be liquidated to cover debts, and in the context of takeover bids where the acquiring company assesses the value of the target's assets.

Question 20

What is the focus of income- flow valuation methods?
A) Past flows attributable to the shareholder
B) Past flows attributable to the company
C) Future flows attributable to the company
D) Future flows attributable to the shareholder

Accepted Answer

The answer of What is the focus of income- flow...

Quiz 20: Mergers

Which of the income valuation models is based on the premise that the market value of ordinary shares represents the sum of the expected future dividend flows, to infinity, discounted to present value?

Calculate the PER for the following company. It is expected to maintain a payout ratio of 40 per cent of earnings. The appropriate discount rate for this risk class is 10 per cent and the expected growth rate in earnings and dividends is 5 per cent.

In which situation is it justifiable to use the formula P C1 ? kE - gc

For a particular share a dividend of 20p will be paid after 1 year, at which time the share is expected to be sold for 250p. If the risk class justifies a rate of return of 20 per cent, how much should an investor pay for the shares today?

Which three of the following could contribute to increases in current working capital, as calculated as part of a cash flow approach?

What should an investor pay for shares in which the rate of return for the risk class is 10 per cent, a dividend of 44p will be paid after 1 year, and the share price after 1 year is expected to be 220p?

Which three of the following are examples of companies where income- flow- based methods of valuation are not especially useful?

For which one of the following would net asset value be the most inappropriate measure of share value?

Which three of the following are most likely to have an effect on a company's growth rate?

Which three of the following are the benefits most likely to be achieved during a takeover?

Which two of the following statements accurately explain why the companies described cannot easily be valued using income- flow- based methods?

What is meant by 'golden handcuffs'?

What is the key difference between Historical PER and Prospective PER?

How does the growth rate of the average corporations as a whole compare with real GDP plus inflation?

Which two terms correctly complete the following statement: "The NAV approach to valuation focuses on values, which may be adjusted to reflect values."?

A company is expected to maintain a payout ratio of 50 per cent of earnings. The appropriate discount rate for this risk class is 15 per cent and the expected growth rate in earnings and dividends is 6 per cent. What is the PER?

Which three of the following are reasons for the valuation of unquoted shares being different from the valuation of quoted shares?

Last year a company had earnings per share of 20p. A year ago the share price was 200p. This year's earnings are likely to be 30p, and the share price today is 250p. What is the historical PER?

In which three of the following situations are asset values particularly useful?

What is the focus of income- flow valuation methods?