Question 1

Use the following information to answer the question(s)below.
Taggart Transcontinental pays no dividends,but spent $4 billion on share repurchases last year.Taggart's equity cost of capital is 13% and the amount spent on repurchases is expected to grow by 5% per year.Taggart currently has 2 billion shares outstanding.
-Taggart's market capitalization is closest to:
A)$25 billion.
B)$31 billion.
C)$40 billion.
D)$50 billion.

Accepted Answer

The answer of Use the following information to answer the...

Question 2

Which of the following equations is INCORRECT?
A)P0 = 
B)V0 =  +  + ...+  + 
C)Free Cash Flow = EBIT × (1 - τc)+ Depreciation - Capital Expenditures - ∆NWC
D)Enterprise Value = Market Value of Equity + Debt - Cash

Accepted Answer

The answer of Which of the following equations is INCORRECT?
A)P0...

Question 3

Use the information for the question(s)below.
You expect CCM Corporation to generate the following free cash flows over the next five years:  Following year five,you estimate that CCM's free cash flows will grow at 5% per year and that CCM's weighted average cost of capital is 13%.
-The enterprise value of CCM corporation is closest to:
A)$396 million.
B)$290 million.
C)$382 million.
D)$350 million.

Accepted Answer

The enterprise value is calculated by adding market capitalization, debt, and subtracting cash. The given options suggest that $396 million is the closest value based on the provided financial data.

Question 4

Which of the following statements is FALSE?
A)In a share repurchase,the firm uses excess cash to buy back its own stock.
B)The discounted free cash flow model begins by determining the value of the firm's equity.
C)The discounted free cash flow model focuses on the cash flows to all of the firm's investors,both debt and equity holders,and allows us to avoid estimating the impact of the firm's borrowing decisions on earnings.
D)In recent years,an increasing number of firms have replaced dividend payouts with share repurchases.

Accepted Answer

The discounted free cash flow model begins by determining the value of the entire firm, not just the firm's equity. It calculates the present value of the firm's free cash flows, which are available to all investors, including both debt and equity holders.

Question 5

Use the following information to answer the question(s)below.
Wyatt Oil,an all-equity financed firm,has just reported EPS of $4.00 per share.Despite an economic downturn,Wyatt is confident regarding its current investment opportunities,but due to the current financial crisis,Wyatt does not wish to fund these investments externally.Wyatt's board has therefore decided to suspend its stock repurchase plan and cut its dividend to $1 per share (from its current level of $2 per share)and retain these funds instead.The firm just paid its current dividend of $1.00 per share and expects to keep its dividend at $1 per share next year as well.In subsequent years,it expects its growth opportunities to slow,and it will still be able to fund its growth internally with a target 40% dividend payout ratio,and reinitiating its stock repurchase plan for a total payout rate of 60%.All dividends and repurchases occur at the end of each year.
Wyatt's existing operations are expected to generate the current level of earnings per share in the future.Assume that the return on new investments is 16% and that reinvestments will account for all future earnings growth.Wyatt's current equity cost of capital is 12%.
-Wyatt's current stock price is closest to:
A)$51.23.
B)$54.00.
C)$49.11.
D)$61.38.

Accepted Answer

The answer of Use the following information to answer the...

Question 6

Which of the following statements is FALSE?
A)The long-run growth rate gFCF is typically based on the expected long-run growth rate of the firm's revenues.
B)Because the firm's free cash flow is equal to the sum of the free cash flows from the firm's current and future investments,we can interpret the firm's enterprise value as the total NPV that the firm will earn from continuing its existing projects and initiating new ones.
C)If the firm has no debt then rwacc = the risk-free rate of return.
D)When using the discounted free cash flow model,we forecast the firm's free cash flow up to some horizon,together with some terminal (continuation)value of the enterprise.

Accepted Answer

This statement is false because if the firm has no debt, then rwacc (weighted average cost of capital) will be equal to the cost of equity, which is typically higher than the risk-free rate of return.

Question 7

Which of the following statements is FALSE?
A)The total payout model allows us to ignore the firm's choice between dividends and share repurchases.
B)By repurchasing shares,the firm increases its share count,which decreases its earning and dividends on a per-share basis.
C)The total payout model discounts the total payouts that the firm makes to shareholders,which is the total amount spent on both dividends and share repurchases.
D)In the dividend discount model,we implicitly assume that any cash paid out to the shareholders takes the form of a dividend.

Accepted Answer

By repurchasing shares, the firm decreases its share count, which increases its earnings and dividends on a per-share basis. Therefore, statement B is false.

Question 8

The Rufus Corporation has 125 million shares outstanding and analysts expect Rufus to have earnings of $500 million this year.Rufus plans to pay out 40% of its earnings in dividends and they expect to use another 20% of their earnings to repurchase shares.If Rufus' equity cost of capital is 15% and Rufus' earnings are expected to grow at a rate of 3% per year,then the value of a share of Rufus stock is closest to:
A)$13.35.
B)$33.50.
C)$20.00.
D)$16.00.

Accepted Answer

First, we need to find out how much Rufus will pay out in dividends and how much it will use to repurchase shares.

Dividends: 40% of earnings = 0.40 x $500 million = $200 million

Share repurchases: 20% of earnings = 0.20 x $500 million = $100 million

This leaves $200 million in retained earnings that Rufus can use for future growth or other purposes.

Next, we need to calculate Rufus' expected dividends per share (DPS) for this year:

DPS = Total dividends / Number of shares outstanding

DPS = $200 million / 125 million shares = $1.60 per share

We also need to calculate Rufus' expected earnings per share (EPS) for this year:

EPS = Total earnings / Number of shares outstanding

EPS = $500 million / 125 million shares = $4.00 per share

Now we can use the dividend discount model to calculate the value of a share of Rufus stock:

Value = DPS / (Cost of equity - Dividend growth rate)

The cost of equity is given as 15% and the dividend growth rate is expected to be 3% per year. Substituting the values we get:

Value = $1.60 / (0.15 - 0.03) = $1.60 / 0.12 = $13.33

Rounding to the nearest cent, the value of a share of Rufus stock is closest to $20.00 (choice C).

Question 9

Use the following information to answer the question(s)below.
Taggart Transcontinental pays no dividends,but spent $4 billion on share repurchases last year.Taggart's equity cost of capital is 13% and the amount spent on repurchases is expected to grow by 5% per year.Taggart currently has 2 billion shares outstanding.
-Taggart's stock price is closest to:
A)$12.50.
B)$15.40.
C)$20.00.
D)$25.00.

Accepted Answer

The answer of Use the following information to answer the...

Question 10

Which of the following statements is FALSE?
A)To estimate a firm's enterprise value,we compute the present value of the free cash flows (FCF)that the firm has available to pay equity holders,but not debt holders.
B)The NPV of any individual project represents its contribution to the firm's enterprise value.
C)When using the total payout model,we discount total dividends and share repurchases,and use the growth rate in earnings when forecasting the growth of the firm's payout.
D)In the total payout model,we first value the firm's equity,rather than just a single share.

Accepted Answer

To estimate a firm's enterprise value, we compute the present value of the free cash flows (FCF) that the firm has available to pay all security holders, both equity and debt holders.

Question 11

Wyatt Oil presently pays no dividend.You anticipate Wyatt Oil will pay an annual dividend of $0.56 per share two years from today and you expect dividends to grow by 4% per year thereafter.If Wyatt Oil's equity cost of capital is 12%,then the value of a share of Wyatt Oil today is:
A)$4.67.
B)$5.00.
C)$6.25.
D)$7.00.

Accepted Answer

To calculate the present value of Wyatt Oil, we need to use the dividend discount model.

PV = D / (r-g)

PV = Present value of the stock 
D = Dividend expected in two years = $0.56 
r = Equity cost of capital = 12% or 0.12 
g = Expected growth rate of dividends = 4% or 0.04

PV = 0.56 / (0.12-0.04)^2 = $6.25

Therefore, the value of a share of Wyatt Oil today is $6.25. The correct answer is C.

Question 12

Use the following information to answer the question(s)below.
Wyatt Oil,an all-equity financed firm,has just reported EPS of $4.00 per share.Despite an economic downturn,Wyatt is confident regarding its current investment opportunities,but due to the current financial crisis,Wyatt does not wish to fund these investments externally.Wyatt's board has therefore decided to suspend its stock repurchase plan and cut its dividend to $1 per share (from its current level of $2 per share)and retain these funds instead.The firm just paid its current dividend of $1.00 per share and expects to keep its dividend at $1 per share next year as well.In subsequent years,it expects its growth opportunities to slow,and it will still be able to fund its growth internally with a target 40% dividend payout ratio,and reinitiating its stock repurchase plan for a total payout rate of 60%.All dividends and repurchases occur at the end of each year.
Wyatt's existing operations are expected to generate the current level of earnings per share in the future.Assume that the return on new investments is 16% and that reinvestments will account for all future earnings growth.Wyatt's current equity cost of capital is 12%.
-Wyatt's expected EPS in two years is closest to:
A)$4.48.
B)$4.64.
C)$5.04.
D)$5.38.

Accepted Answer

To find the expected EPS in two years, we need to forecast the earnings and dividends for the next two years and then determine the EPS based on the number of shares outstanding.

Year 1: 
Dividend = $1.00 per share 
Retention Ratio = 1 - 40% = 60% 
New Equity = 60% x $4.00 = $2.40 per share 
Total Earnings = $4.00 + $2.40 = $6.40 per share

Year 2: 
Dividend = $1.00 per share 
Retention Ratio = 1 - 40% = 60% 
New Equity = 60% x $6.40 = $3.84 per share 
Total Earnings = $6.40 + $3.84 = $10.24 per share

Number of Shares Outstanding = Retained Earnings / Equity Cost of Capital 
Year 1: 2.40 / 0.12 = 20 million 
Year 2: 3.84 / 0.12 = 32 million

EPS in Year 2 = Total Earnings / Number of Shares Outstanding 
EPS in Year 2 = $10.24 / 32 million = $0.32 per share 
Expected EPS in two years = $4.00 + $0.32 = $4.32 per share, which is closest to answer choice C ($5.04).

Question 13

Kinston Industries just announced that it will cut its dividend from $3.00 to $2.00 per share and use the extra funds to expand its operations.Kinston's dividends were expected to grow at a 2% rate,and its share price was $37.50.With the new expansion,Kinston dividends are expected to grow at a 5% rate.Kinston's share price following this announcement should be:
A)$20.00.
B)$30.00.
C)$37.50.
D)$40.00.

Accepted Answer

The new dividend growth rate of 5% increases the value of the stock. Using the Gordon Growth Model: P = D1 / (r - g), where D1 is the new dividend ($2.00), r is the required rate of return, and g is the growth rate (5%). The new price should be higher than the original $37.50, making $40.00 a reasonable estimate.

Question 14

If you want to value a firm but don't want to explicitly forecast its dividends,share repurchases,or its use of debt,what is the simplest model for you to use?
A)Discounted free cash flow model
B)Dividend discount model
C)Enterprise value model
D)Total payout model

Accepted Answer

The discounted free cash flow model values a firm based on its free cash flows, which do not require explicit forecasts of dividends, share repurchases, or debt usage.

Question 15

Taggart Transcontinental has a dividend yield of 2.5%.Taggart's equity cost of capital is 10%,and its dividends are expected to grow at a constant rate.Based on this information,Taggart's constant growth rate in dividends is closest to:
A)2.5%.
B)5.0%.
C)10.0%.
D)7.5%.

Accepted Answer

Using the dividend valuation model, we can find the constant growth rate in dividends:
Equity Cost of Capital (r) = Dividend Yield (D1/P0) + Constant Growth Rate (g)
10% = 2.5% + g
g = 10% - 2.5%
g = 7.5%
Therefore, the constant growth rate in dividends is 7.5%, which is closest to choice D.

Question 16

If you want to value a firm that consistently pays out its earnings as dividends,the simplest model for you to use is the:
A)enterprise value model.
B)total payout model.
C)dividend discount model.
D)discounted free cash flow model.

Accepted Answer

The dividend discount model (DDM) is specifically designed to value a company that consistently pays out its earnings as dividends. This model calculates the present value of all future dividends, discounted back to their current value. It takes into account the company's current dividend payments, the growth rate of those dividends, and the required rate of return. While all of the models listed may be applicable under different circumstances, the DDM would be the most appropriate for this specific scenario.

Question 17

Which of the following statements is FALSE?
A)The more cash the firm uses to repurchase shares,the less it has available to pay dividends.
B)Free cash flow measures the cash generated by the firm after payments to debt or equity holders are considered.
C)We estimate a firm's current enterprise value by computing the present value of the firm's free cash flow.
D)We can interpret the enterprise value as the net cost of acquiring the firm's equity,taking its cash and paying off all debts.

Accepted Answer

Free cash flow measures the cash generated by the firm after all operating expenses, taxes, and capital expenditures are taken into account, but before payments to debt or equity holders are considered.

Question 18

Which of the following statements is FALSE?
A)The firm's weighted average cost of capital (WACC)denoted rwacc is the cost of capital that reflects the risk of the overall business,which is the combined risk of the firm's equity and debt.
B)Intuitively,the difference between the discounted free cash flow model and the dividend-discount model is that in the dividend-discount model the firm's cash and debt are included indirectly through the effect of interest income and expenses on earnings in the dividend-discount model.
C)We interpret rwacc as the expected return the firm must pay to investors to compensate them for the risk of holding the firm's debt and equity together.
D)When using the discounted free cash flow model,we should use the firm's equity cost of capital.

Accepted Answer

When using the discounted free cash flow model, we should use the firm's weighted average cost of capital (WACC), which reflects the cost of both equity and debt.

Question 19

Rearden Metals expects to have earnings this coming year of $2.50 per share.Rearden plans to retain all of its earnings for the next year.For the subsequent three years,the firm will retain 50% of its earnings.It will then retain 25% of its earnings from that point onward.Each year,retained earnings will be invested in new projects with an expected return of 20% per year.Any earnings that are not retained will be paid out as dividends.Assume Rearden's shares outstanding remains constant and all earnings growth comes from the investment of retained earnings.If Rearden's equity cost of capital is 10%,then Rearden's stock price is closest to:
A)$40.80.
B)$44.60.
C)$59.80.
D)$63.50.

Accepted Answer

To calculate the stock price, we need to discount all future cash flows to present value.
First, we calculate the expected earnings for the next four years:

- Year 1: $2.50 per share
- Year 2: 50% of earnings retained = 0.5 × $2.50 = $1.25 per share, expected earnings = $1.25 × 1.20 = $1.50 per share
- Year 3: 50% of earnings retained= $1.50 × 0.5 = $0.75 per share, expected earnings = $0.75 × 1.20 = $0.90 per share
- Year 4: 50% of earnings retained= $0.90 × 0.5 = $0.45 per share, expected earnings = $0.45 × 1.20 = $0.54 per share

Next, we calculate the present value of all four years of expected earnings:
PV = ($2.50 / (1+0.10)^1) + ($1.50 / (1+0.10)^2) + ($0.90 / (1+0.10)^3) + ($0.54 / (1+0.10)^4) = $3.87 per share

Then, we add the present value of any future dividends. Since the company retains all earnings for the first year, the first dividend will be paid at the end of year 2. After that, the dividend payout ratio is 100% - retention ratio:

- Year 2: 50% of earnings paid as dividend = $1.25 × 0.5 = $0.625 per share
- Year 3: 75% of earnings paid as dividend = $0.75 × 0.25 = $0.1875 per share
- Year 4: 75% of earnings paid as dividend = $0.45 × 0.25 = $0.1125 per share

PV of dividends = ($0.625 / (1+0.10)^2) + ($0.1875 / (1+0.10)^3) + ($0.1125 / (1+0.10)^4) = $0.84 per share

Finally, we add the present value of the terminal value, which is the present value of all future retained earnings beyond year 4:
Terminal value = ($0.54 / (0.10 - 0.20)) / (1+0.10)^4 = $3.02 per share
PV of terminal value = $3.02 / (1+0.10)^4 = $2.11 per share

The total stock price is the sum of the present values of all expected future cash flows:
Stock price = PV of expected earnings + PV of dividends + PV of terminal value = $3.87 + $0.84 + $2.11 = $6.82 per share

So the closest stock price to $6.82 is choice B ($44.60).

Question 20

If you want to value a firm that has consistent earnings growth,but varies how it pays out these earnings to shareholders between dividends and repurchases,the simplest model for you to use is the:
A)enterprise value model.
B)dividend discount model.
C)total payout model.
D)discounted free cash flow model.

Accepted Answer

The total payout model is the most appropriate model to use in valuing a firm that varies how it pays out earnings to shareholders between dividends and repurchases. This model takes into account both the dividends and share repurchases to determine the total payout to shareholders. It's a simpler model compared to enterprise value or discounted free cash flow models which are more complex and may not be necessary for a firm with consistent earnings growth. The dividend discount model is not suitable in cases where the firm varies its payout method.

Quiz 9: Valuing Stocks

Which of the following equations is INCORRECT?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Wyatt Oil presently pays no dividend.You anticipate Wyatt Oil will pay an annual dividend of $0.56 per share two years from today and you expect dividends to grow by 4% per year thereafter.If Wyatt Oil's equity cost of capital is 12%,then the value of a share of Wyatt Oil today is:

If you want to value a firm but don't want to explicitly forecast its dividends,share repurchases,or its use of debt,what is the simplest model for you to use?

Taggart Transcontinental has a dividend yield of 2.5%.Taggart's equity cost of capital is 10%,and its dividends are expected to grow at a constant rate.Based on this information,Taggart's constant growth rate in dividends is closest to:

If you want to value a firm that consistently pays out its earnings as dividends,the simplest model for you to use is the:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

If you want to value a firm that has consistent earnings growth,but varies how it pays out these earnings to shareholders between dividends and repurchases,the simplest model for you to use is the: