Question 1

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?

Accepted Answer

D

Question 2

The free cash flow to the firm model uses which of the following as the discount rate?

Accepted Answer

The free cash flow to the firm (FCFF) model uses the weighted average cost of capital (WACC) as the discount rate because it reflects the overall cost of capital, including both equity and debt.

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?

Accepted Answer

The price of a stock with a constant dividend can be calculated using the formula for a perpetuity: Price = Dividend / Required Return. Here, Price = $0.25 / 0.05 = $5.00.

Question 4

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

Accepted Answer

An increase in the estimated constant growth rate for dividends suggests higher future cash flows, making the stock more valuable to the investor, thus increasing the price they are willing to pay.

Question 5

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

Accepted Answer

Small changes in the discount rate (k) or growth rate (g) can significantly impact the estimated intrinsic value, making the model highly sensitive to these assumptions.

Question 6

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

Accepted Answer

Discounted cash flow (DCF) involves estimating future cash flows, determining an appropriate discount rate, and calculating the present value to find intrinsic value. Comparing intrinsic value to a relative value metric is not a step in DCF; it involves comparing to market or industry benchmarks.

Question 7

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

Accepted Answer

Free cash flow to equity (FCFE) measures the cash flow available to equity shareholders after accounting for capital expenditures, interest, and principal repayments on debt.

Question 8

Which of the following represent two major approaches used to value stocks?

Accepted Answer

Discounted cash flow techniques and relative valuation techniques are the two major approaches used to value stocks. Discounted cash flow involves estimating the present value of expected future cash flows, while relative valuation involves comparing a company's valuation metrics to those of similar companies.

Question 9

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?

Accepted Answer

The estimated stock price in year 7 should consider the discounted value of all dividends from year 7 onwards, as this reflects the future cash flows the stock will generate after the holding period.

Question 10

Jed plans to purchase a deferred dividend preferred stock. The stock has a dividend rate of 5%, a $100 par value, and will pay its first annual dividend in six years. If Jed's required return on the stock is 6.75%, what price should he pay for the stock now?

Accepted Answer

The price of the stock can be calculated using the present value of the deferred dividends. The dividend is $5 (5% of $100 par value), and the first payment is in six years. The present value of a perpetuity starting in six years is calculated as $5 / 0.0675 = $74.07, and then discounted back to the present value: $74.07 / (1 + 0.0675)^6 = $53.44.

Question 11

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

Accepted Answer

Companies with high growth rates generally have higher P/E ratios because investors are willing to pay more for the potential of future earnings growth.

Question 12

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

Accepted Answer

The answer of Which of the following is not a...

Question 13

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

Accepted Answer

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is often used as a proxy for cash flow in the Price/Cash Flow (P/CF) ratio because it reflects the company's operational profitability and cash-generating ability before accounting for non-cash expenses and financial costs.

Question 14

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

Accepted Answer

Analysts may use any of these definitions of earnings depending on the context and purpose of the analysis.

Question 15

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? $$\begin{array} { | c | c | c | c | c | } 
\hline \mathbf { D } _ { \mathbf { 1 } } & \mathbf { D } _ { \mathbf { 2 } } & \mathbf { D } _ { \mathbf { 1 } } & \mathbf { D } _ { \mathbf { 4 } } & \text { Later } \
\hline \$ 2.00 & \$ 2.40 & \$ 2.76 & \$ 3.17 & \mathbf { 6 \% } \text { prowth } \
\hline
\end{array}$$

Accepted Answer

The stock price is calculated using the dividend discount model: P = D1/(1+r) + D2/(1+r)^2 + D3/(1+r)^3 + D4/(1+r)^4 + D4*(1+g)/(r-g)/(1+r)^4. Plugging in the values, P = 2/(1.1) + 2.4/(1.1)^2 + 2.76/(1.1)^3 + 3.17/(1.1)^4 + 3.17*1.06/(0.1-0.06)/(1.1)^4 = $65.42.

Question 16

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

Accepted Answer

The relative value measure derived from the DCF model is not used in relative valuation comparisons, as DCF is an intrinsic valuation method, not a relative one.

Question 17

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?

Accepted Answer

The highest amount Sam should pay for the stock is calculated using the Gordon Growth Model (Dividend Discount Model): P = D1 / (r - g), where D1 is the expected dividend ($1.25), r is the required return (12% or 0.12), and g is the growth rate (10% or 0.10). P = 1.25 / (0.12 - 0.10) = $62.50.

Question 18

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 return is closest to:

Accepted Answer

The answer of Hannett Inc. has a stock price of...

Question 19

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?

Accepted Answer

If Stephen's valuation using the dividend discount model suggests the stock is worth $23.50, but the market price is $27.00, the stock is overvalued according to his analysis. Therefore, he should sell it if he owns it or consider short selling if he believes the market price will eventually align with his valuation.

Question 20

The estimated EPS and dividend per share (DPS) for Herker Corp. next year are $4 and $2, respectively. Herker's stock price is $92 and analysts estimate Herker's required return at 8%. What is the present value of growth opportunities (PVGO) for Herker?

Accepted Answer

The answer of The estimated EPS and dividend per share...

Quiz 10: Common Stock Valuation