Question 1

Zephyr Inc. sells wind based systems for generating electricity. The company pays no dividends, but you estimate the share will be worth $50 per share 5 years from now and you require a 15% rate of return for share investments of this type. What price should you be willing to pay for this share?

Accepted Answer

The price you should be willing to pay is the present value of the future price, which is $50 discounted at a 15% rate over 5 years: $50 / (1 + 0.15)^5 = $24.86.

Question 2

If the market multiple is 23.0 and the P/E ratio of a company is 27.4, then the share's relative P/E is

Accepted Answer

The relative P/E is calculated by dividing the company's P/E ratio by the market multiple: 27.4 / 23.0 = 1.19.

Question 3

Michelak's Maritime Industries has relatively stable earnings and pays an annual dividend of $2.50 per share. This dividend has remained constant over the past few years and is expected to remain constant for some time to come. If you want to earn 12% on an investment in the company's shares, how much should you pay to purchase each share?

Accepted Answer

The price of a stock with constant dividends can be calculated using the formula: Price = Dividend / Required Rate of Return. Here, Price = $2.50 / 0.12 = $20.83.

Question 4

The single most important issue in the share valuation process is a company's

Accepted Answer

Expected future returns are the most important factor in share valuation because they represent the potential return on investment for shareholders.

Question 5

What is the required rate of return on a ordinary share that is expected to pay a $0.75 annual dividend next year if dividends are expected to grow at 2 percent annually and the current share price is $8.59?

Accepted Answer

The answer of What is the required rate of return...

Question 6

Martin's Inc. is expected to pay annual dividends of $2.50 a share for the next three years. After that, dividends are expected to increase by 3% annually. What is the current value of this share to you if you require a 9% rate of return on this investment?

Accepted Answer

The answer of Martin's Inc. is expected to pay annual...

Question 7

The value of a share is a function of

Accepted Answer

The value of a share is primarily determined by its expected future returns, as investors are interested in the potential future cash flows and growth prospects of the company.

Question 8

One share valuation model holds that the value of a share is a function of its future dividends, and that the dividends will increase at an annual rate which will remain unchanged over time. This share valuation model is known as the

Accepted Answer

The constant-growth dividend valuation model assumes that dividends will grow at a constant annual rate, which is used to calculate the value of a share.

Question 9

An internal rate of return (IRR) is the discount rate that

Accepted Answer

The answer of An internal rate of return (IRR) is...

Question 10

The current annual sales of Flower Bud, Inc. are $178,000. Sales are expected to increase by 4% next year. The company has a net profit margin of 5% which is expected to remain constant for the next couple of years. There are 10,000 shares outstanding. The market multiple is 16.4 and the relative P/E of the firm is 1.21. What is the expected market price per share for next year?

Accepted Answer

The answer of The current annual sales of Flower Bud,...

Question 11

The major forces behind earnings per share are

Accepted Answer

The answer of The major forces behind earnings per share...

Question 12

James is willing to settle for a 10% rate of return on EG shares at a time when investors, on average, are requiring an 11% rate of return on the same shares. Which of the following will happen?

Accepted Answer

James is willing to accept a lower rate of return than the market, so he will be happy to buy the shares at a lower price than he was willing to pay.

Question 13

The Frisco Company just paid $2.20 as its annual dividend. The dividends have been increasing at a rate of 4% annually and this trend is expected to continue. The share is currently selling for $63.60 a share. What is the rate of return on this share?

Accepted Answer

The rate of return can be calculated using the Gordon Growth Model: Rate of Return = (Dividend / Price) + Growth Rate = ($2.20 / $63.60) + 4% = 7.60%.

Question 14

William is the type of share market investor who focuses on factors such as a company's book value, debt load, return on equity, and cash flow. In searching for share investments, he looks at a company's historical performance and attempts to find undervalued shares. This information indicates that William is the type of investor known as

Accepted Answer

William is a value investor because he focuses on a company's fundamentals, such as book value and cash flow, to find undervalued shares.

Question 15

The Merry Co. has current annual sales of $350,000 and a net profit margin of 6%. Sales are expected to increase by 5% annually while the profit margin is expected to remain constant. What is the projected after- tax earnings for two years from now?

Accepted Answer

The projected sales in two years will be $350,000 * (1.05)^2 = $385,875. With a net profit margin of 6%, the after-tax earnings will be 6% of $385,875, which is $23,153.

Question 16

GLOO stock's P/E ratio is 45 at a time when the market's P/E ratio is 15. GLOO's realtive P/E ratio is

Accepted Answer

The relative P/E ratio is calculated by dividing the company's P/E ratio by the market's P/E ratio. So, GLOO's relative P/E ratio is 45 / 15 = 3.

Question 17

In applying the variable- growth dividend valuation model to a company's share, analysts frequently define the growth rate, g, as equal to

Accepted Answer

The growth rate, g, in the variable-growth dividend valuation model is often defined as the return on equity (ROE) multiplied by the firm's retention rate (1 - dividend payout ratio). This is known as the sustainable growth rate.

Question 18

ABC Company share currently has a market value equivalent to its intrinsic value. Marco perceives that ABC Company is increasing its level of risk and therefore Marco increases his required rate of return on ABC share. This change in the required rate of return

Accepted Answer

An increase in the required rate of return will reduce the intrinsic value of the share to Marco, as the present value of future cash flows will be discounted at a higher rate.

Question 19

The constant- growth dividend valuation model is best suited for use with

Accepted Answer

The constant-growth dividend valuation model assumes a stable growth rate in dividends, which is most applicable to mature, dividend-paying companies that have predictable and stable dividend growth.

Question 20

One common method of estimating the growth rate of dividends is to

Accepted Answer

The growth rate of dividends can be estimated using the formula: Growth Rate = Return on Equity (ROE) x Retention Rate. The retention rate is the portion of earnings not paid out as dividends, which is used to reinvest in the business.

Quiz 8: Share Valuation