Question 1

For which one of the following situations will the price-to-sales valuation model work but the dividend and cash flow models will not?

Accepted Answer

The price-to-sales valuation model is suitable for a newly-formed biotechnology company with negative earnings because it does not require the company to be profitable, unlike the dividend and cash flow models which rely on positive earnings and cash flows to value a company.

Question 2

For which one of the following situations will the dividend valuation models be least reliable?

Accepted Answer

Dividend valuation models are least reliable for firms that do not pay dividends, as these models require dividend payments to calculate the value of the firm. A young firm that does not pay dividends and is unlikely to do so in the near future cannot be effectively valued using dividend valuation models.

Question 3

Early in 2019, Mathew is analyzing shares of Janeff Corp. He expects the following dividends per share (end of year). 2019 $1.00
2020 $1.25
2021 $1.50
He expects 2021 earnings per share to be $4.50 and Janeff's P/E ratio to be 20. His required rate of return for this stock is 12%. He should pay no more than

Accepted Answer

The price in 2021 can be estimated using the P/E ratio: $4.50 * 20 = $90. The present value of dividends and the price in 2021, discounted at 12%, is $67.02.

Question 4

The constant growth dividend valuation model works best for mature companies with a long record of paying dividends.

Accepted Answer

The constant growth dividend valuation model assumes dividends grow at a constant rate indefinitely, making it most suitable for mature companies with stable, predictable dividend payments.

Question 5

When using the price-to-cash-flow method of valuation EBITDA is a widely accepted measure of cash flow.

Accepted Answer

EBITDA (earnings before interest, taxes, depreciation, and amortization) is a widely accepted measure of cash flow because it represents the cash generated by a company's operations before taking into account non-cash expenses such as depreciation and amortization.

Question 6

None of the commonly used valuation approaches can assign a value to a company with no earnings.

Accepted Answer

Valuation approaches such as the Discounted Cash Flow (DCF) method can value companies based on future cash flow projections, not just current earnings, allowing for the valuation of companies with no current earnings.

Question 7

Early in 2019, Maria bought shares of MBA Inc. at $27.85 per share. She received the following dividends per share (end of year). $$\begin{array} { l l } 
2019 & \$ 1.50 \
2020 & \$ 2.00 \
2021 & \$ 2.50
\end{array}$$ Immediately after receiving the 2021 dividend, she sold the stock for $32.50 per share. Her internal rate of return on this investment was

Accepted Answer

The internal rate of return (IRR) is the rate that makes the net present value (NPV) of all cash flows from a particular investment equal to zero. In this case, Maria's cash flows can be represented as follows: an initial outflow of $27.85 when she buys the stock, inflows of $1.50, $2.00, and $2.50 for the dividends received at the end of 2019, 2020, and 2021 respectively, and finally an inflow of $32.50 when she sells the stock immediately after receiving the 2021 dividend. The IRR is the rate $r$ that satisfies the equation:$$-27.85 + \frac{1.50}{(1+r)} + \frac{2.00}{(1+r)^2} + \frac{2.50 + 32.50}{(1+r)^3} = 0$$Solving this equation for $r$ gives an IRR of approximately 11.99%, which corresponds to option C.

Question 8

Equinox Bioengineering began operations one year ago. In its first year of operation, sales were $85 million and the net loss was $(5.1 million). Free cash flow was $(300,000). Equinox has 10 million shares outstanding. If you think the price to sales ratio for this company should be 1 or less, what is the most you should pay per share?

Accepted Answer

The price to sales ratio is calculated as the market capitalization (price per share times number of shares) divided by sales. If the ratio should be 1 or less, and sales were $85 million with 10 million shares outstanding, the market cap should be $85 million or less. Dividing $85 million by 10 million shares gives a maximum price per share of $8.50.

Question 9

The price-to-cash-flow method of stock valuation generally

Accepted Answer

The price-to-cash-flow method typically uses EBITDA or operating cash flow from the cash flow statement as a measure of cash flow, as these are considered more reflective of a company's cash-generating ability than net income.

Question 10

At a time when the market P/E ratio is 21, Kaperr Security has a relative P/E of .7 and EPS of $3.00. The price of Kaperr stock is

Accepted Answer

The price of Kaperr stock is calculated by multiplying the market P/E ratio by the relative P/E of Kaperr and then by the EPS of Kaperr. So, the calculation is 21 (market P/E) * 0.7 (relative P/E) * $3.00 (EPS) = $44.10.

Question 11

NRBG Inc. generated EBITDA of $181,818,182 million this year and that is expected to grow by 10% over the coming year. NRBG has 40 million shares outstanding; similar companies trade around 9 times cash flow. What are NRBG's expected cash flow and price per share?

Accepted Answer

NRBG's expected cash flow next year is $181,818,182 million * 1.10 = $200,000,000 million. Dividing by 40 million shares gives $5.00 per share. With a multiple of 9 times cash flow, the price per share is $5.00 * 9 = $45.00.

Question 12

Higher relative P/E ratios may indicate investor pessimism concerning a company's future.

Accepted Answer

Higher relative P/E ratios typically indicate investor optimism about a company's future growth and earnings potential, not pessimism.

Question 13

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

Accepted Answer

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

Question 14

To use the Price-to-Sales valuation approach you also need to know the after tax profit margin.

Accepted Answer

The Price-to-Sales (P/S) valuation approach focuses on the relationship between a company's stock price and its revenue per share, not requiring information about the company's after-tax profit margin.

Question 15

Cortland Co.'s most recent EPS were $3.25 and they are expected to grow at a rate of 5% for the near future. The stock currently sells for $48.75. What are the price to earnings ratios based on trailing and forecasted earnings per share?

Accepted Answer

The price to earnings (P/E) ratio based on trailing earnings per share (EPS) is calculated by dividing the current stock price by the most recent EPS. For Cortland Co., this is $48.75 / $3.25 = 15. The P/E ratio based on forecasted EPS is calculated by dividing the current stock price by the forecasted EPS. The forecasted EPS is the most recent EPS grown at the expected growth rate, which is $3.25 * (1 + 5%) = $3.4125. The P/E ratio based on this forecasted EPS is $48.75 / $3.4125 ≈ 14.30.

Question 16

Hallowell Inc. has free cash flow of $2.5 million and 1.25 million shares outstanding. If you believe the price to cash flow ratio for this company should be 11, what is the highest price you should pay for the stock?

Accepted Answer

The highest price you should pay for the stock is calculated by first finding the total value of the company based on the price to cash flow ratio, which is $2.5 million * 11 = $27.5 million. Then, divide this total value by the number of shares outstanding to find the price per share: $27.5 million / 1.25 million shares = $22.00 per share.

Question 17

The free cash flow to equity approach does not require present value calculations.

Accepted Answer

The free cash flow to equity approach involves calculating the present value of future cash flows available to equity shareholders, after accounting for debts and reinvestments, to determine the value of a company's equity.

Question 18

In the price/earnings approach to stock valuation,

Accepted Answer

The price/earnings approach to stock valuation typically uses forecasted earnings per share (EPS) to estimate a stock's value, as it aims to predict future performance rather than rely on historical data.

Question 19

How can you determine the current value of a non-dividend paying stock?

Accepted Answer

The answer of How can you determine the current value...

Question 20

The Highlight Company has a book value of $56.50 per share, and is currently trading at a price of $59.00 per share. You are interested in investing in Highlight, and have just used a present-value based stock valuation model to calculate a present (intrinsic) value of $55.00 per share for Highlight's stock. Assuming that your calculations are correct you should

Accepted Answer

The correct choice is to not buy the stock because the present (intrinsic) value you calculated ($55.00) is less than the current market price per share ($59.00), indicating the stock may be overvalued based on your valuation model.

Quiz 8: Stock Valuation