Question 1

Firm A has a stock price of $35 and 60% of the value of the stock is in the form of PVGO.Firm B also has a stock price of $35 but only 20% of the value of Stock B is in the form of PVGO.We know that _________.
I.Stock A will give us a higher return than Stock B
II.an investment in Stock A is probably riskier than an investment in Stock B
III.Stock A has higher forecast earnings growth than Stock B

Accepted Answer

Stock A having a higher percentage of its value in PVGO suggests it relies more on future growth opportunities, indicating higher risk and potentially higher forecast earnings growth compared to Stock B.

Question 2

A stock is priced at $45 per share.The stock has earnings per share of $3.00 and a market capitalization rate of 14%.What is the stock's PVGO?

Accepted Answer

PVGO = Earnings per share / Market capitalization ratePVGO = $3.00 / 14%PVGO = $21.43

Question 3

The free cash flow to the firm is reported as $205 million.The interest expense to the firm is $22 million.If the tax rate is 35% and the net debt of the firm increased by $25,what is the market value of the firm if the FCFE grows at 2% and the cost of equity is 11%?

Accepted Answer

First, we need to calculate the Free Cash Flow to Equity (FCFE) using the Free Cash Flow to the Firm (FCFF):

FCFE = FCFF - Interest Expense (1 - Tax Rate) + Net Borrowing
FCFE = $205M - $22M(1 - 0.35) + $25M
FCFE = $149.75M

Next, we can use the Gordon Growth Model to calculate the market value of the firm:

Market Value = FCFE / (Cost of Equity - Growth Rate)
Market Value = $149.75M / (0.11 - 0.02)
Market Value = $1.4975B / 0.09
Market Value = $16.6389B

Finally, we need to add the net debt to get the enterprise value:

Enterprise Value = Market Value + Net Debt
Enterprise Value = $16.6389B + $25M
Enterprise Value = $2.397B

Therefore, the best choice is B, $2.397 billion.

Question 4

The free cash flow to the firm is $300 million in perpetuity,the cost of equity equals 14% and the WACC is 10%.If the market value of the debt is $1.0 billion,what is the value of the equity using the free cash flow valuation approach?

Accepted Answer

Using the free cash flow valuation approach, the value of the firm is calculated as follows:

Value of the firm = Free Cash Flow to the Firm / (WACC - growth rate)

Since the free cash flow to the firm is given as $300 million in perpetuity, the growth rate is zero. Therefore, the value of the firm is:

Value of the firm = $300 million / (10% - 0%)

Value of the firm = $3 billion

Now, to find the value of equity, we subtract the market value of debt from the value of the firm:

Value of equity = Value of the firm - Market value of debt

Value of equity = $3 billion - $1 billion

Value of equity = $2 billion

Therefore, the value of the equity using the free cash flow valuation approach is $2 billion. The correct answer is B).

Question 5

A firm reports EBIT of $100 million.The income statement shows depreciation of $20 millions.If the tax rate is 35% and total capital expenditures and increases in working capital total $10 million,what is the free cash flow to the firm?

Accepted Answer

Free Cash Flow to the Firm (FCFF) is calculated as: FCFF = EBIT(1 - Tax Rate) + Depreciation - Capital Expenditures - Increases in Working Capital. Plugging in the values: FCFF = $100 million * (1 - 0.35) + $20 million - $10 million = $65 million + $20 million - $10 million = $75 million.

Question 6

A firm increases its dividend plowback ratio.All else equal you know that _____________.

Accepted Answer

11eaaae8_8b53_0625_a4b8_c74eea966d8c_TB6474_11 = 11eaaae8_8b53_0626_a4b8_1bf2acb0e74c_TB6474_11

Question 7

Transportation stocks currently provide an expected rate of return of 15%.TTT,a large transportation company,will pay a year-end dividend of $3 per share.If the stock is selling at $60 per share,what must be the market's expectation of the constant growth rate of TTT dividends?

Accepted Answer

To calculate the constant growth rate of TTT dividends, we can use the Gordon Growth Model:

Expected return = (dividend yield) + (constant dividend growth rate)

15% = (3/60) + (constant dividend growth rate)

Solving for the constant dividend growth rate, we get:

Constant dividend growth rate = 10%

Therefore, the market's expectation of the constant growth rate of TTT dividends is 10%. The correct answer is (B).

Question 8

If a firm has a free cash flow equal to $50 million and that cash flow is expected to grow at 3% forever,what is the total firm value given a WACC of 9.5%?

Accepted Answer

To calculate the firm value, we use the formula: 
Firm value = Free cash flow / (WACC - growth rate) 
Plugging in the given values, we get: 
Firm value = 50 / (0.095 - 0.03) = 769 
Therefore, the total firm value is $769 million. The correct answer is C.

Question 9

ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock.
-At what P/E ratio would you expect ART to sell?

Accepted Answer

We can use the Gordon Growth Model to solve for the expected P/E ratio.

ROE = Net Income / Equity
0.25 = Earnings per Share * Plowback Ratio / Equity 
0.25 = $3 * 0.20 / Equity 
Equity = $15

Expected Dividend per Share = Earnings per Share - Earnings per Share * Plowback Ratio 
Expected Dividend per Share = $3 - $3 * 0.20 = $2.40

Expected Price per Share = Expected Dividend per Share / (Required Rate of Return - Growth Rate) 
Growth Rate = ROE * Plowback Ratio = 0.25 * 0.20 = 0.05 
Expected Price per Share = $2.40 / (0.12 - 0.05) = $34.29

Expected P/E Ratio = Price per Share / Earnings per Share = $34.29 / $3 = 11.43

The closest option is B, 11.43.

Question 10

A firm has a stock price of $54.75 per share.The firm's earnings are $75 million and the firm has 20 million shares outstanding.The firm has an ROE of 15% and a plowback of 65%.What is the firm's PEG ratio?

Accepted Answer

The PEG ratio is calculated as the P/E ratio divided by the growth rate. The P/E ratio is (Price per share / Earnings per share) = $54.75 / ($75 million / 20 million shares) = 14.6. The growth rate is ROE * plowback = 15% * 65% = 9.75%. Thus, PEG = 14.6 / 9.75 = 1.50.

Question 11

A firm is expected to produce earnings next year of $3.00 per share.It plans to reinvest 25% of its earnings at 20%.If the cost of equity if 11%,what should be the value of the stock?

Accepted Answer

The answer of A firm is expected to produce earnings...

Question 12

The EBIT of a firm is $300,the tax rate is 35%,the depreciation is $20,capital expenditures are $60 and the increase in net working capital is $30.What is the free cash flow to the firm?

Accepted Answer

Free cash flow to the firm = EBIT*(1-tax rate) + Depreciation - Capital Expenditures - Increase in Net Working Capital
= 300*(1-0.35) + 20 - 60 - 30
= $125. Therefore, the best choice is B.

Question 13

ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of 0.20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock.
-At what price would you expect ART to sell?

Accepted Answer

To calculate the expected stock price, we can use the Gordon Growth Model:
P0 = (E1 / (r - g))
where
P0 = current stock price
E1 = earnings per share next year
r = required rate of return
g = growth rate of dividends

Since the question asks for stock price, we need to modify the formula slightly to account for the plowback ratio:
P0 = [(Earnings per share current year)x(1+g)] / (r - g)

Given:
- Current earnings per share = $3
- ROE = 25%, which means the growth rate of earnings = ROE x plowback ratio = 0.25 x 0.2 = 0.05
- Plowback ratio = 0.20
- Required rate of return (r) = 12%

Using these values, we can calculate the expected stock price:
P0 = [(3*(1+0.05)) / (0.12 - 0.05)]
P0 = $34.29

Therefore, the best choice is B) $34.29.

Question 14

The free cash flow to the firm is reported as $405 million.The interest expense to the firm is $76 million.If the tax rate is 35% and the net debt of the firm increased by $50,what is the free cash flow to the equity holders of the firm?

Accepted Answer

The answer of The free cash flow to the firm...

Question 15

The free cash flow to the firm is reported as $198 million.The interest expense to the firm is $15 million.If the tax rate is 35% and the net debt of the firm increased by $20 million,what is the market value of the firm if the FCFE grows at 3% and the cost of equity is 14%?

Accepted Answer

The answer of The free cash flow to the firm...

Question 16

The free cash flow to the firm is reported as $275 million.The interest expense to the firm is $60 million.If the tax rate is 35% and the net debt of the firm increased by $33,what is the free cash flow to the equity holders of the firm?

Accepted Answer

The free cash flow to the equity holders is calculated as the free cash flow to the firm minus the interest expense and taxes on interest expense. The interest expense is $60 million, and the tax rate is 35%. Therefore, the taxes on interest expense are $60 million * 35% = $21 million. The free cash flow to the equity holders is therefore $275 million - $60 million - $21 million = $194 million.

Question 17

What is the present value of growth opportunities for ART?

Accepted Answer

The answer of What is the present value of growth...

Question 18

A firm has an earnings retention ratio of 40%.The stock has a market capitalization rate of 15% and an ROE of 18%.What is the stock's P/E ratio?

Accepted Answer

First, we need to calculate the dividend payout ratio:

Dividend Payout Ratio = 1 - Retention Ratio
Dividend Payout Ratio = 1 - 0.4
Dividend Payout Ratio = 0.6

Next, we can use the Gordon Growth Model to calculate the P/E ratio:

P/E Ratio = (ROE - Dividend Payout Ratio) / (Market Capitalization Rate - Growth Rate)

We can estimate the growth rate by multiplying ROE by the retention ratio:

Growth Rate = ROE x Retention Ratio
Growth Rate = 0.18 x 0.4
Growth Rate = 0.072

Now we can plug in the numbers:

P/E Ratio = (0.18 - 0.6) / (0.15 - 0.072)
P/E Ratio = -0.42 / 0.078
P/E Ratio = -5.38

This result doesn't make sense because a P/E ratio cannot be negative. The reason for the negative result is that the retention ratio is so high that the company is not paying out enough dividends to offset the earnings retained. This means that investors are valuing the stock at a discount which leads to a negative P/E ratio.

To get a positive P/E ratio, we need to lower the retention ratio (increase the dividend payout ratio) or increase the market capitalization rate. The only choice that achieves this is B (7.69).

Question 19

What price do you expect ART shares to sell for in 4 years?

Accepted Answer

Based on the linear regression equation, the estimated price for ART shares in 4 years is $41.68.

Question 20

A common stock pays an annual dividend per share of $1.80.The risk-free rate is 5 percent and the risk premium for this stock is 4 percent.If the annual dividend is expected to remain at $1.80 per share,what is the value of the stock?

Accepted Answer

We can use the constant growth dividend discount model to calculate the value of the stock. The formula is:

Stock Value = Dividend / (Discount Rate - Growth Rate)

We know that the annual dividend is $1.80 per share, and the growth rate is zero because the dividend is expected to remain constant. The discount rate is equal to the sum of the risk-free rate and the risk premium, which is 9 percent (5 percent + 4 percent). Plugging these values into the formula gives us:

Stock Value = $1.80 / (0.09 - 0) = $20.00

Therefore, the value of the stock is $20.00.

Quiz 13: Equity Valuation