Question 1

The required rate of return on a common stock investment is also known as the:

Accepted Answer

The required rate of return on a common stock investment is the minimum expected rate of return that an investor is willing to accept for investing in a particular stock, considering the risk associated with it. It reflects the investor's expectations for compensation for the risk of investing in the stock.

Question 2

The following terms are interchangeable except for:

Accepted Answer

The terms discount rate, required rate of return, and capitalization rate are often used interchangeably in finance, particularly in the context of valuing investments or projects. They all refer to the rate of return that an investment is expected to generate. However, the capital gains rate is different; it refers to the tax rate on the profit from the sale of an asset or investment, making it not interchangeable with the others.

Question 3

The intrinsic value of common stock is calculated by:

Accepted Answer

The intrinsic value of common stock is calculated by the present value of all expected cash flows, which includes both dividends and any expected capital gains.

Question 4

Earnings are important in stock valuation for all of the following reasons except:

Accepted Answer

A company without earnings can still have a positive value due to factors like assets, growth potential, or strategic value.

Question 5

Which of the following is a problem in using the dividend discount model (DDM) to value common stock?

Accepted Answer

The dividend discount model (DDM) specifically values stocks based on the present value of future dividends. It inherently cannot value firms that do not pay dividends, as it requires dividend payments to calculate the stock's value.

Question 6

Which of the following is not one of the dividend growth rate models?

Accepted Answer

The infinite growth model is not a recognized dividend growth rate model. The other options (zero growth, constant growth, and a negative but still constant growth model) are variations that can be applied to forecast dividends.

Question 7

The constant growth dividend model is also known as the:

Accepted Answer

The constant growth dividend model, which is used to value a stock by assuming constant growth in dividends, is also known as the Gordon's Model, named after Myron J. Gordon who was instrumental in further developing the model.

Question 8

The zero-growth dividend model:

Accepted Answer

The zero-growth dividend model is equivalent to the valuation model for preferred stocks and perpetual bonds because it assumes dividends remain constant over time, similar to the fixed payments from preferred stocks and perpetual bonds.

Question 9

The variant of the dividend discount model that is most appropriate for a start-up company that pays smaller dividends early in its life but is expected to increase them after several years would be the:

Accepted Answer

The multiple growth model is most appropriate for a start-up company that pays smaller dividends early in its life but is expected to increase them after several years. This model allows for different growth rates to be applied at different times, reflecting the company's anticipated growth phases.

Question 10

Which of the following statements regarding intrinsic value and market price is true?

Accepted Answer

Intrinsic value is an estimate of the true value of a stock based on fundamental analysis. If the intrinsic value equals the market price, it suggests the stock is fairly valued, reflecting all known information and is in a state of equilibrium.

Question 11

The intrinsic value of any stock is its:

Accepted Answer

The intrinsic value of a stock is determined by discounting the expected future dividends to their present value, reflecting the stock's true underlying value based on its potential to generate cash flows for shareholders.

Question 12

Which of the following statements regarding dividend discount models is not true?

Accepted Answer

The statement that few money managers use the model to estimate intrinsic value is not true. Many money managers and investors use dividend discount models (DDMs) as a fundamental analysis tool to estimate the intrinsic value of a company's stock by predicting the dividends the company will generate in the future.

Question 13

Which of the following is not true for the P/E ratio?

Accepted Answer

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

Question 14

An investor planning to sell stock at the end of two years can still use the DDM to value the stock because the anticipated selling price is:

Accepted Answer

The Dividend Discount Model (DDM) values a stock based on the present value of its future dividends, and the anticipated selling price can be considered as the present value of all future dividends beyond the selling point. Thus, the selling price in two years is effectively built into the model through the present value of anticipated dividends from that point forward.

Question 15

Which of the following relationships in the P/E ratio should not hold, other things being equal?

Accepted Answer

All the relationships should hold because they are based on the fundamental valuation model where P/E is influenced by dividend payout, growth rate, and required return.

Question 16

A firm has net income of $1 million with 250,000 shares outstanding with a total market value of $16 million. What is its P/E ratio?

Accepted Answer

The answer of A firm has net income of $1...

Question 17

If interest rates rise and other factors remain constant, the P/E ratio of a company will:

Accepted Answer

The answer of If interest rates rise and other factors...

Question 18

Which of the following variables does not have a direct relationship with the P/E ratio?

Accepted Answer

The required rate of return for the company's stock is not a variable that has a direct relationship with the P/E ratio. The P/E ratio is calculated by dividing the current market price of a stock by its annual earnings per share. The dividend payout ratio, expected growth rate of dividends, and expected growth rate of earnings are all variables that can affect the P/E ratio.

Question 19

Which of the following changes will likely lead to a lower P/E, assuming other factors are equal?

Accepted Answer

A decrease in the growth rate of earnings typically leads to a lower Price to Earnings (P/E) ratio because investors are willing to pay less for each dollar of earnings when they expect those earnings to grow more slowly in the future.

Question 20

Which of the following statements regarding P/E ratios is true?

Accepted Answer

Over the long term, low P/E ratio stocks tend to have higher returns than high P/E ratio stocks.

Quiz 13: Common Stock Valuation