Question 1

What is the percentage of a firm's net income which is reinvested in the firm to support future growth called?

Accepted Answer

The percentage of a firm's net income which is reinvested in the firm to support future growth is called the retention ratio. It represents the portion of earnings that are not paid out as dividends but instead are kept by the firm for reinvestment in its core business or other opportunities. The payout ratio refers to the percentage of earnings that are paid out as dividends to shareholders. The distribution percentage, equity ratio, and equity reinvestment are not commonly used terms in finance.

Question 2

How is a sustainable dividend growth rate defined?

Accepted Answer

A sustainable dividend growth rate is defined as the rate that can be supported over time by a company's earnings. In other words, the company should be able to continue increasing its dividend payments at a consistent rate without putting its financial stability at risk. This means that the rate of growth should be in line with the company's earnings growth rate and should not exceed its ability to generate profits.

Question 3

An analysis of which of the following are commonly included as part of fundamental analysis?
I. sales
II. book value
III. earnings per share
IV. cash flow

Accepted Answer

E

Question 4

The constant perpetual growth model assumes the:

Accepted Answer

The constant perpetual growth model, also known as the Gordon Growth Model, assumes that dividends will grow at a constant rate indefinitely, but for the model to be valid, the growth rate of dividends must be less than the discount rate. This ensures the present value of future dividends converges to a finite number.

Question 5

A firm's current stock price divided by the firm's revenue per share is referred to as which one of the following ratios?

Accepted Answer

The ratio of a firm's current stock price divided by the firm's revenue per share is commonly known as the price-to-sales (P/S) ratio. It is a valuation metric that indicates how much investors are willing to pay for each dollar of the company's sales. The higher the P/S ratio, the more expensive the stock is perceived to be.

Question 6

The net income per share divided by the market price per share is called the:

Accepted Answer

The net income per share divided by the market price per share is called the earnings yield.

Question 7

Based on the dividend discount model, an increase in which of the following will lower the current value of a stock?
I. amount of the next dividend
II. dividend growth rate
III. discount rate

Accepted Answer

III only. According to the dividend discount model, the current value of a stock increases with higher dividends and dividend growth rates, but decreases with a higher discount rate.

Question 8

Growth stocks are frequently described as having which one of the following characteristics?

Accepted Answer

Growth stocks are characterized by having high potential for future earnings growth, which is usually reflected in high price-to-earnings (P/E) ratios.

Question 9

The model used to value the stock of a firm which has a short-term growth rate that varies from its long-term growth rate is called the _____ dividend growth model.

Accepted Answer

The two-stage dividend growth model is used when the short-term growth rate of a firm differs from its long-term growth rate. The model breaks the expected growth rate into two stages and calculates the present value of each stage separately, then adds them together to give the stock's total value.

Question 10

The portion of net income that is held by a firm, for future growth, comprises which one of the following balance sheet accounts?

Accepted Answer

Retained earnings refer to the portion of net income that a firm keeps for future growth rather than paying out as dividends to shareholders.

Question 11

What is the market value of a share of stock divided by the net income per share called?

Accepted Answer

The market value of a share of stock divided by the net income per share is called the price-earnings ratio (P/E ratio). This ratio indicates how much investors are willing to pay for each dollar of earnings generated by the company.

Question 12

Which one of the following terms is used to identify the evaluation method that determines the value of a stock by reviewing a firm's financial statement in conjunction with other financial and economic information?

Accepted Answer

Fundamental analysis is the evaluation method that determines the value of a stock by reviewing a firm's financial statement in conjunction with other financial and economic information. Technical analysis involves analyzing past market data and trends to predict future price movements. Conceptual analysis is not a common term in finance, and prediction valuation and discounted valuation are not specific evaluation methods.

Question 13

The price-book ratio is computed as the market value per share divided by the per share book value of:

Accepted Answer

The price-book ratio compares the market value (what investors are willing to pay for a share) to the book value (the value of the company's assets minus its liabilities) per share of equity. Choice A is incorrect because total assets include both debt and equity, not just equity. Choice B is incorrect because long-term debt is not used in the calculation of equity. Choice D is incorrect because adding long-term debt and equity would result in a higher book value per share, which would make the price-book ratio lower. Choice E is incorrect because net working capital is not relevant to the calculation of the price-book ratio.

Question 14

The dividend discount model assumes that:

Accepted Answer

The answer of The dividend discount model assumes that:
...

Question 15

The model used to value a stock that pays a dividend which increases at a constant rate forever is referred to as which one of the following? Assume the growth rate is less than the discount rate.

Accepted Answer

The model used to value a stock that pays a dividend which increases at a constant rate forever is referred to as the constant perpetual growth model. It assumes that the growth rate of dividends remains constant indefinitely, which implies that the dividends and the stock price grow at the same rate. This model is also known as the Gordon growth model or the dividend discount model.

Question 16

What is the accounting relationship in which earnings per share minus dividends equal the change in book value per share called?

Accepted Answer

The clean surplus relationship states that the change in book value per share equals earnings per share minus dividends. This relationship is important for accounting purposes as it ensures proper tracking and reporting of earnings and dividends.

Question 17

What is beta?

Accepted Answer

Beta is a measure of a stock's risk relative to the stock market average. A beta greater than 1.0 indicates that the stock is more volatile than the overall market, and a beta less than 1.0 indicates that the stock is less volatile than the market. Beta is not a rate of return measure, the return on a stock relative to the overall market, the rate of dividend growth, or the percentage of net income paid out as a dividend.

Question 18

The Free Cash Flow Model: I. can be used to value a company with negative earnings
II) is based on a firm having positive cash flows
III) requires that a firm pay a dividend
IV) directly estimates a value for a firm's equity

Accepted Answer

The Free Cash Flow Model can be used to value a company with negative earnings by focusing on the cash flow generated by the company rather than its earnings. However, the model is based on the firm having positive cash flows, and it does not require the firm to pay a dividend. Although the model indirectly estimates the value of a firm's equity, it does not directly estimate this value. Therefore, statements I and II are true, statement III is false, and statement IV is partially true but not completely accurate.

Question 19

What is the percentage of a firm's earnings that is distributed to shareholders called?

Accepted Answer

The percentage of a firm's earnings that is distributed to shareholders is commonly referred to as the payout ratio. This is calculated by dividing the total amount of dividends paid out by the company by its net income.

Question 20

The method of valuing a stock based on the present value of the future income derived from that stock is called:

Accepted Answer

The dividend discount model is a method of valuing a stock based on the present value of the future income derived from that stock, specifically the dividends paid by the company. This method takes into account the time value of money and the risk associated with the investment.

Quiz 6: Common Stock Valuation