Question 1

An increase in the required rate of return k will increase the P/E ratio.

Accepted Answer

An increase in the required rate of return k will decrease the P/E ratio. This is because a higher required rate of return means that investors expect higher returns on their investment, and therefore they are willing to pay less for each dollar of earnings. As a result, the P/E ratio will decrease.

Question 2

Price-to-sales ratio is still considered the predominant firm valuation technique.

Accepted Answer

The price-to-earnings (P/E) ratio is more commonly used as the predominant firm valuation technique, as it takes into account the company's profitability, not just sales.

Question 3

The sustainable growth rate can be calculated by taking the dividend payout ratio time return on equity (ROE).

Accepted Answer

The sustainable growth rate can be calculated by taking the retention ratio (1 - dividend payout ratio) times return on equity (ROE).

Question 4

Future tax rates are difficult to estimate because they are politically influenced.

Accepted Answer

Future tax rates depend on government policies and political decisions. Since political decisions are influenced by various factors like economic conditions, public opinion, and political ideologies, estimating future tax rates is a challenging task.

Question 5

A major advantage of the cyclical indicator approach is that it spans all important major economic sectors, including the service sector and import-exports.

Accepted Answer

The cyclical indicator approach primarily focuses on economic indicators that reflect the overall economic activity, but it may not comprehensively cover all sectors, such as the service sector and import-exports, in detail.

Question 6

There is a negative relationship between the capacity utilization rate and the profit margin.

Accepted Answer

The capacity utilization rate measures the extent to which an enterprise or a nation uses its installed productive capacity. A higher capacity utilization rate often indicates a higher level of demand for a company's products or services, which can lead to higher sales volumes and potentially higher profit margins. Conversely, a lower capacity utilization rate can indicate weaker demand, potentially leading to lower sales and profit margins. However, the relationship is not inherently negative, as various factors, including operational efficiency, cost management, and market pricing, also significantly influence profit margins.

Question 7

In the present value of operating free cash flow technique, the firm's operating free cash flow to the firm is discounted at the firm's weighted average cost of capital (WACC).

Accepted Answer

The present value of operating free cash flow technique involves discounting the operating free cash flow to the firm at the firm's weighted average cost of capital (WACC). This reflects the cost of capital for the firm and the time value of money.

Question 8

An increase in the retention ratio will cause a decrease in the growth rate.

Accepted Answer

An increase in the retention ratio (the proportion of earnings not paid out as dividends) typically leads to an increase in the growth rate, as more earnings are reinvested into the company for future growth.

Question 9

The best-known measure of relative value for common stock is the P/E ratio.

Accepted Answer

The P/E ratio, or price-to-earnings ratio, is indeed the best-known measure of relative value for common stock. It is calculated by dividing the current market price per share by the earnings per share, and it is often used by investors to gauge how expensive or inexpensive a stock is compared to its earnings.

Question 10

Dividend growth is positively related to the return on equity.

Accepted Answer

Dividend growth is positively related to the return on equity. Companies with higher returns on equity are more likely to have a larger pool of profits to distribute as dividends, leading to higher dividend growth.

Question 11

The authors of the text prefer forward valuation ratios as opposed to historical valuation variables in relative valuation methods.

Accepted Answer

The statement clearly states that the authors prefer forward valuation ratios over historical valuation variables, indicating that A is the correct answer.

Question 12

It is reasonable to expect corporate sales to be closely related to GNP.

Accepted Answer

Gross National Product (GNP) measures the total value of goods and services produced by a country's residents, regardless of their location, over a specific period. Corporate sales reflect the revenue generated by the business through the sale of its products or services. Since the overall economic activity affects the demand for goods and services, GNP can be considered a significant indicator of the level of economic activity. Therefore, it is reasonable to expect that corporate sales will be closely related to GNP.

Question 13

As the market's return on equity increases so will the P/E ratio.

Accepted Answer

The price-to-earnings (P/E) ratio is a valuation metric used to determine how much investors are willing to pay per dollar of earnings generated by a company. A higher P/E ratio indicates that investors are more optimistic about the company's future earnings growth prospects. A company with a higher return on equity (ROE) is typically seen as a more profitable and efficient company, which can lead to higher earnings growth and therefore a higher P/E ratio. Therefore, as the market's return on equity increases, it is likely that the P/E ratio will also increase.

Question 14

Changes in the dividend payout ratio are positively related to changes in the retention rate.

Accepted Answer

The dividend payout ratio and retention rate are inversely related, meaning when one increases the other decreases. Therefore, changes in the dividend payout ratio are negatively related to changes in the retention rate.

Question 15

The price/cash flow ratio has grown in prominence and use for valuing firms because many analysts contend that a firm's cash flow is less subject to manipulation than the firm's earnings per share.

Accepted Answer

The statement is true. The price/cash flow ratio is considered a more reliable measure of a company's value because it reflects its true ability to generate cash and is less likely to be manipulated than earnings per share. Cash flow is considered a more accurate measure of a company's financial health since it takes into account non-cash transactions and does not include accounting adjustments. As a result, many analysts and investors prefer to use the price/cash flow ratio rather than the price/earnings ratio to value firms.

Question 16

Estimating net profit margin directly is difficult because it is so volatile.

Accepted Answer

Net profit margin can be affected by various factors such as changes in pricing, cost of goods sold, expenses, or taxes. These factors can fluctuate greatly over time, making it difficult to estimate the net profit margin accurately.

Question 17

Present value of free cash flow to equity resembles the present value of earnings concept except that it includes the capital expenditures required to maintain and grow the firm and the change in working capital required for a growing firm.

Accepted Answer

The statement is true. The present value of free cash flow to equity takes into account the capital expenditures and changes in working capital required to maintain and grow the firm, along with the present value of expected earnings. This approach helps investors and analysts assess a company's ability to generate cash flows in the future and create shareholder value over the long term.

Question 18

When estimating a major stock market value using the earnings multiplier approach, near-term estimates of the required rate of return and growth rate are essential due to the impact of near-term events on cash flows.

Accepted Answer

The answer of When estimating a major stock market value...

Question 19

The constant growth dividend growth model is not appropriate for the valuation of growth companies.

Accepted Answer

The constant dividend growth model assumes a steady growth rate in perpetuity, which is not realistic for growth companies that can experience volatile and fluctuating growth rates. Therefore, alternative valuation methods such as discounted cash flow analysis may be more appropriate for these types of companies.

Question 20

Price-to-book value ratio cannot be used to estimate the value of firms with negative earnings or negative cash flows.

Accepted Answer

The price-to-book value ratio is based on a company's market capitalization divided by its book value, and it can be used regardless of a company's earnings or cash flow status, as it does not directly relate to profitability.

Quiz 9: The Top-Down Approach to Market, Industry, and Company Analysis