Question 1

Zorba's is a small chain of restaurants whose stock is not publicly traded. The average P/E ratio for similar restaurant chains is 16.5; the P/E ratio for the S&P 500 Index is 15.2. This year's earnings were $1.21 per share and next year's earnings are forecasted at $1.46 per share. A reasonable price for a share of Zorba's stock is
A) $24.
B) $20.
C) $18.
D) $16.

Accepted Answer

To calculate the reasonable price of Zorba's stock, we can use the formula:
Price per share = Earnings per share * P/E ratio

This year's earnings per share (EPS) for Zorba's is $1.21. Next year's forecasted EPS is $1.46. We will use the average P/E ratio for similar restaurant chains, which is 16.5.

Using the formula, we can find the reasonable price per share:
Price per share = $1.46 * 16.5 = $24.09 (rounded to the nearest cent)

Therefore, the best choice is A) $24.

Question 2

The stock valuation model D1/(Rc - g) requires Rc > G.

Accepted Answer

This is true because if the required rate of return (Rc) is less than the dividend growth rate (g), the formula would result in a negative or zero value, which does not make sense for stock valuation purposes. Therefore, Rc needs to be greater than g in order for the formula to provide a meaningful result.

Question 3

Stock valuation is more precise than bond valuation as stock cash flows are more certain.

Accepted Answer

Bond valuation is generally considered to be more precise than stock valuation as bond cash flows are usually more predictable and have a set maturity date. Stock cash flows, on the other hand, are not guaranteed and can fluctuate based on market conditions and company performance. Therefore, stock valuation involves a greater level of uncertainty and is typically harder to predict accurately.

Question 4

Home Depot stock is currently selling for $136 per share. Next year's dividend is expected to be $3.31; next year's earnings per share are expected to be $6.55. Home Depot's P/E ratio is
A) .048.
B) 22.03.
C) 20.75
D) 41.08

Accepted Answer

First we need to calculate the P/E ratio using the formula P/E = Market Price per share / Earnings per share.

P/E = $136 / $6.55 = 20.76

Therefore, the P/E ratio is 20.75 (rounded to two decimal places).

Question 5

Is the following common stock priced correctly? If no, what is the correct price?
Price = $26.25
Required rate of return = 13%
Dividend year 0 = $2.00
Dividend year 1 = $2.10

Accepted Answer

The answer of Is the following common stock priced correctly?...

Question 6

If a stock has a much higher than normal P/E ratio, investors probably expect
A) slow growth in earnings.
B) rapid growth in earnings.
C) large increases in the price of the stock.
D) a declining stock price

Accepted Answer

A high P/E ratio typically indicates that investors expect earnings to grow rapidly in the future. Therefore, option B is the best choice.

Question 7

The GAP's most recent earnings per share were $1.75. Analysts forecast next year's earnings per share at $1.88. If the appropriate P/E ratio is 15, a share of GAP stock should be valued at
A) $28.20.
B) $26.25.
C) $27.23.
D) $8.57.

Accepted Answer

The value of a share of GAP stock, based on the forecasted earnings per share and the P/E ratio, is calculated by multiplying the forecasted earnings per share ($1.88) by the P/E ratio (15). This results in $1.88 * 15 = $28.20.

Question 8

Tannerly Worldwide's common stock is currently selling for $48 a share. If the expected dividend at the end of the year is $2.40 and last year's dividend was $2.00, what is the rate of return implicit in the current stock price?

Accepted Answer

The answer of Tannerly Worldwide's common stock is currently selling...

Question 9

You can purchase one share of Sumter Company common stock for $80 today. You expect the price of the common stock to increase to $85 per share in one year. The company pays an annual dividend of $3.00 per share. What is your expected rate of return for Sumter stock?

Accepted Answer

The answer of You can purchase one share of Sumter...

Question 10

If the ROE on a new investment is less than the firm's required rate of return
A) the investment increases the firm's value.
B) the investment leaves the firm's value unchanged.
C) the effect on the firm's value is unpredictable.
D) the investment reduces the firm's value.

Accepted Answer

If the ROE on a new investment is less than the firm's required rate of return, it means the investment is not generating enough return to justify the cost of the investment. This results in a negative net present value, indicating that the investment will reduce the firm's overall value. Therefore, the correct answer is D.

Question 11

You are considering the purchase of AMDEX Company stock. You anticipate that the company will pay dividends of $2.00 per share next year and $2.25 per share the following year. You believe that you can sell the stock for $17.50 per share two years from now. If your required rate of return is 12%, what is the maximum price that you would pay for a share of AMDEX Company stock?

Accepted Answer

The answer of You are considering the purchase of AMDEX...

Question 12

The P/E ratio is calculated by dividing
A) the current stock price by stockholders' equity.
B) total assets by net income.
C) the current stock price by earnings per share.
D) the current stock price by operating cash flow per share.

Accepted Answer

The P/E (Price-to-Earnings) ratio is calculated by dividing the current stock price by earnings per share, which represents the amount of earnings attributable to each share of stock. This ratio is commonly used to evaluate the valuation of a company's stock and how much investors are willing to pay for each dollar of earnings. Options A, B, and D do not accurately reflect the calculation of the P/E ratio.

Question 13

Cumulative voting allows a shareholder to cast all of his or her votes for one director rather than voting on each director separately.

Accepted Answer

Cumulative voting is a method of voting in which a shareholder can choose to concentrate all of his or her votes for one candidate or distribute them among several candidates. This allows minority shareholders to have a better chance of electing representatives to the board of directors.

Question 14

The retail analyst at Morgan-Sachs values stock of the GAP at $38.00 per share. They are using the average industry "forward" P/E ratio of 17. Their forecasted earnings per share for next year is
A) $0.54.
B) $1.50.
C) $2.24
D) There is not enough information calculate earnings per share.

Accepted Answer

To calculate the forecasted earnings per share for next year, we need to use the formula:

Earnings per share = Stock Price / P/E Ratio

Using the given information, we can plug in the values:

Earnings per share = $38.00 / 17
Earnings per share = $2.24

Therefore, the forecasted earnings per share for next year is $2.24.

Question 15

Which of the following factors will influence a firm's P/E ratio?
A) The investors' required rate of return
B) Firm investment opportunities
C) General market conditions
D) All of the above

Accepted Answer

All of the above factors influence a firm's P/E ratio. Investors' required rate of return affects the earnings portion of the ratio, firm investment opportunities affect the growth potential of the company, and general market conditions will affect both earnings and growth potential.

Question 16

Draper Company's common stock paid a dividend last year of $3.70. You believe that the long-term growth in the dividends of the firm will be 8% per year. If your required return for Draper is 14%, how much are you willing to pay for the stock?

Accepted Answer

The answer of Draper Company's common stock paid a dividend...

Question 17

McDonald's stock currently sells for $123. It's expected earnings per share are $5.12. The average P/E ratio for the industry is 24. If investors expected the same growth rate and risk for McDonald's as for an average firm in the same industry, it's stock price would
A) stay about the same.
B) rise.
C) fall.
D) there is not enough information.

Accepted Answer

The correct answer is A.The P/E ratio is a measure of how much investors are willing to pay for a share of a company's stock relative to its earnings per share. The average P/E ratio for the industry is 24, which means that investors are willing to pay $24 for every $1 of earnings per share. If investors expected the same growth rate and risk for McDonald's as for an average firm in the same industry, then they would be willing to pay the same P/E ratio for McDonald's stock. This means that McDonald's stock price would stay about the same.

Question 18

The common stock of Cranberry, Inc. is selling for $26.75 on the open market. A dividend of $3.68 is expected to be distributed, and the growth rate of this company is estimated to be 5.5%. If Richard Dean, an average investor, is considering purchasing this stock at the market price, what is his expected rate of return?

Accepted Answer

The answer of The common stock of Cranberry, Inc. is...

Question 19

The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.

Accepted Answer

This statement is true according to the theory of efficient markets, which assumes that market prices reflect all available information and that investors are rational and risk-averse. If the market price is lower than the required rate of return, investors will rush to buy the stock, driving up the price and lowering the expected rate of return. Conversely, if the market price is higher than the required rate of return, investors will sell the stock, driving down the price and raising the expected rate of return. At the margin, where the next investor can choose to buy or not buy the stock, the expected rate of return equals the required rate of return.

Question 20

Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1 and grows at a rate of 5%.

Accepted Answer

The answer of Determine the rate of return on a...

Quiz 10: Stock Valuation

The stock valuation model D1/(Rc - g) requires Rc > G.

Stock valuation is more precise than bond valuation as stock cash flows are more certain.

Home Depot stock is currently selling for $136 per share. Next year's dividend is expected to be $3.31; next year's earnings per share are expected to be $6.55. Home Depot's P/E ratio is

Is the following common stock priced correctly? If no, what is the correct price? Price = $26.25 Required rate of return = 13% Dividend year 0 = $2.00 Dividend year 1 = $2.10

If a stock has a much higher than normal P/E ratio, investors probably expect

The GAP's most recent earnings per share were $1.75. Analysts forecast next year's earnings per share at $1.88. If the appropriate P/E ratio is 15, a share of GAP stock should be valued at

Tannerly Worldwide's common stock is currently selling for $48 a share. If the expected dividend at the end of the year is $2.40 and last year's dividend was $2.00, what is the rate of return implicit in the current stock price?

You can purchase one share of Sumter Company common stock for $80 today. You expect the price of the common stock to increase to $85 per share in one year. The company pays an annual dividend of $3.00 per share. What is your expected rate of return for Sumter stock?

If the ROE on a new investment is less than the firm's required rate of return

The P/E ratio is calculated by dividing

Cumulative voting allows a shareholder to cast all of his or her votes for one director rather than voting on each director separately.

The retail analyst at Morgan-Sachs values stock of the GAP at $38.00 per share. They are using the average industry "forward" P/E ratio of 17. Their forecasted earnings per share for next year is

Which of the following factors will influence a firm's P/E ratio?

Draper Company's common stock paid a dividend last year of $3.70. You believe that the long-term growth in the dividends of the firm will be 8% per year. If your required return for Draper is 14%, how much are you willing to pay for the stock?

McDonald's stock currently sells for $123. It's expected earnings per share are $5.12. The average P/E ratio for the industry is 24. If investors expected the same growth rate and risk for McDonald's as for an average firm in the same industry, it's stock price would

The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.

Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1 and grows at a rate of 5%.