Chapter 18 Flashcards by Matt Mitchell

________ is equal to the total market value of the firm’s common stock divided by (the replacement cost of the firm’s assets less liabilities).

A. Book value per share

B. Liquidation value per share

C. Market value per share

D. Tobin’s Q

E. None of the options

D. Tobin’s Q

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High P/E ratios tend to indicate that a company will _______, ceteris paribus.

A. grow quickly

B. grow at the same speed as the average company

C. grow slowly

D. not grow

E. None of the options

A. grow quickly

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_________ is equal to (common shareholders’ equity/common shares outstanding).

A. Book value per share

B. Liquidation value per share

C. Market value per share

D. Tobin’s Q

A. Book value per share

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________ are analysts who use information concerning current and prospective profitability of a firm to assess the firm’s fair market value.

A. Credit analysts

B. Fundamental analysts

C. Systems analysts

D. Technical analysts

E. Specialists

B. Fundamental analysts

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The _______ is defined as the present value of all cash proceeds to the investor in the stock.

A. dividend payout ratio

B. intrinsic value

C. market capitalization rate

D. plowback ratio

B. intrinsic value

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_______ is the amount of money per common share that could be realized by breaking up the firm, selling the assets, repaying the debt, and distributing the remainder to shareholders.

A. Book value per share

B. Liquidation value per share

C. Market value per share

D. Tobin’s Q

B. Liquidation value per share

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Since 1955, Treasury bond yields and earnings yields on stocks were

A. identical.

B. negatively correlated.

C. positively correlated.

D. uncorrelated.

C. positively correlated

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Historically, P/E ratios have tended to be

A. higher when inflation has been high.

B. lower when inflation has been high.

C. uncorrelated with inflation rates but correlated with other macroeconomic variables.

D. uncorrelated with any macroeconomic variables including inflation rates.

B. lower when inflation has been high

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The ______ is a common term for the market consensus value of the required return on a stock.

A. dividend payout ratio

B. intrinsic value

C. market capitalization rate

D. plowback rate

E. None of the options

C. market capitalisation rate

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The _________ is the fraction of earnings reinvested in the firm.

A. dividend payout ratio

B. retention rate

C. plowback ratio

D. dividend payout ratio and plowback ratio

E. retention rate and plowback ratio

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The Gordon model

A. is a generalization of the perpetuity formula to cover the case of a growing perpetuity.

B. is valid only when g is less than k.

C. is valid only when k is less than g.

D. is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when g is less than k.

E. is a generalization of the perpetuity formula to cover the case of a growing perpetuity and is valid only when k is less than g.

D. is a generalisation of the perpetuity formula to cover the case of a growing perpetuity and is valid only when g is less than k

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You wish to earn a return of 13% on each of two stocks, X and Y. Stock X is expected to pay a dividend of $3 in the upcoming year while stock Y is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock X

A. will be greater than the intrinsic value of stock Y.

B. will be the same as the intrinsic value of stock Y.

C. will be less than the intrinsic value of stock Y.

D. will be the same or greater than the intrinsic value of stock Y.

E. None of the options

C. will be less than the intrinsic value of stock Y

PV0 = D1/(k - g); given k and g are equal, the stock with the larger dividend will have the higher value.

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You wish to earn a return of 11% on each of two stocks, C and D. Stock C is expected to pay a dividend of $3 in the upcoming year while stock D is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends for both stocks is 7%. The intrinsic value of stock C

A. will be greater than the intrinsic value of stock D.

B. will be the same as the intrinsic value of stock D.

C. will be less than the intrinsic value of stock D.

D. will be the same or greater than the intrinsic value of stock D.

E. None of the options.

C. will be less than the intrinsic value of stock D

PV0 = D1/(k - g); given k and g are equal, the stock with the larger dividend will have the higher value.

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You wish to earn a return of 12% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock A and 10% for stock B. The intrinsic value of stock A

A. will be greater than the intrinsic value of stock B.

B. will be the same as the intrinsic value of stock B.

C. will be less than the intrinsic value of stock B.

D. will be the same or greater than the intrinsic value of stock B.

E. None of the options

C. will be less than the intrinsic value of stock B

PV0 = D1/(k - g); given k and g are equal, the stock with the larger dividend will have the higher value.

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You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C

A. will be greater than the intrinsic value of stock D.

B. will be the same as the intrinsic value of stock D.

C. will be less than the intrinsic value of stock D.

D. will be the same or greater than the intrinsic value of stock D.

E. None of the options

C. will be less than the intrinsic value of stock D

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Each of two stocks, A and B, are expected to pay a dividend of $5 in the upcoming year. The expected growth rate of dividends is 10% for both stocks. You require a rate of return of 11% on stock A and a return of 20% on stock B. The intrinsic value of stock A

A. will be greater than the intrinsic value of stock B.

B. will be the same as the intrinsic value of stock B.

C. will be less than the intrinsic value of stock B.

D. cannot be calculated without knowing the market rate of return.

A. will be greater than the intrinsic value of stock B

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Each of two stocks, C and D, are expected to pay a dividend of $3 in the upcoming year. The expected growth rate of dividends is 9% for both stocks. You require a rate of return of 10% on stock C and a return of 13% on stock D. The intrinsic value of stock C

A. will be greater than the intrinsic value of stock D.

B. will be the same as the intrinsic value of stock D.

C. will be less than the intrinsic value of stock D.

D. cannot be calculated without knowing the market rate of return.

A. will be greater than the intrinsic value of stock D

PV0 = D1/(k - g); given k and g are equal, the stock with the larger dividend will have the higher value.

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If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces to

A. V0 = (Expected dividend yield in year 1)/k.

B. V0 = (Expected EPS in year 1)/k.

C. V0 = (Treasury bond yield in year 1)/k.

D. V0 = (Market return in year 1)/k.

B. V0 = (Expected EPS in year 1) / k

If ROE = k, no growth is occurring; b = 0; EPS = DPS.

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Low Tech Company has an expected ROE of 10%. The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends.

A. 6.0%

B. 4.8%

C. 7.2%

D. 3.0%

A. 6.0 %

10% x 0.60

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Music Doctors Company has an expected ROE of 14%. The dividend growth rate will be ________ if the firm follows a policy of paying 60% of earnings in the form of dividends.

A. 4.8%

B. 5.6%

C. 7.2%

D. 6.0%

B. 5.6%

14% x 0.40

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Medtronic Company has an expected ROE of 16%. The dividend growth rate will be ________ if the firm follows a policy of paying 70% of earnings in the form of dividends.

A. 3.0%

B. 6.0%

C. 7.2%

D. 4.8%

16% x 0.30

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High Speed Company has an expected ROE of 15%. The dividend growth rate will be ________ if the firm follows a policy of paying 50% of earnings in the form of dividends.

A. 3.0%

B. 4.8%

C. 7.5%

D. 6.0%

C. 7.5%

15% x 0.50

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Light Construction Machinery Company has an expected ROE of 11%. The dividend growth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends.

A. 3.0%

B. 4.8%

C. 8.25%

D. 9.0%

C. 8.25%

11% x 0/75

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Xlink Company has an expected ROE of 15%. The dividend growth rate will be _______ if the firm follows a policy of plowing back 75% of earnings.

A. 3.75%

B. 11.25%

C. 8.25%

D. 15.0%

B. 11.25%

15% x 0.75

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Think Tank Company has an expected ROE of 26%. The dividend growth rate will be _______ if the firm follows a policy of plowing back 90% of earnings. A. 2.6% B. 10% C. 23.4% D. 90%

C. 23.4% 26% x 0.90

Bubba Gumm Company has an expected ROE of 9%. The dividend growth rate will be _______ if the firm follows a policy of plowing back 10% of earnings. A. 90% B. 10% C. 9% D. 0.9%

D. 09% 9% x 0.10

A preferred stock will pay a dividend of $2.75 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $0.275 B. $27.50 C. $31.82 D. $56.25

B. $27.50 2.75 / 0.10

A preferred stock will pay a dividend of $3.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 9% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $33.33 B. $0.27 C. $31.82 D. $56.25

A. $33.33 3.00/0.09

A preferred stock will pay a dividend of $1.25 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 12% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $11.56 B. $9.65 C. $11.82 D. $10.42

D. $10.42 1.25/0.12

A preferred stock will pay a dividend of $3.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 11% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $0.39 B. $0.56 C. $31.82 D. $56.25

C. $31.82 3.50 / 0.11

A preferred stock will pay a dividend of $7.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $0.75 B. $7.50 C. $64.12 D. $56.25 E. None of the options

E. None of the options 7.5 / 0.10

A preferred stock will pay a dividend of $6.00 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. A. $0.60 B. $6.00 C. $600 D. $60.00 E. None of the options

D. $60.00 6/0.10

You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return. A. $30.23 B. $24.11 C. $26.52 D. $27.50 E. None of the options

A. $30.23 .10 = (32 - P + 1.25)/P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.

You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $0.75 in dividends and $16 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 12% return. A. $23.91 B. $14.96 C. $26.52 D. $27.50 E. None of the options

B. $14.96 .12 = (16 - P + 0.75)/P; .12P = 16 - P + 0.75; 1.12P = 16.75; P = 14.96

You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $2.50 in dividends and $28 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 15% return. A. $23.91 B. $24.11 C. $26.52 D. $27.50 E. None of the options

C. $26.52 .15 = (28 - P + 2.50)/P; .15P = 28 - P + 2.50; 1.15P = 30.50; P = 26.52.

You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $3.50 in dividends and $42 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return. A. $23.91 B. $24.11 C. $26.52 D. $27.50 E. None of the options

E. None of the options .10 = (42 - P + 3.50)/P; .10P = 42 - P + 3.50; 1.1P = 45.50; P = 41.36.

Paper Express Company has a balance sheet which lists $85 million in assets, $40 million in liabilities, and $45 million in common shareholders' equity. It has 1,400,000 common shares outstanding. The replacement cost of the assets is $115 million. The market share price is $90. What is Paper Express's book value per share? A. $1.68 B. $2.60 C. $32.14 D. $60.71 E. None of the options

C. $32.14 $45M/1.4M = $32.14.

Paper Express Company has a balance sheet which lists $85 million in assets, $40 million in liabilities, and $45 million in common shareholders' equity. It has 1,400,000 common shares outstanding. The replacement cost of the assets is $115 million. The market share price is $90. What is Paper Express's market value per share? A. $1.68 B. $2.60 C. $32.14 D. $60.71 E. None of the options

E. None of the options The price of $90

One of the problems with attempting to forecast stock market values is that A. there are no variables that seem to predict market return. B. the earnings multiplier approach can only be used at the firm level. C. the level of uncertainty surrounding the forecast will always be quite high. D. dividend payout ratios are highly variable. E. None of the options

C. the level of uncertainty surrounding the forecast will always be quite high

The most popular approach to forecasting the overall stock market is to use A. the dividend multiplier. B. the aggregate return on assets. C. the historical ratio of book value to market value. D. the aggregate earnings multiplier. E. Tobin's Q.

D. the aggregate earnings multiplier

Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25. The market's required rate of return on Sure's stock is A. 14.0%. B. 17.5%. C. 16.5%. D. 15.25%. E. None of the options

C. 16.5% 4% + 1.25(14% - 4%) = 16.5%.

Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25. What is the intrinsic value of Sure's stock today? A. $20.60 B. $20.00 C. $12.12 D. $22.00

A. $20.60 k = .04 + 1.25 (.14 - .04); k = .165; .165 = (22 - P + 2)/P; .165P = 24 - P; 1.165P = 24 ; P = 20.60.

If Sure's intrinsic value is $21.00 today, what must be its growth rate? A. 0.0% B. 10% C. 4% D. 6% E. 7%

E. 7% k = .04 + 1.25 (.14 - .04); k = .165; .165 = 2/21 + g; g = .07.

Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2. What is the return you should require on Torque's stock? A. 12.0% B. 14.6% C. 15.6% D. 20% E. None of the options

B. 14.6% 5% + 1.2(13% - 5%) = 14.6%.

Torque Corporation is expected to pay a dividend of $1.00 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The stock of Torque Corporation has a beta of 1.2. What is the intrinsic value of Torque's stock? A. $14.29 B. $14.60 C. $12.33 D. $11.62

D. $11.62 k = 5% + 1.2(13% - 5%) = 14.6%; P = 1/(.146 - .06) = $11.62

Midwest Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Midwest Airline has a beta of 3.00. The return you should require on the stock is A. 10%. B. 18%. C. 30%. D. 42%.

C. 30% 6% + 3(14% - 6%) = 30%.

Fools Gold Mining Company is expected to pay a dividend of $8 in the upcoming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Fools Gold Mining Company has a beta of -0.25. The return you should require on the stock is A. 2%. B. 4%. C. 6%. D. 8%.

B. 4% 6% + [-0.25(14% - 6%)] = 4%.

High Tech Chip Company is expected to have EPS in the coming year of $2.50. The expected ROE is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 70%, the growth rate of dividends should be A. 5.00%. B. 6.25%. C. 6.60%. D. 7.50%. E. 8.75%.

E. 8.75% 12.5% × 0.7 = 8.75%.

A company paid a dividend last year of $1.75. The expected ROE for next year is 14.5%. An appropriate required return on the stock is 10%. If the firm has a plowback ratio of 75%, the dividend in the coming year should be A. $1.80. B. $2.12. C. $1.77. D. $1.94.

D. $1.94. g = .145 × .75 = 10.875%; $1.75(1.10875) = $1.94

High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be A. $1.00. B. $2.50. C. $2.69. D. $2.81. E. None of the options

C. $2.69 g = .125 × .6 = 7.5%; $2.50(1.075) = $2.69.

Suppose that the average P/E multiple in the oil industry is 20. Dominion Oil is expected to have an EPS of $3.00 in the coming year. The intrinsic value of Dominion Oil stock should be A. $28.12. B. $35.55. C. $60.00. D. $72.00. E. None of the options

C. $60.00 20 × $3.00 = $60.00.

Suppose that the average P/E multiple in the oil industry is 22. Exxon is expected to have an EPS of $1.50 in the coming year. The intrinsic value of Exxon stock should be A. $33.00. B. $35.55. C. $63.00. D. $72.00. E. None of the options

A. $33.00 22 x $1.50

Suppose that the average P/E multiple in the oil industry is 16. Shell Oil is expected to have an EPS of $4.50 in the coming year. The intrinsic value of Shell Oil stock should be A. $28.12. B. $35.55. C. $63.00. D. $72.00. E. None of the options

D. $72.00 16 x $4.50

Suppose that the average P/E multiple in the gas industry is 17. KMP is expected to have an EPS of $5.50 in the coming year. The intrinsic value of KMP stock should be A. $28.12. B. $93.50. C. $63.00. D. $72.00. E. None of the options

B. $93.50 17 x $5.50

An analyst has determined that the intrinsic value of HPQ stock is $20 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it would be reasonable to assume the expected EPS of HPQ in the coming year is A. $3.63. B. $4.44. C. $0.80. D. $22.50.

C. $0.80 $20(1/25) = $0.80.

An analyst has determined that the intrinsic value of Dell stock is $34 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 27, then it would be reasonable to assume the expected EPS of Dell in the coming year will be A. $3.63. B. $4.44. C. $14.40. D. $1.26.

D. $1.26 $34(1/27) = $1.26.

An analyst has determined that the intrinsic value of IBM stock is $80 per share using the capitalized earnings model. If the typical P/E ratio in the computer industry is 22, then it would be reasonable to assume the expected EPS of IBM in the coming year is A. $3.64. B. $4.44. C. $14.40. D. $22.50.

A. $3.64 $80(1/22) = $3.64.

Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the coming year. Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Old Quartz Gold Mining Company has a beta of -0.25. The intrinsic value of the stock is A. $80.00. B. $133.33. C. $200.00. D. $400.00.

B. $133.33 k = 6% + [-0.25(14% - 6%)] = 4%; P = 8/[.04 - (-.02)] = $133.33.

Low Fly Airline is expected to pay a dividend of $7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Low Fly Airline has a beta of 3.00. The intrinsic value of the stock is A. $46.67. B. $50.00. C. $56.00. D. $62.50.

A. $46.67 6% + 3(14% - 6%) = 30%; P = 7/(.30 - .15) = $46.67.

Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation has a beta of 0.75. The intrinsic value of the stock is A. $10.71. B. $15.00. C. $17.75. D. $25.00.

D. $25.00 6% + 0.75(14% - 6%) = 12%; P = 1.50/(.12 - .06) = $25

Low Tech Chip Company is expected to have EPS of $2.50 in the coming year. The expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a dividend payout ratio of 40%, the intrinsic value of the stock should be A. $22.73. B. $27.50. C. $28.57. D. $38.46.

D. $38.46 g = 14% × 0.6 = 8.4%; Expected DPS = $2.50(0.4) = $1.00; P = 1/(.11 - .084) = $38.46

Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year. Dividends are expected to grow at a rate of 10% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The stock is trading in the market today at a price of $90.00. What is the market capitalization rate for Risk Metrics? A. 13.6% B. 13.9% C. 15.6% D. 16.9% E. None of the options

B. 13.9% k = 3.50/90 + .10; k = 13.9%.

Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year. Dividends are expected to grow at a rate of 10% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. The stock is trading in the market today at a price of $90.00. What is the approximate beta of Risk Metrics's stock? A. 0.8 B. 1.0 C. 1.1 D. 1.4 E. None of the options

C. 1.1 k = 13.9%; 13.9 = 5% + b(13% - 5%) = 1.11.

The market capitalization rate on the stock of Flexsteel Company is 12%. The expected ROE is 13% and the expected EPS are $3.60. If the firm's plowback ratio is 50%, the P/E ratio will be A. 7.69. B. 8.33. C. 9.09. D. 11.11. E. None of the options

B. 9.09 g = 13% × 0.5 = 6.5%; .5/(.12 - .065) = 9.09.

The market capitalization rate on the stock of Flexsteel Company is 12%. The expected ROE is 13% and the expected EPS are $3.60. If the firm's plowback ratio is 75%, the P/E ratio will be A. 7.69. B. 8.33. C. 9.09. D. 11.11. E. None of the options

D. 11.11 g = 13% × 0.75 = 9.75%; .25/(.12 - .0975) = 11.11

The market capitalization rate on the stock of Fast Growing Company is 20%. The expected ROE is 22% and the expected EPS are $6.10. If the firm's plowback ratio is 90%, the P/E ratio will be A. 7.69. B. 8.33. C. 9.09. D. 11.11. E. 50.

E. 50 g = 22% × 0.90 = 19.8%; .1/(.20 - .198) = 50

JCPenney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of $1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A. $33.00 B. $40.67 C. $71.80 D. $66.00 E. None of the options

C. $71.80

Exercise Bicycle Company is expected to pay a dividend in year 1 of $1.20, a dividend in year 2 of $1.50, and a dividend in year 3 of $2.00. After year 3, dividends are expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth _______ today. A. $33.00 B. $39.86 C. $55.00 D. $66.00 E. $40.68

E. $40.68

Antiquated Products Corporation produces goods that are very mature in their product life cycles. Antiquated Products Corporation is expected to pay a dividend in year 1 of $1.00, a dividend of $0.90 in year 2, and a dividend of $0.85 in year 3. After year 3, dividends are expected to decline at a rate of 2% per year. An appropriate required rate of return for the stock is 8%. The stock should be worth A. $8.98. B. $10.57. C. $20.00. D. $22.22.

A. $8.98

Mature Products Corporation produces goods that are very mature in their product life cycles. Mature Products Corporation is expected to pay a dividend in year 1 of $2.00, a dividend of $1.50 in year 2, and a dividend of $1.00 in year 3. After year 3, dividends are expected to decline at a rate of 1% per year. An appropriate required rate of return for the stock is 10%. The stock should be worth A. $9.00. B. $10.57. C. $20.00. D. $22.22.

A. $10.57

Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The projected free cash flow of Utica Manufacturing Company for the coming year is A. $150,000. B. $180,000. C. $300,000. D. $380,000.

B. $180,000

Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The total value of the equity of Utica Manufacturing Company should be A. $1,000,000. B. $2,000,000. C. $3,000,000. D. $4,000,000.

B. $2,000,000 Projected free cash flow = $180,000; V0 = 180,000/(.15 - .06) = $2,000,000.

A firm's earnings per share increased from $10 to $12, dividends increased from $4.00 to $4.80, and the share price increased from $80 to $90. Given this information, it follows that A. the stock experienced a drop in the P/E ratio. B. the firm had a decrease in dividend payout ratio. C. the firm increased the number of shares outstanding. D. the required rate of return decreased.

A. the stock experienced a drop in the P/E ratio $80/$10 = 8; $90/$12 = 7.5

In the dividend discount model, which of the following are not incorporated into the discount rate? A. Real risk-free rate B. Risk premium for stocks C. Return on assets D. Expected inflation rate

C. Return on assets

A company whose stock is selling at a P/E ratio greater than the P/E ratio of a market index most likely has A. an anticipated earnings growth rate which is less than that of the average firm. B. a dividend yield which is less than that of the average firm. C. less predictable earnings growth than that of the average firm. D. greater cyclicality of earnings growth than that of the average firm.

B. a dividend yield which is less than that of the average firm

Other things being equal, a low ________ would be most consistent with a relatively high growth rate of firm earnings and dividends. A. dividend payout ratio B. degree of financial leverage C. variability of earnings D. inflation rate

A. dividend payout ratio

A firm has a return on equity of 14% and a dividend payout ratio of 60%. The firm's anticipated growth rate is A. 5.6%. B. 10%. C. 14%. D. 20%.

A. 5.6% 14% x 0.40

A firm has a return on equity of 20% and a dividend payout ratio of 30%. The firm's anticipated growth rate is A. 6%. B. 10%. C. 14%. D. 20%.

C. 14% 20% x 0.70

Sales Company paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of earnings as dividends for the foreseeable future. If the firm is expected to generate a 10% return on equity in the future, and if you require a 12% return on the stock, the value of the stock is A. $17.67. B. $13.00. C. $16.67. D. $18.67.

A. $17.67 g = 10% × 0.6 = 6%; P = 1 (1.06)/(.12 - .06) = $17.67.

Assume that Bolton Company will pay a $2.00 dividend per share next year, an increase from the current dividend of $1.50 per share that was just paid. After that, the dividend is expected to increase at a constant rate of 5%. If you require a 12% return on the stock, the value of the stock is A. $28.57. B. $28.79. C. $30.00. D. $31.78. E. None of the options

A. $28.57 P1 = 2 (1.05)/(.12 - .05) = $30.00; PV of P1 = $30/1.12 = $26.78; PV of D1 = 2/1.12 = 1.79; PO = $26.78 + $1.79 = $28.57.

The growth in dividends of Music Doctors, Inc. is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years; after this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on Music Doctors, Inc. is 11%. Last year's dividends per share were $2.75. What should the stock sell for today? A. $8.99 B. $25.21 C. $39.71 D. $110.00 E. None of the options

C. $39.71

The growth in dividends of ABC, Inc. is expected to be 15% per year for the next three years, followed by a growth rate of 8% per year for two years; after this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on ABC, Inc. is 13%. Last year's dividends per share were $1.85. What should the stock sell for today? A. $8.99 B. $25.21 C. $40.00 D. $27.74 E. None of the options

D. $27.74

The growth in dividends of XYZ, Inc. is expected to be 10% per year for the next two years, followed by a growth rate of 5% per year for three years; after this five-year period, the growth in dividends is expected to be 2% per year, indefinitely. The required rate of return on XYZ, Inc. is 12%. Last year's dividends per share were $2.00. What should the stock sell for today? A. $8.99 B. $25.21 C. $40.00 D. $110.00 E. None of the options

B. $25.21

If a firm has a required rate of return equal to the ROE A. the firm can increase market price and P/E by retaining more earnings. B. the firm can increase market price and P/E by increasing the growth rate. C. the amount of earnings retained by the firm does not affect market price or the P/E. D. the firm can increase market price and P/E by retaining more earnings and increasing the growth rate. E. None of the options

C. the amount of earnings retained by the firm does not affect market price or the P/E

According to James Tobin, the long run value of Tobin's Q should tend toward A. 0. B. 1. C. 2. D. infinity. E. None of the options

B. 1

The goal of fundamental analysts is to find securities A. whose intrinsic value exceeds market price. B. with a positive present value of growth opportunities. C. with high market capitalization rates. D. All of the options E. None of the options

A. whose intrinsic value exceed market price

The dividend discount model A. ignores capital gains. B. incorporates the after-tax value of capital gains. C. includes capital gains implicitly. D. restricts capital gains to a minimum. E. None of the options

C. includes capital gains implicity

Many stock analysts assume that a mispriced stock will A. immediately return to its intrinsic value. B. return to its intrinsic value within a few days. C. never return to its intrinsic value. D. gradually approach its intrinsic value over several years. E. None of the options

D. gradually approach its intrinsic value over several years

Investors want high plowback ratios A. for all firms. B. whenever ROE > k. C. whenever k > ROE. D. only when they are in low tax brackets. E. whenever bank interest rates are high.

B. whenever ROE > k

Because the DDM requires multiple estimates, investors should A. carefully examine inputs to the model. B. perform sensitivity analysis on price estimates. C. not use this model without expert assistance. D. feel confident that DDM estimates are correct. E. carefully examine inputs to the model and perform sensitivity analysis on price estimates.

E. carefully examine inputs to the model and perform sensitivity analysis on price estimates

According to Peter Lynch, a rough rule of thumb for security analysis is that A. the growth rate should be equal to the plowback rate. B. the growth rate should be equal to the dividend payout rate. C. the growth rate should be low for emerging industries. D. the growth rate should be equal to the P/E ratio. E. None of the options

D. the growth rate should be equal to the P/E ratio

For most firms, P/E ratios and risk A. will be directly related. B. will have an inverse relationship. C. will be unrelated. D. will both increase as inflation increases.

B. will have an inverse relationship

Dividend discount models and P/E ratios are used by __________ to try to find mispriced securities. A. technical analysts B. statistical analysts C. fundamental analysts D. dividend analysts E. psychoanalysts

C. fundamental analysts

Which of the following is the best measure of the floor for a stock price? A. Book value B. Liquidation value C. Replacement cost D. Market value E. Tobin's Q

B. Liquidation value

Who popularized the dividend discount model, which is sometimes referred to by his name? A. Burton Malkiel B. Frederick Macaulay C. Harry Markowitz D. Marshall Blume E. Myron Gordon

E. Myron Gordon

If a firm follows a low-investment-rate plan (applies a low plowback ratio), its dividends will be _______ now and _______ in the future than a firm that follows a high-reinvestment-rate plan. A. higher; higher B. lower; lower C. lower; higher D. higher; lower E. It is not possible to tell.

D. higher; lower

The present value of growth opportunities (PVGO) is equal to I) the difference between a stock's price and its no-growth value per share. II) the stock's price. III) zero if its return on equity equals the discount rate. IV) the net present value of favorable investment opportunities. A. I and IV B. II and IV C. I, III, and IV D. II, III, and IV E. III and IV

C. I, III, and IV

Low P/E ratios tend to indicate that a company will _______, ceteris paribus. A. grow quickly B. grow at the same speed as the average company C. grow slowly D. P/E ratios are unrelated to growth. E. None of the options

C. grow slowly

Earnings management is A. when management makes changes in the operations of the firm to ensure that earnings do not increase or decrease too rapidly. B. when management makes changes in the operations of the firm to ensure that earnings do not increase too rapidly. C. when management makes changes in the operations of the firm to ensure that earnings do not decrease too rapidly. D. the practice of using flexible accounting rules to improve the apparent profitability of the firm.

D. the practice of using flexible accounting rules to improve the apparent profitability of the firm

A version of earnings management that became common in the 1990s was A. when management makes changes in the operations of the firm to ensure that earnings do not increase or decrease too rapidly. B. reporting "pro forma earnings." C. when management makes changes in the operations of the firm to ensure that earnings do not increase too rapidly. D. when management makes changes in the operations of the firm to ensure that earnings do not decrease too rapidly.

B. reporting "pro forma earnings"

GAAP allows A. no leeway to manage earnings. B. minimal leeway to manage earnings. C. considerable leeway to manage earnings. D. earnings management if it is beneficial in increasing stock price. E. None of the options

C. considerable leeway to manage earnings

The most appropriate discount rate to use when applying a FCFE valuation model is the A. required rate of return on equity. B. WACC. C. risk-free rate. D. None of the options

A. required rate of return on equity

WACC is the most appropriate discount rate to use when applying a ______ valuation model. A. FCFF B. FCFE C. DDM D. FCFF or DDM depending on the debt level of the firm E. P/E

A. FCFF

The most appropriate discount rate to use when applying a FCFF valuation model is the A. required rate of return on equity. B. WACC. C. risk-free rate. D. required rate of return on equity or risk-free rate depending on the debt level of the firm. E. None of the options

B. WACC

The required rate of return on equity is the most appropriate discount rate to use when applying a ______ valuation model. A. FCFE B. FCEF C. DDM D. FCEF or DDM E. P/E

A. FCFE

FCF and DDM valuations should be ____________ if the assumptions used are consistent. A. very different for all firms B. similar for all firms C. similar only for unlevered firms D. similar only for levered firms E. None of the options

B. similar for all firms

Siri had a FCFE of $1.6M last year and has 3.2M shares outstanding. Siri's required return on equity is 12% and WACC is 9.8%. If FCFE is expected to grow at 9% forever, the intrinsic value of Siri's shares are A. $68.13. B. $18.17. C. $26.35. D. $14.76. E. None of the options

B. $18.17 $1.6M/3.2M = $0.50 FCFE per share; .50 × 1.09 = .545; .545/(.12 - .09) = 18.17

Zero had a FCFE of $4.5M last year and has 2.25M shares outstanding. Zero's required return on equity is 10% and WACC is 8.2%. If FCFE is expected to grow at 8% forever, the intrinsic value of Zero's shares are A. $108.00. B. $1080.00. C. $26.35. D. $14.76. E. None of the options

A. $108.00 $4.5M/2.25M = $2.00 FCFE per share; 2.00 × 1.08 = 2.16; 2.16/(.10 - .08) = 108.

See Candy had a FCFE of $6.1M last year and has 2.32M shares outstanding. See's required return on equity is 10.6% and WACC is 9.3%. If FCFE is expected to grow at 6.5% forever, the intrinsic value of See's shares are A. $108.00. B. $68.30. C. $26.35. D. $14.76.

B. $68.30 $6.1M/2.32M = $2.6293 FCFE per share; 2.6293 × 1.065 = 2.800; 2.80/(.106 - .065) = 68.30

SI International had a FCFE of $122.1M last year and has 12.43M shares outstanding. SI's required return on equity is 11.3% and WACC is 9.8%. If FCFE is expected to grow at 7.0% forever, the intrinsic value of SI's shares are A. $108.00. B. $68.29. C. $244.43. D. $14.76.

C. $244.43 $122.1M/12.43M = $9.823 FCFE per share; 9.823 × 1.07 = 10.51; 10.51/(.113 - .07) = 244.43

Highpoint had a FCFE of $246M last year and has 123M shares outstanding. Highpoint's required return on equity is 10% and WACC is 9%. If FCFE is expected to grow at 8.0% forever, the intrinsic value of Highpoint's shares are A. $21.60. B. $108. C. $244.42. D. $216.00.

B. $108 $246M/123M = $2.00 FCFE per share; 2.00 × 1.08 = 2.16; 2.16/(.10 - .08) = 108.

SGA Consulting had a FCFE of $3.2M last year and has 3.2M shares outstanding. SGA's required return on equity is 13% and WACC is 11.5%. If FCFE is expected to grow at 8.5% forever, the intrinsic value of SGA's shares are A. $21.60. B. $26.56. C. $244.42. D. $24.11.

D. $24.11 $3.2M/3.2M = $1.00 FCFE per share; 1.00 × 1.085 = 1.085; 1.085/(.13 - .085) = 24.11

Seaman had a FCFE of $4.6B last year and has 113.2M shares outstanding. Seaman's required return on equity is 11.6% and WACC is 10.4%. If FCFE is expected to grow at 5% forever, the intrinsic value of Seaman's shares are A. $646.48. B. $64.66. C. $6,464.8. D. $6.46.

A. $646.48 $4.6B/113.2M = $40.636 FCFE per share; 40.636 × 1.05 = 42.6678; 42.6678/(.116 - .05) = 646.48.

Consider the free cash flow approach to stock valuation. F&G Manufacturing Company is expected to have before-tax cash flow from operations of $750,000 in the coming year. The firm's corporate tax rate is 40%. It is expected that $250,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $125,000. After the coming year, cash flows are expected to grow at 7% per year. The appropriate market capitalization rate for unleveraged cash flow is 13% per year. The firm has no outstanding debt. The projected free cash flow of F&G Manufacturing Company for the coming year is A. $250,000. B. $180,000. C. $300,000. D. $380,000.

A. $250,000

Consider the free cash flow approach to stock valuation. F&G Manufacturing Company is expected to have before-tax cash flow from operations of $750,000 in the coming year. The firm's corporate tax rate is 40%. It is expected that $250,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $125,000. After the coming year, cash flows are expected to grow at 7% per year. The appropriate market capitalization rate for unleveraged cash flow is 13% per year. The firm has no outstanding debt. The total value of the equity of F&G Manufacturing Company should be A. $1,615,156.50. B. $2,479,168.95. C. $3,333,333.33. D. $4,166,666.67.

D. $4,1666,666.67 Projected free cash flow = $250,000; V0 = 250,000/(.13 - .07) = $4,166,666.67

Boaters World is expected to have per share FCFE in year 1 of $1.65, per share FCFE in year 2 of $1.97, and per share FCFE in year 3 of $2.54. After year 3, per share FCFE is expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A. $77.53 B. $40.67 C. $82.16 D. $71.80 E. None of the options

D. $71.80

Smart Draw Company is expected to have per share FCFE in year 1 of $1.20, per share FCFE in year 2 of $1.50, and per share FCFE in year 3 of $2.00. After year 3, per share FCFE is expected to grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The stock should be worth _______ today. A. $33.00 B. $40.68 C. $55.00 D. $66.00 E. $12.16

B. $40.68

Old Style Corporation produces goods that are very mature in their product life cycles. Old Style Corporation is expected to have per share FCFE in year 1 of $1.00, per share FCFE of $0.90 in year 2, and per share FCFE of $0.85 in year 3. After year 3, per share FCFE is expected to decline at a rate of 2% per year. An appropriate required rate of return for the stock is 8%. The stock should be worth A. $127.63. B. $10.57. C. $20.00. D. $22.22. E. $8.98.

E. $8.98

Goodie Corporation produces goods that are very mature in their product life cycles. Goodie Corporation is expected to have per share FCFE in year 1 of $2.00, per share FCFE of $1.50 in year 2, and per share FCFE of $1.00 in year 3. After year 3, per share FCFE is expected to decline at a rate of 1% per year. An appropriate required rate of return for the stock is 10%. The stock should be worth A. $9.00. B. $101.57. C. $10.57. D. $22.22. E. $47.23.

C. $10.57

The growth in per share FCFE of SYNK, Inc. is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years; after this five-year period, the growth in per share FCFE is expected to be 3% per year, indefinitely. The required rate of return on SYNC, Inc. is 11%. Last year's per share FCFE was $2.75. What should the stock sell for today? A. $28.99 B. $35.21 C. $54.67 D. $56.37 E. $39.71

E. $39.71

The growth in per share FCFE of FOX, Inc. is expected to be 15% per year for the next three years, followed by a growth rate of 8% per year for two years; after this five-year period, the growth in per share FCFE is expected to be 3% per year, indefinitely. The required rate of return on FOX, Inc. is 13%. Last year's per share FCFE was $1.85. What should the stock sell for today? A. $28.99 B. $24.47 C. $26.84 D. $27.74 E. $19.18

D. $27.74

The growth in per share FCFE of CBS, Inc. is expected to be 10% per year for the next two years, followed by a growth rate of 5% per year for three years; after this five-year period, the growth in per share FCFE is expected to be 2% per year, indefinitely. The required rate of return on CBS, Inc. is 12%. Last year's per share FCFE was $2.00. What should the stock sell for today? A. $8.99 B. $22.51 C. $40.00 D. $25.21 E. $27.12

D. $25.21

Stingy Corporation is expected have EBIT of $1.2M this year. Stingy Corporation is in the 30% tax bracket, will report $133,000 in depreciation, will make $76,000 in capital expenditures, and will have a $24,000 increase in net working capital this year. What is Stingy's FCFF? A. 1,139,000 B. 1,200,000 C. 1,025,000 D. 921,000 E. 873,000

E. 873,000 FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 1,200,000(.7) + 133,000 - 76,000 - 24,000 = 873,000.

Fly Boy Corporation is expected have EBIT of $800k this year. Fly Boy Corporation is in the 30% tax bracket, will report $52,000 in depreciation, will make $86,000 in capital expenditures, and will have a $16,000 increase in net working capital this year. What is Fly Boy's FCFF? A. 510,000 B. 406,000 C. 542,000 D. 596,000 E. 682,000

A. 510,000 FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 800,000(.7) + 52,000 - 86,000 - 16,000 = 510,000.

Lamm Corporation is expected have EBIT of $6.2M this year. Lamm Corporation is in the 40% tax bracket, will report $1.2M in depreciation, will make $1.4M in capital expenditures, and will have a $160,000 increase in net working capital this year. What is Lamm's FCFF? A. 6,200,000 B. 6,160,000 C. 3,360,000 D. 3,680,000 E. 4,625,000

C. 3,360,000 FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 6,200,000(.6) + 1,200,000 - 1,400,000 - 160,000 = 3,360,000

Rome Corporation is expected have EBIT of $2.3M this year. Rome Corporation is in the 30% tax bracket, will report $175,000 in depreciation, will make $175,000 in capital expenditures, and will have no change in net working capital this year. What is Rome's FCFF? A. 2,300,000 B. 1,785,000 C. 1,960,000 D. 1,610,000 E. 1,435,000

D. 1,610,000 FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 2,300,000(.7) + 175,000 - 175,000 - 0 = 1,610,000.

Chapter 18 Flashcards

(127 cards)