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Chapter 18 Equity Valuation Models
Multiple Choice Questions
1.
________ 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 above.
Answer: D Difficulty: Easy
Rationale: Book value per share is assets minus liabilities divided by number of shares.
Liquidation value per share is the amount a shareholder would receive in the event of
bankruptcy. Market value per share is the market price of the stock.
2.
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 above
Answer: A Difficulty: Easy
Rationale: Investors pay for growth; hence the high P/E ratio for growth firms; however,
the investor should be sure that he or she is paying for expected, not historic, growth.
3.
_________ 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
E)
none of the above
Answer: A Difficulty: Easy
Rationale: See rationale for test bank question 18.1
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Chapter 18 Equity Valuation Models
4.
________ are analysts who use information concerning current and prospective
profitability of a firms to assess the firm's fair market value.
A)
Credit analysts
B)
Fundamental analysts
C)
Systems analysts
D)
Technical analysts
E)
Specialists
Answer: B Difficulty: Easy
Rationale: Fundamentalists use all public information in an attempt to value stock
(while hoping to identify undervalued securities).
5.
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
E)
none of the above
Answer: B Difficulty: Easy
Rationale: The cash flows from the stock discounted at the appropriate rate, based on
the perceived riskiness of the stock, the market risk premium and the risk free rate,
determine the intrinsic value of the stock.
6.
_______ 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
E)
None of the above
Answer: B Difficulty: Easy
Rationale: See explanation for test bank question 18.1.
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Chapter 18 Equity Valuation Models
7.
Since 1955, Treasury bond yields and earnings yields on stocks were_______.
A)
identical
B)
negatively correlated
C)
positively correlated
D)
uncorrelated
Answer: C Difficulty: Easy
Rationale: The earnings yield on stocks equals the expected real rate of return on the
stock market, which should be equal to the yield to maturity on Treasury bonds plus a
risk premium, which may change slowly over time. The yields are plotted in Figure
18.8.
8.
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
E)
none of the above
Answer: B Difficulty: Easy
Rationale: P/E ratios have tended to be lower when inflation has been high, reflecting
the market's assessment that earnings in these periods are of
artificially distorted by inflation, and warranting lower P/E ratios.
9.
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 above
Answer: C Difficulty: Easy
Rationale: The market capitalization rate, which consists of the risk- free rate, the
systematic risk of the stock and the market risk premium, is the rate at which a stock's
cash flows are discounted in order to determine intrinsic value.
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Chapter 18 Equity Valuation Models
10.
The _________ is the fraction of earnings reinvested in the firm.
A)
dividend payout ratio
B)
retention rate
C)
plowback ratio
D)
A and C
E)
B and C
Answer: E Difficulty: Easy
Rationale: Retention rate, or plowback ratio, represents the earnings reinvested in the
firm. The retention rate, or (1 - plowback) = dividend payout.
11.
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)
A and B.
E)
A and C.
Answer: D Difficulty: Easy
Rationale: The Gordon model assumes constant growth indefinitely. Mathematically, g
must be less than k; otherwise, the intrinsic value is undefined.
12.
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)
cannot be calculated without knowing the market rate of return
B)
will be greater than the intrinsic value of stock Y
C)
will be the same as the intrinsic value of stock Y
D)
will be less than the intrinsic value of stock Y
E)
none of the above is a correct answer.
Answer: D Difficulty: Easy
Rationale: 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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Chapter 18 Equity Valuation Models
13.
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)
cannot be calculated without knowing the market rate of return
E)
none of the above is a correct answer.
Answer: C Difficulty: Easy
Rationale: PV0 = D1/(k-g); given k and g are equal, the stock with the larger dividend
will have the higher value.
14.
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 $$2 in the upcoming year. The expected growth rate of
dividends is 9% for stock A and 10% for stock B. The intrinsic value of stock A _____.
A)
will be greater than the intrinsic value of stock B
B)
will be the same as the intrinsic value of stock B
C)
will be less than the intrinsic value of stock B
D)
cannot be calculated without knowing the rate of return on the market portfolio.
E)
none of the above is a correct statement.
Answer: C Difficulty: Easy
Rationale: PV0 = D1/(k-g); given that dividends are equal, the stock with the higher
growth rate will have the higher value.
15.
You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is
expected to pay a dividend of $$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)
cannot be calculated without knowing the rate of return on the market portfolio.
E)
none of the above is a correct statement.
Answer: C Difficulty: Easy
Rationale: PV0 = D1/(k-g); given that dividends are equal, the stock with the higher
growth rate will have the higher value.
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Chapter 18 Equity Valuation Models
16.
Each of two stocks, A and B, are expected to pay a dividend of $$5 in the upcoming year.
The expected growth rate of dividends is 10% for both stocks. You require a rate of
return of 11% on stock A and a return of 20% on stock B. The intrinsic value of stock A
_____.
A)
will be greater than the intrinsic value of stock B
B)
will be the same as the intrinsic value of stock B
C)
will be less than the intrinsic value of stock B
D)
cannot be calculated without knowing the market rate of return.
E)
none of the above is true.
Answer: A Difficulty: Easy
Rationale: PV0 = D1/(k-g); given that dividends are equal, the stock with the larger
required return will have the lower value.
17.
Each of two stocks, C and D, are expected to pay a dividend of $$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.
E)
none of the above is true.
Answer: A Difficulty: Easy
Rationale: PV0 = D1/(k-g); given that dividends are equal, the stock with the larger
required return will have the lower value.
18.
If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces
to
A)
V
0
= (Expected Dividend Per Share in Year 1)/k
B)
V
0
= (Expected EPS in Year 1)/k
C)
V
0
= (Treasury Bond Yield in Year 1)/k
D)
V
0
= (Market return in Year 1)/k
E)
none of the above
Answer: B Difficulty: Moderate
Rationale: If ROE = k, no growth is occurring; b = 0; EPS = DPS
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Chapter 18 Equity Valuation Models
19.
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%
E)
none of the above
Answer: A Difficulty: Easy
Rationale: 10% X 0.60 = 6.0%.
20.
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%
E)
none of the above
Answer: B Difficulty: Easy
Rationale: 14% X 0.40 = 5.6%.
21.
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%
E)
none of the above
Answer: D Difficulty: Easy
Rationale: 16% X 0.30 = 4.8%.
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Chapter 18 Equity Valuation Models
22.
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%
E)
none of the above
Answer: C Difficulty: Easy
Rationale: 15% X 0.50 = 7.5%.
23.
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%
E)
none of the above
Answer: C Difficulty: Easy
Rationale: 11% X 0.75 = 8.25%.
24.
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%
E)
none of the above
Answer: B Difficulty: Easy
Rationale: 15% X 0.75 = 11.25%.
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Chapter 18 Equity Valuation Models
25.
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%
E)
none of the above
Answer: C Difficulty: Easy
Rationale: 26% X 0.90 = 23.4%.
26.
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%
E)
none of the above
Answer: D Difficulty: Easy
Rationale: 9% X 0.10 = 0.9%.
27.
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)
$$56.25
E)
none of the above
Answer: B Difficulty: Moderate
Rationale: 2.75 / .10 = 27.50
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Chapter 18 Equity Valuation Models
28.
A preferred stock will pay a dividend of $$3.00in 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
E)
none of the above
Answer: A Difficulty: Moderate
Rationale: 3.00 / .09 = 33.33
29.
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)
$$10.42
E)
none of the above
Answer: D Difficulty: Moderate
Rationale: 1.25 / .12 = 10.42
30.
A preferred stock will pay a dividend of $$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
E)
none of the above
Answer: C Difficulty: Moderate
Rationale: 3.50 / .11 = 31.82
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Chapter 18 Equity Valuation Models
31.
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)
$$56.25
E)
none of the above
Answer: E Difficulty: Moderate
Rationale: 7.50 / .10 = 75.00
32.
A preferred stock will pay a dividend of $$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)
$$600
D)
$$5.40
E)
none of the above
Answer: E Difficulty: Moderate
Rationale: 6.00 / .10 = 60.00
33.
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 above
Answer: A Difficulty: Moderate
Rationale: .10 = (32 - P + 1.25) / P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.
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Chapter 18 Equity Valuation Models
34.
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 above
Answer: B Difficulty: Moderate
Rationale: .12 = (16 - P + 0.75) / P; .12P = 16 - P + 0.75; 1.12P = 16.75; P = 14.96.
35.
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 above
Answer: C Difficulty: Moderate
Rationale: .15 = (28 - P + 2.50) / P; .15P = 28 - P + 2.50; 1.15P = 30.50; P = 26.52.
36.
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 above
Answer: E Difficulty: Moderate
Rationale: .10 = (42 - P + 3.50) / P; .10P = 42 - P + 3.50; 1.1P = 45.50; P = 41.36.
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Chapter 18 Equity Valuation Models
Use the following to answer questions 37-40:
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 $$90.
37.
What is Paper Express's book value per share?
A)
$$1.68
B)
$$2.60
C)
$$32.14
D)
$$60.71
E)
none of the above
Answer: C Difficulty: Moderate
Rationale: $$45M/1.4M = $$32.14.
38.
What is Paper Express's market value per share?
A)
$$1.68
B)
$$2.60
C)
$$32.14
D)
$$60.71
E)
none of the above
Answer: E Difficulty: Easy
39.
What is Paper Express's replacement cost per share?
A)
$$1.68
B)
$$2.60
C)
$$53.57
D)
$$60.71
E)
none of the above
Answer: C Difficulty: Moderate
Rationale: $$115M - 40M/1.4M = $$53.57.
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Chapter 18 Equity Valuation Models
40.
What is Paper Express's Tobin's q?
A)
1.68
B)
2.60
C)
53.57
D)
60.71
E)
none of the above
Answer: A Difficulty: Moderate
Rationale: $$90/ 53.57 = 1.68
41.
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 above.
Answer: C Difficulty: Easy
Rationale: Although some variables such as market dividend yield appear to be strongly
related to market return, the market has great variability and so the level of uncertainty
in any forecast will be high.
42.
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.
Answer: D Difficulty: Easy
Rationale: The earnings multiplier approach is the most popular approach to forecasting
the overall stock market.
Use the following to answer questions 43-44:
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.
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Chapter 18 Equity Valuation Models
43.
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 above
Answer: C Difficulty: Moderate
Rationale: 4% + 1.25(14% - 4%) = 16.5%.
44.
What is the intrinsic value of Sure's stock today?
A)
$$20.60
B)
$$20.00
C)
$$12.12
D)
$$22.00
E)
none of the above
Answer: A Difficulty: Difficult
Rationale: k = .04 + 1.25 (.14 - .04); k = .165; .165 = (22 - P + 2) / P; .165P = 24 - P;
1.165P = 24 P = 20.60.
45.
If Sure's intrinsic value is $$21.00 today, what must be its growth rate?
A)
0.0%
B)
10%
C)
4%
D)
6%
E)
7%
Answer: E Difficulty: Difficult
Rationale: k = .04 + 1.25 (.14 - .04); k = .165; .165 = 2/21 + g; g = .07
Use the following to answer questions 46-47:
Torque Corporation is expected to pay a dividend of $$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.
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Chapter 18 Equity Valuation Models
46.
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 above
Answer: B Difficulty: Moderate
Rationale: 5% + 1.2(13% - 5%) = 14.6%.
47.
What is the intrinsic value of Torque's stock?
A)
$$14.29
B)
$$14.60
C)
$$12.33
D)
$$11.62
E)
none of the above
Answer: D Difficulty: Difficult
Rationale: k = 5% + 1.2(13% - 5%) = 14.6%; P = 1 / (.146 - .06) = $$11.62.
48.
Midwest Airline is expected to pay a dividend of $$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%
E)
none of the above
Answer: C Difficulty: Moderate
Rationale: 6% + 3(14% - 6%) = 30%.
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Chapter 18 Equity Valuation Models
49.
Fools Gold Mining Company is expected to pay a dividend of $$8 in the upcoming year.
Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return
is 6% and the expected return on the market portfolio is 14%. The stock of Fools Gold
Mining Company has a beta of -0.25. The return you should require on the stock is
________.
A)
2%
B)
4%
C)
6%
D)
8%
E)
none of the above
Answer: B Difficulty: Moderate
Rationale: 6% + [-0.25(14% - 6%)] = 4%.
50.
High Tech Chip Company is expected to have EPS in the coming year of $$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%
Answer: E Difficulty: Easy
Rationale: 12.5% X 0.7 = 8.75%.
51.
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)
$$1.94
E)
none of the above
Answer: D Difficulty: Moderate
Rationale: g = .155 X .75 = 10.875%; $$1.75(1.10875) = $$1.94
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Chapter 18 Equity Valuation Models
52.
High Tech Chip Company paid a dividend last year of $$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 above
Answer: C Difficulty: Moderate
Rationale: g = .125 X .6 = 7.5%; $$2.50(1.075) = $$2.69
53.
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)
$$72.00
E)
none of the above
Answer: C Difficulty: Easy
Rationale: 20 X $$3.00 = $$60.00.
54.
Suppose that the average P/E multiple in the oil industry is 22. Exxon Oil is expected to
have an EPS of $$1.50 in the coming year. The intrinsic value of Exxon Oil stock should
be _____.
A)
$$33.00
B)
$$35.55
C)
$$63.00
D)
$$72.00
E)
none of the above
Answer: A Difficulty: Easy
Rationale: 22 X $$1.50 = $$33.00.
435
Chapter 18 Equity Valuation Models
55.
Suppose that the average P/E multiple in the oil industry is 16. Mobil Oil is expected to
have an EPS of $$4.50 in the coming year. The intrinsic value of Mobil Oil stock should
be _____.
A)
$$28.12
B)
$$35.55
C)
$$63.00
D)
$$72.00
E)
none of the above
Answer: D Difficulty: Easy
Rationale: 16 X $$4.50 = $$72.00.
56.
Suppose that the average P/E multiple in the gas industry is 17. KMP is expected to
have an EPS of $$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 above
Answer: B Difficulty: Easy
Rationale: 17 X $$5.50 = $$93.50.
57.
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)
$$22.50
E)
none of the above
Answer: C Difficulty: Easy
Rationale: $$20(1/25) = $$0.80.
436
Chapter 18 Equity Valuation Models
58.
An analyst has determined that the intrinsic value of Dell stock is $$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 is
______.
A)
$$3.63
B)
$$4.44
C)
$$14.40
D)
$$1.26
E)
none of the above
Answer: D Difficulty: Easy
Rationale: $$34(1/27) = $$1.26.
59.
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)
$$22.50
E)
none of the above
Answer: A Difficulty: Easy
Rationale: $$80(1/22) = $$3.64.
60.
Old Quartz Gold Mining Company is expected to pay a dividend of $$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)
$$400.00
E)
none of the above
Answer: B Difficulty: Difficult
Rationale: k = 6% + [-0.25(14% - 6%)] = 4%; P = 8 / [.04 - (-.02)] = $$133.33.
437
Chapter 18 Equity Valuation Models
61.
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)
$$62.50
E)
none of the above
Answer: A Difficulty: Moderate
Rationale: 6% + 3(14% - 6%) = 30%; P = 7 / (.30 - .15) = $$46.67.
62.
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)
$$25.00
E)
none of the above
Answer: D Difficulty: Moderate
Rationale: 6% + 0.75(14% - 6%) = 12%; P = 1.50 / (.12 - .06) = $$25.
63.
Low Tech Chip Company is expected to have EPS in the coming year of $$2.50. The
expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm
has a dividend payout ratio of 40%, the intrinsic value of the stock should be
A)
$$22.73
B)
$$27.50
C)
$$28.57
D)
$$38.46
E)
none of the above
Answer: D Difficulty: Difficult
Rationale: g = 14% X 0.6 = 8.4%; Expected DPS = $$2.50(0.4) = $$1.00; P = 1 / (.11
- .084) = $$38.46.
438
Chapter 18 Equity Valuation Models
Use the following to answer questions 64-65:
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.
64.
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 above
Answer: B Difficulty: Moderate
Rationale: k = 3.50 / 90 + .10; k = 13.9%
65.
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 above
Answer: C Difficulty: Difficult
Rationale: k = 13.9% from 18.64; 13.9 = 5% + b(13% - 5%) = 1.11.
66.
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 above
Answer: C Difficulty: Difficult
Rationale: g = 13% X 0.5 = 6.5%; .5/(.12-.065) = 9.09
439
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