Ch 11 - MC/FIll-In
14. Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because: a. debt is typically less risky because fixed claims bear less residual risk than equity claims. b. equity bears less residual risk than debt. c. equity capital costs are tax deductible. d. the yield to maturity on equity is inversely related to its market value.
ANS: A
1. Which of the following is not a problem with using a dividend-based valuation formula? a. Dividends are arbitrarily established. b. Dividends represent a transfer of wealth to shareholders. c. Some firms do not pay a regular periodic dividend. d. It is a challenge to forecast the final liquidating dividend.
ANS: B
10. When deriving the equity value of a firm, an analyst forecasts the real dividends expected to be paid in the future. In this case, which discount rate should be used? a. The nominal rate of return b. The real rate of return c. The risk-free rate of return d. The risk adjusted rate of return
ANS: B
16. Under the cash-flow-based valuation approach, free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model because: a. this approach focuses on earnings as a measure of the capital that a firm creates. b. over the life of the firm, the free cash flows into the firm and cash flows paid out of the firm in dividends to shareholders will be equivalent. c. over the life of the firm, the free cash flows out of the firm for investments and cash flows paid into the firm in dividends from these investments will be equivalent. d. this approach focuses on wealth distribution to shareholders.
ANS: B
9. One rationale for using expected dividends in valuation is: a. Dividends are a necessary payment in order for a firm to have value. b. Dividends are paid in cash, and cash serves as a measurable common denominator for comparing the future benefits of alternative investment opportunities. c. Dividends are the most reliable measure of value because most companies payout dividends to shareholders. d. Dividend payout ratios are set based on profitability.
ANS: B
13. Firm-specific factors that increase the firm's nondiversifiable risk include all of the following except: a. Exposure to interest rate changes b. Exposure to inflation c. Exposure to management competence d. Exposure to cyclicality
ANS: C
17. Returns on systematic risk-free securities (like U.S. Treasury securities) should exhibit what type of correlation with returns on a diversified market wide portfolio of stocks? a. Nearly perfect correlation b. Perfect correlation c. No correlation d. Unable to tell without specifics about the portfolio
ANS: C
19. With respect to dividends and priority in liquidation, what has priority over common stock? a. treasury stock b. debt capital c. preferred stock d. nonconvertible common equity
ANS: C
8. Equity-based valuation models are based on all metrics except: a. dividends b. cash flow c. working capital d. earnings
ANS: C
18. If a firm has a market beta of 0.9, is subject to an income tax rate of 35 percent, has a risk-free rate of 6 percent, a market risk premium of 7 percent, and has a market value of debt to market value of equity ratio of 60 percent, what does the market expect the firm to generate in terms of equity returns using CAPM? a. 6% b. 7% c. 12.3% d. 13%
ANS: C 12.3% = [.06 + (0.9 x .07)]
11. Equity valuation models based on dividends, cash flows, and earnings have been the topic of many theoretical and empirical research studies in recent years. All of the following are true regarding these studies except: a. Share prices in the capital markets generally correlate closely with share value. b. Share prices do not always equal share values. c. Temporary deviations of price from value occur. d. Unexpected changes in earnings, dividends, and cash flows do not correlate closely with changes in stock prices.
ANS: D
12. The historical discount rate of the firm may be a good indicator of the appropriate discount rate to apply to the firm in the future, when all of the following conditions hold true except: a. The current risk of the firm is the same as the expected future risk of the firm. b. Expected future interest rates are likely to equal current interest rates. c. The existing capital structure of the firm is the same as the expected future capital structure of the firm. d. The current mix of debt and equity financing is equal.
ANS: D
15. All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except: a. Analyze the firm's strategy in terms of the competition. b. Assess the quality of the firm's accounting and financial reporting. c. Derive forecasts of future earnings from the firm's projected financial statements. d. Obtain the national ranking of the firm's external auditors.
ANS: D
5. A company with a new Capital structure will increase the __________ and at the same time the __________ risk.
ANS: Leverage, systematic
6. A company with a market beta of 1 has systemic risk ____________________ to the average amount of systemic risk of all equity securities in the market.
ANS: equal
8. Normally, valuation methods are designed to produce reliable estimates of the value of a firm's ______________________________.
ANS: equity shares
9. Dividends measure the cash that ____________________ ultimately receive from investing in an equity share.
ANS: investors
7. Because the market equity beta reflects the level of operating leverage, financial leverage, variability of sales, and other characteristics of a firm, there are situations where an analyst might have to adjust the beta because of changes in the capital structure. A situation that might require an analyst to estimate a new levered beta is a(n) ___________________________________.
ANS: leveraged buyout
3. One criticism in using the CAPM to calculate the cost of equity capital is that ______________________________ and the __________________________________________________ are quite sensitive to the time period and methodology used in their computation.
ANS: market betas, excess market rate of return
2. To determine the appropriate weights to use in the weighted average cost of capital, an analyst will need to determine the ______________________________ of the debt, preferred stock and common equity capital.
ANS: market values
4. If dividend projections include the effect of inflation, then the discount rate used should be a(n) ____________________ rate.
ANS: nominal
1. In theory, the value of a share of common equity is the present value of ____________________________________________________________.
ANS: the expected future dividends
