Chapter 8
Even if a company does not officially follow a fixed-dividend policy, dividend payments are ___
Fairly stable from one time period to another
T/F. A decline in earnings that investors expect to be temporary may actually increase a firm's P/E ratio.
TRUE
T/F. A drawback to the price-to-cash-flow method of valuation is that there is no generally accepted cash flow measure.
TRUE
Columbus Co.'s sales revenue for the most recent quarter was $2.5 million and cost of goods sold was $1.5 million. If sales grow by 15% in the next quarter and all ratios remain the same, gross profit will be ___
$1.15 million
Lindor Inc.'s $100 par value preferred stock pays a dividend fixed at 8% of par. To earn 12% on an investment in this stock, you need to purchase the shares at a per share price of ___
$66.67
Which one of the following is a correct equation to calculate earnings per share?
(profit margin)(total asset turnover)(equity multiplier)(book value per share)
The Hopkinton Company just paid $2.25 as its annual dividend. The dividends have been increasing at a rate of 5% annually and this trend is expected to continue. The stock is currently selling for $63.60 a share. What is the rate of return on this stock?
8.70%
When using the constant-growth dividend valuation model, which of the following will lower the value of the stock?
An increase in the required rate of return
ABC Company stock currently has a market value equivalent to its intrinsic value. Marco perceives that ABC Company is increasing its level of risk and therefore Marco increases his required rate of return on ABC stock. This change in the required rate of return ___
Will reduce the intrinsic value of ABD stock to Marco
The value of a stock is a function of ___
Future returns
The risk free rate is 2%. The expected rate of return on the market is 12%. Beta and the expected rate of return for four stocks are as follows.: ABC .8 , 10%; DEF 1, 12%; GHI 1.2 , 13%, and JKL 2, 22%. Which of these stocks should not be purchased?
GHI
James is willing to settle for a 10% rate of return on EG stock at a time when investors, on average, are requiring an 11% rate of return on the same stock. Which of the following will happen?
James will be happy to buy the stock for less than he was willing to pay
John requires a 12% rate of return on EG stock at a time when investors, on average, are requiring an 11% rate of return on the same stock. Which of the following will happen?
John will not be able to buy the stock unless the price changes
For which one of the following situations will the dividend-growth models work especially well?
Mature firm with a policy of increasing its earnings and dividends at an average rate of 5% per year
The major forces behind earnings per share are ___
Net income and the number of shares outstanding
For which one of the following situations will the price-to-sales valuation model work but the dividend and cash flow models will not?
Newly-formed biotechnology company with negative earnings
The Highlight Company has a book value of $56.50 per share, and is currently trading at a price of $59.00 per share. You are interested in investing in Highlight, and have just used a present-value based stock valuation model to calculate a present (intrinsic) value of $55.00 per share for Highlight's stock. Assuming that your calculations are correct you should ___
Not buy the stock, because the present value is less than the market price per share
Over the last year, a firm's earnings per share increased from $1.20 to $1.40, its dividends per share increased from $0.50 to $0.60, and its share price increased from $21 to $24. The firm maintained a relative P/E of 1.10 over the entire time period. Given this information, it follows that the ___
Overall market P/E is declining
An internal rate of return (IRR) is the discount rate that ___
Produces a present value of future benefits equal to the market price of a stock
In applying the variable-growth dividend valuation model to a company's stock, analysts frequently define the growth rate, g, as equal to ___
ROE multiplied by the firm's retention rate
Which one of the following is is most likely to increase the price of a stock?
Rapid growth in earnings
T/F. The free cash flow to equity approach does not require that a stock pay dividends.
TRUE
T/F. The intrinsic value of a zero-growth stock can be found simply by dividing the dividend by the required rate of return.
TRUE
T/F. The key to the future financial success of a company lies in the sales growth and the net profit margin.
TRUE
T/F. The required rate of return denotes the minimum rate of return an investor should expect.
TRUE
T/F. There is no assurance that the actual rate of return on an asset will be similar to the projected rate of return.
TRUE
Which of the following approaches to stock valuation is NOT based on a multiple of some figure from the financial statements?
The dividends-growth model
An investor should purchase a stock when ___
The expected rate of return equals or exceeds the required return
Which of the following variables used in determining a stock's intrinsic value can be known with the greatest level of confidence?
The risk free rate of return
The intrinsic value of a stock is greater than its current market price if ___
The stock's IRR exceeds the required rate of return
T/F. The investor's internal rate of return is always equal to the firm's rate of return on equity.
FALSE
T/F. The most important factors influencing a stock's current price are its past earnings and dividends.
FALSE
Which of the following can be considered discounted cash flow methods of stock valuation? I. The constant growth dividend valuation model II. The variable growth dividend valuation model III. The price to cash flow method IV. The cash flow to equity method
I, II and IV
Heather believes that by carefully examining a company's fundamentals and by applying the best valuation models she can identify stocks whose market prices are lower than their intrinsic values. In order for this to be true ___
Some stocks must be incorrectly prices
T/F. A company's estimated future earnings and its P/E ratio can be used to estimate the stock's future price.
TRUE
T/F. A stock's value depends on future cash flows.
TRUE
A firm with a price to sales ratio of 1 would usually be considered ___
Undervalued
Global Warning's EPS for the current year is $2.75 and its current P/E ratio is 50. You have forecasted that EPS will grow by 10% but the P/E ratio will fall to 40. What do you expect the price of a share of GW's stock to be at the end of next year?
$121
The common stock of Rob's Discount Furniture is currently selling at $65.20 a share. The company adheres to a 60% dividend payout ratio and has a P/E ratio of 19. There are 42,000 shares of stock outstanding. What is the amount of the annual net income for the firm?
$144,126
The current annual sales of Flower Bud, Inc. are $178,000. Sales are expected to increase by 4% next year. The company has a net profit margin of 5% which is expected to remain constant for the next couple of years. There are 10,000 shares of common stock outstanding. The market multiple is 16.4 and the relative P/E of the firm is 1.21. What is the expected market price per share of common stock for next year?
$18.37
DMC3 Inc. will pay no dividend for 2016 or 2017. At the end of 2018, it will pay a dividend of $1.50.Thereafter dividends will grow at 4% per year. The required rate of return is 10%. The intrinsic value of DMC3 shares is (assume you are at the beginning of 2016)
$20.66
Hallowell Inc. has free cash flow of $2.5 million and 1.25 million shares outstanding. If you believe the price to cash flow ratio for this company should be 11, what is the highest price you should pay for the stock?
$22.00
The Merry Co. has current annual sales of $350,000 and a net profit margin of 6%. Sales are expected to increase by 5% annually while the profit margin is expected to remain constant. What is the projected after-tax earnings for two years from now?
$23,153
Markhem Enterprises is expected to earn $1.34 per share this year. The company has a dividend payout ratio of 40% and a P/E ratio of 18. What should one share of common stock in Markhem Enterprises be selling for in the market?
$24.12
Zephyr Inc. sells wind based systems for generating electricity. The company pays no dividends, but you estimate the stock will be worth $50 per share 5 years from now and you require a 15% rate of return for stock investments of this type. What price should you be willing to pay for this stock?
$24.86
Michelak's Maritime Industries has relatively stable earnings and pays an annual dividend of $3.00 per share. This dividend has remained constant over the past few years and is expected to remain constant for some time to come. If you want to earn 11% on an investment in the common stock of Michelak's, how much should you pay to purchase each share of stock?
$27.27
MBA Inc. will pay a dividend for the first time at the end of 2016. It projects the following dividend per share: 2016 $1.50 2017 $2.00 2018 $2.50 Beginning with 2016 dividends will grow at 4% per year. The required rate of return is 12%. The intrinsic value of MBA shares is
$27.85
Martin's Inc. is expected to pay annual dividends of $2.50 a share for the next three years. After that, dividends are expected to increase by 3% annually. What is the current value of this stock to you if you require a 9% rate of return on this investment?
$39.47
Walpurg, Inc. paid $1.30 as an annual dividend per share last year. The company is expected to increase their annual dividends by 6% each year. How much should you pay to purchase one share of this stock if you require a 9% rate of return on this investment?
$45.93
Early in 2015, Mathew is analyzing shares of Janeff Corp. He expects the following dividends per share (end of year). 2015 $1.00 2016 $1.25 2017 $1.50 He expects 2017 earnings per share to be $4.50 and Janeff's P/E ratio to be 20. His required rate of return for this stock is 12%. He should pay no more than
$67.02 per share
Equinox Bioengineering began operations in January of 2015. In its first year of operation, sales were $85 million and the net loss was $(5.1 million). Free cash flow was $(300,000). Equinox has 10 million shares outstanding. If you think the price to sales ratio for this company should be 1 or less, what is the most you should pay per share.
$8.50
Most analysts would not feel comfortable forecasting a firm's future earnings for more than ___
1 to 3 years
If the market multiple is 20.24 and the P/E ratio of a company is 24.5, then the stock's relative P/E is ___
1.21
What is the required rate of return on a common stock that is expected to pay a $0.75 annual dividend next year if dividends are expected to grow at 2 percent annually and the current stock price is $8.59?
10.73%
Ivonne has bought shares of RIO, Inc. stock for $25.00 per share. She expects a 1.00 dividend at the end of this year. After 2 years, she expects to receive a dividend of $1.25 and to sell the stock for $28.75. What is Ivonne's required rate of return?
11.6%
Early in 2015, Maria bought shares of MBA Inc. at $27.85 per share. She received the following dividends per share (end of the year). 2015 $1.50 2016 $2.00 2017 $2.50 Immediately after receiving the 2017 dividend, she sold the stock for $32.50 per share. Her internal rate of return on this investment was
11.89%
The risk-free rate of return is 2.2 percent, the expected market return is 11 percent, and the beta for Solstice, Inc. is 1.12. What is Solstice's required rate of return?
12.05%
Newton, Inc. just paid an annual dividend of $0.95. Their dividends are expected to increase by 4% annually. Newton Company stock is selling for $11.54 a share. What is the required rate of return on this stock implied by the dividend-growth model?
12.6%
Macoun Co.'s most recent EPS were $3.25 and they are expected to grow at a rate of 5% for the near future. The stock currently sells for $48.75. What is the price to forecasted earnings ratio?
14.30
GLOO stock's P/E ratio is 45 at a time when the market's P/E ratio is 15. GLOO's relative P/E ratio is ___
3
A company has an annual dividend growth rate of 5% and a retention rate of 40%. The company's dividend payout ratio is ___
60%
The dividend valuation model (DVM) cannot accommodate which of the following assumptions?
A constant growth rate of dividends greater than the required rate of return
Which of the following will lead to an increase in earnings per share?
An increase in the return on equity if book value per share stays the same
T/F. The value of a stock using the price to cash flow approach is to multiply the P/E ratio times operating cash flow divided by the number of shares outstanding.
FALSE
One stock valuation model holds that the value of a share of stock is a function of its future dividends and that the dividends will increase at an annual rate which will remain unchanged over time. This stock valuation model is known as the ___
Constant growth dividend valuation model
EBITDA is an acronym for ___
Earnings before interest, taxes, depreciation, and amortization
P/E ratios could rise even as earnings fall if ___
Earnings fall at a faster rate than stock prices
The single most important issue in the stock valuation process is a company's
Expected future returns
The most uncertain value used in the Capital Asset Pricing Model is ___
Expected return on the market
T/F. A stock will be an attractive investment if the required rate of return exceeds the expected rate of return.
FALSE
T/F. A temporary decline in earnings per share usually results in a temporary reduction of dividends.
FALSE
T/F. Companies with high P/E ratios tend to also have high dividend payout ratios.
FALSE
T/F. Generally speaking, the higher the price-to-sales ratio, the better.
FALSE
T/F. If the annual dividend on a stock never changes, its price will never change.
FALSE
T/F. None of the commonly used valuation approaches can assign a value to a company with no earnings.
FALSE
T/F. One of the easiest aspects of the dividend valuation model (DVM) is specifying the appropriate growth rate for a firm's dividends over time.
FALSE
T/F. Stocks trading at high price to book value multiples may be especially attractive to bargain hunters.
FALSE
T/F. The dividend valuation model estimates the value of a share of stock as the future value of all dividends.
FALSE
T/F. The first step in predicting a stock's future price is to forecast profits.
FALSE
T/F. The free cash flow to equity approach does not require present value calculations.
FALSE
T/F. The greater the perceived risk of an asset, the lower the expected rate of return.
FALSE
T/F. The rate of dividend growth can be estimated by multiplying the return on equity rate by the dividend payout ratio.
FALSE
T/F. The required rate of return estimated by the Capital Asset Pricing Model is not suitable for use in dividend valuation models.
FALSE
T/F. To use the Price-to-Sales valuation approach you also need to know the after tax profit margin.
FALSE
In the price/earnings approach to stock valuation, ___
Forecasted EPS are typically used
A company that wants to maintain both a constant growth rate in dividends and a constant payout ratio will have to ___
Grow earnings at the same rate as dividends
Which of the following contributes to high P/E ratios?
High rate of earnings growth
High P/E ratios can be expected when investors expect ___
High rate of growth in earnings
Which of the following will affect the firm's future cash flows? I. state of the economy II. state of the industry III. the firm's recent and current earnings IV. new products in the firm's pipeline
I, II and IV
Which of the following variables affect the P/E ratio? I. capital structure of a firm II. amount of dividends to be paid III. inflation rate IV. earnings rate of growth
I, II, III and IV
Commonly used multiples for determining a stock's value include: I. price to earnings. I. price to sales. III. price to cash flow. IV. price to dividends.
I, II, and III
Which of the following are key inputs to determining the intrinsic value of an asset? I. the required rate of return II. future cash flows III. current stock price IV. timing of future cash flows
I, II, and IV
Which of the following statements concerning the constant-growth dividend valuation model is (are) correct? I. One simple method of estimating the dividend growth rate is to analyze the historical pattern of dividends. II. The expected total return equals the return from capital gains plus the return from dividends paid. III. The model is applicable to growth firms with initially high growth rates. IV. The intrinsic value calculated using this method can change from one investor to another if their risk-return payoffs differ.
I, II, and IV
In the Capital Asset Pricing Model, which of the following factors are used to determine the required rate of return? I. the risk-free interest rate II. future cash flows III. expected return on the market portfolio IV. beta
I, III and IV
Which of the following statements concerning the Price to Cash-Flow approach to stock valuation are true? I. The Price to Cash-Flow method works just as well for non-dividend paying stocks as it does for dividend-paying stocks. II. The Price to Cash-Flow calculate s the intrinsic value of a stock as the present value of future cash flows. III. The Price to Cash-Flow ratio divides the market price of one share of stock by cash flow per share. IV. The Price to Cash-Flow method does not directly calculate the intrinsic value of a share.
I, III and IV
The variable-growth dividend valuation model ___
Is valuable because it accounts for the general growth patterns of most companies
Which of the following will most directly influence a company's market value?
Its future cash flows
T/F. A stock's internal rate of return (IRR) is the discount rate that cause the present value of future dividends and the price at which a stock is expected to be sold to equal the current price of the stock.
TRUE
T/F. Both beta and the expected return on the market portfolio incorporate risk into the Capital Asset Pricing Model.
TRUE
T/F. High price/sales multiples often go with high profit margins.
TRUE
T/F. If net income rises, but the number of shares outstanding remains the same, EPS will rise.
TRUE
T/F. Neither the P/E approach nor the cash flow to equity approach rely on dividends as the key input into the valuation of a stock.
TRUE
T/F. One method of estimating the dividend growth rate is to calculate the discount rate that equates today's dividend with the dividend paid several years ago.
TRUE
T/F. The approach to stock valuation which holds that the value of a share of stock is a function of its future dividends is known as the dividend valuation model (DVM).
TRUE
T/F. The common-size income statement expresses every item on the income statement as a percentage of sales.
TRUE
T/F. The constant growth dividend valuation model works best for mature companies with a long record of paying dividends.
TRUE
T/F. The dividend valuation model (DVM) is very sensitive to the growth rate (g) being used, because it affects both the model's numerator and its denominator.
TRUE
T/F. The efficient market hypothesis holds that a stock's intrinsic value and market value are essentially the same.
TRUE
T/F. The estimated price of a stock in the future is important because it includes the projected capital gain on the stock.
TRUE
T/F. The growth rate of dividends cannot be permanently greater than the required rate of return.
TRUE
T/F. The intrinsic value of an asset equals the present value of all future cash flows at a given discount rate.
TRUE
T/F. The rate of growth can exceed the required return during the variable-growth period without invalidating the variable growth dividend valuation model.
TRUE
T/F. The sales forecast depends on factors both internal and external to the firm.
TRUE
The intrinsic value of a stock provides a purchase price for the stock ___
That is reasonable given the associated level of risk
In general, the higher the retention ratio ___
The higher the future growth rate of the company
The constant-growth dividend valuation model is best suited for use with ___
The stocks of mature, dividend-paying companies
The price-to-cash-flow method of stock valuation generally ___
Uses either EBITDA or operating cash flow from the cash flow statement as a measure of cash flow.