Finance Exam Chapter 8
a firm is expected to have net earnings of $1,480,000 three years from now. there are 500,000 shares of stock outstanding. the firm's current P/E ratio is 18 and it is expected to remain that level. what is the firm's expected stock price for year 3?
$53.28 explanation: P/E ratio x (expected net earnings/outstanding stocks)
a firm is expected to have net earnings of $4.00 per share of stock outstanding. the firm's current P/E ratio is 14 and it is expected to remain at that level. what is the firm's expected stock price for year 2?
$56.00 explanation: P2= P/E ratio x per-share earnings (14x4.00)
assume you are computing P0, which is the current price of a stock. What discount factor will you use to discount the dividend in year 3?
(1+i)^3
which statements are correct?
- a market order will execute immediately, regardless of the price - a limit sell order may never be executed - a limit sell order will only execute at the limit price or higher
which of these accurately recaps dividend growth estimations and limitations as they apply to the dividend growth model?
- dividends can grow quickly in the short-run but cannot exceed the overall economic growth rate over the long run - dividend growth can be estimated based on historical data, dividend trends, or analyst's forecasts
which of these are basic assumptions of a variable growth rate valuation?
- g1 applies to a designated number of years - g2 < i - g1 can be negative, positive, or equal to zero
which of these services should you expect to receive from a full-service brokerage firm?
- investment advice - in-depth research on individual stocks
which of these applies to the valuation of a preferred stock?
- preferred dividend payments are assumed to be infinite - preferred dividends are assumed to be a constant dollar amount
how can a preferred stock be valued?
- preferred stock can be valued as a perpetuity, PV=PMT/i - preferred stock can be valued using the constant-growth model
a stock has a dividend yield of 1.4 percent. what is the expected return if the growth rate is 4 percent? what if the growth rate is 8 percent?
5.4 percent; 9.4 percent
a stock has an expected rate of return of 10.6 percent based on a 9 percent rate of growth. what will the expected rate of return be if analysts revise the firm's growth rate to 7.5 percent?
9.1% explanation: dividend yield= expected rate of return-rate of growth; expected rate of return= dividend yield + (new) growth rate
if you want to estimate a future price, Pn, using the P/E valuation formula, you should use the estimated earnings for which year?
Year n
which one of these best defines the dividend discount model?
a stock valuation method based on the present value of all future dividends
what is the key premise upon which the dividend discount model is based?
all future cash flows from a stock are dividend payments
which of these is correct?
dealers are willing to sell stocks at the ask price
which one of these defines the current value of a stock?
discounted value of both the future dividends and the future stock price
what is the primary purpose of the P/E valuation formula?
estimate the future price of a stock
in a stock valuation formula, what does the symbol D1 represent?
estimated dividend in time period 1, or next year's dividend when solving for the current price
T/F: a dealer will buy stock from an investor at the ask price
false
which one of these generally applies to preferred stock?
higher dividend yields than a common stock issued by the same issuer
which one of these generally applies to preferred stock?
higher dividend yields than common stock issued by the same issuer
Mary placed an order to purchase 100 shares of ABC stock at the going price. The order was filled as soon as it reached the floor of the exchange. What type of order did Mary place?
market buy order
which of the terms best describes the trading process used by NASDAQ?
multiple market maker system
the overall rate of growth for a firm and its industry is 3.5 percent. which of these combinations of dividend growth rates are acceptable when computing the current value of the firm's stock?
short-run growth= 15%; long-run growth= 3%
what is the best definition of the variable-growth rate stock valuation method?
stock valuation method used when a firm's current growth rate is expected to change in the future
how is the discount rate used to value a stock related to the expected return on the stock? assume the stock price fairly reflects the stock's value
the discount rate should equal the expected rate of return
what does it mean when a P/E is designated as a trailing P/E?
the earnings used in the P/E calculation were for the past four quarters
how is the discount rate used to evaluate a security related to the security's level of risk?
the higher the level of risk, the higher the discount rate needs to be
Just before the market closes, ABC stock is selling for $43 a share, so you place a market sell order for 300 shares. The order reaches the trading floor after the market closes for the day. The next morning, ABC stock opens at a price of $28 a share. What happens to your order?
the order is executed at a price of $28 a share
what is an advantage of a market order?
the order will execute immediately
which of these is a correct interpretation of a P/E ratio?
the stock with the lowest P/E has the lowest current price per dollar of earnings
why do you have to use the dividend at time n + 1 to compute the terminal price in the two-stage growth valuation model?
the terminal price is the time n price. the dividend used to compute a price must always be one time period ahead of the price
which one of these applies to stock valuation?
the value of a stock today equals the discounted value of the future expected cash flows
what is the purpose of the terminal price that is used in conjunction with a variable-growth rate stock value formula?
to replace all of the dividends paid in stage 2
T/F: a P/E is a measure of relative value
true
T/F: a forward P/E is less accurate than a trailing P/E
true
a preferred stock has which of these characteristics?
zero dividend growth
