FIN 600 - Smartbook Chp. 4

The ______ ratio is the ratio of dividends to earnings per share.

payout

A firm cuts its dividend payout ratio. As a result you know that the firm's _______.

plowback ratio will increase.

The ______ is found by dividing the current price per share by last year's earnings per share.

price earnings ratio

Sales of new shares of stock occur in the:

primary market

A company that reinvests earnings at below the market capitalization will _________ share value.

reduce; Reason: A company that reinvests earnings at below the market capitalization rate may increase earnings but will reduce the share value.

The trading of existing shares occurs in the ______ market.

secondary

Organized auction markets include ________

the New York Stock Exchange

The firm's cost of equity capital is ______ the required rate of return to the shareholders.

the same as

Growth rates often decline in the future and ROE drops. Therefore it is often useful to use a ___________ model to value stocks.

two-stage DCF; Reason: The constant growth model no longer works if the growth rate declines; therefore, a 2 stage discount factor method is needed in this situation.

What is the total return for a stock currently sells for $108, pays a dividend in one year of $3.20, and has a constant growth rate of 3.5 percent?

6.46%; Reason: R = ($3.20/$108) + .035 = .0646, or 6.46%

How is free cash flow defined?

Cash flow available for distribution to a firm's investors; Reason: Correct. Free cash flow is the cash that is available for distribution to the investors in the firm after the investments that are necessary to sustain the firm's ongoing operations are made. (See chapter 2.)

True or false: Free cash flow is the firm's new investments less any old tax expenditures.

False; Reason: Free cash flow is the firm's earnings less any new investment expenditures.

True or false: Securities in the same risk will likely have different expected rates of return.

False; Reason: Securities in the same risk must have the same expected rates of return.

Free cash flow is _________.

cash flow from assets

The underlying assumption of the ________ formula is that there will be regular future growth.

constant-growth DCF

The dividend yield is determined by dividing next year's expected cash dividend by the ____.

current stock price; Reason: Dividend yield = Div1/P0

The NASDAQ market is a(n) ______ market rather than an auction market.

dealer

Growth rates often ___________ in the future and ROE ________. Therefore it is often useful to use a two-stage DCF model to value stocks.

decline, drops Reason: The constant growth model no longer works if the growth rate declines; therefore, a 2 stage discount factor method is needed in this situation.

Generally speaking, as the firm progresses through the industry life cycle you would expect the PVGO to ________ as a percent of share price.

decrease; Reason: As firms mature and move through the industry life cycle, it is expected that growth opportunities decrease and therefore that PVGO decreases as a percentage of share price.

The underlying assumption of the constant-growth DCF formula is that there will be regular ________.

future growth

When evaluating the value of a firm, in addition to book value, an investor may also consider which of the following? -going-concern value -face value -yield value -secondary value

going-concern value

Multiplying the plowback ratio by the ROE for a firm gives an estimate of the firm's ___________.

growth rate

The constant growth dividend discount model (DDM) can be used only when the ___________.

growth rate is less than the discount rate

The value of a firm is the function of its ______ rate and its _______ rate.

growth; discount

You can track trades in public corporations' stock easily on the ________.

internet

The cost of equity capital is the ______.

investment opportunity rate

A firm without growth opportunities should sell for ____ a firm with growth opportunities.

less than; Reason: Higher growth opportunities create higher value today.

A firm with growth opportunities should sell for ____ a firm without growth opportunities.

more than; Reason: Higher growth opportunities create higher value today.

Which of the following occurs in the primary market?

Newly-issued stocks are initially sold

A zero-growth stock pays a dividend of $3 per share and has a discount rate of 10%. What will the stock's price be?

$30.00; Reason: P0 = $3/0.10 = $30

If a firm has a free cash flow equal to $50 million and that cash flow is expected to grow at 3% forever, what is the total firm value given a WACC of 10%?

$714 million; Reason: Total value = 50/(.10 -.03) = 714

What is the value of a stock if next year's dividend is $6, the discount rate is 11 percent and the constant rate of growth is 3 percent?

$75; Reason: P0 =$6/(.11 - .03) = $75 Do not multiply the dividend by 1 + the growth rate, because you're given next year's dividend.

If a firm has a free cash flow equal to $50 million and that cash flow is expected to grow at 3% forever, what is the total firm value given a WACC of 9.5%?

$769 million; Reason: Total value = 50/(.095 - .03) = 769.23

What is the price of a stock if its dividend a year from now is expected to be $3.20, the discount rate is 9 percent, and the constant rate of growth is 5 percent?

$80; Reason: P0 = $3.20/(.09 - .05) = $80

When evaluating the value of a firm, in addition to book value, an investor may also consider which of the following?

-going-concern value -liquidation value

A firm has an expected ROE of 15%. If it pays out 30% of it earnings as dividends, its dividend growth rate will be _____.

.105; Reason: g= plowback x ROE = (1-.30)x.15 =.105

What is the total return for a stock that currently sells for $100, pays a dividend in one year of $2, and has a constant growth rate of 8 percent?

10%; Reason: R = ($2/$100) + .08 = .10, or 10%

You are evaluating a particular stock and observe that the companies in that stock's risk class offer an expected rate of return of 15%. You therefore expect that the stock will earn:

15%

A zero-growth stock pays a dividend of $2 per share and has a discount rate of 10%. What will the stock's price be?

20.00; Reason: P0 = $2/0.10 = $20

The two most important stock markets in the United States are the New York Stock Exchange and the ______.

NASDAQ

Which one of these represents the present value of a growing perpetuity? R = P0 - (Div/g) P0 = Div - (g/R) P0 = Div/[(R−g)^2] P0= Div/(R−g)

P0= Div/(R−g)

When valuing a stock we often think of it as the value of average earnings under no growth plus the present value of growth opportunities. Which of the following represents this? P0=(PVGO/r)+EPS P0=(EPS/r)+PVGO g = plowback x ROE P0=DIV/r

P0=(EPS/r)+PVGO

______ is the ratio of earnings per share to book equity per share.

Return on equity

True or false: Free cash flow is the firm's earnings less any new investment expenditures.

True

True or false: You can track trades in public corporations' stock easily on the Internet.

True

All else constant, the dividend yield will increase if the stock price ____.

decreases; Reason: Let's take an example. Suppose a company pays a $2.50 dividend and the stock price is $50 - the dividend yield is $2.50/$50 = 5%. Suppose the stock price increases to $60 - then the dividend yield decreases to $2.50/$60 = 4.17%. Alternatively, if the stock price drops to $40, the dividend yield increases to $2.50/$40 = 6.25%.

The value of a firm is the function of its growth rate and its _______ rate.

discount

Return on equity is the ratio of __________ to book equity per share.

earnings per share

The payout ratio is the ratio of dividends to:

earnings per share

The price earnings ratio is found by dividing the current price per share by last year's ______.

earnings per share