Chapter 18
WACC is the most appropriate discount rate to use when applying a ______ valuation model. A. FCFF B. FCFE C. DDM D. A or C depending on the debt level of the firm E. P/E
A. FCFF
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
C. $0.80 $20(1/25) = $0.80.
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. 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
C. $32.14 $45M/1.4M = $32.14.
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. 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
A. $20.60 k = .04 + 1.25 (.14 - .04); k = .165; .165 = (22 - P + 2) / P; .165P = 24 - P; 1.165P = 24 ; P = 20.60.
Boaters World is expected to have per share FCFE in year 1 of $1.65, per share FCFE in year 2 of $1.97, and per share FCFE in year 3 of $2.54. After year 3, per share FCFE is expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A. $77.53 B. $40.67 C. $82.16 D. $66.00 E. none of the above
A. $77.53 P3 = $2.54 (1.08) / (.11 - .08) = $91.44; PV of P3 = $91.44/(1.08)3 = $72.5880; PO = $4.94 + $72.59 = $77.53.
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. 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
A. 1.68 $90/ 53.57 = 1.68
A firm has a return on equity of 14% and a dividend payout ratio of 60%. The firm's anticipated growth rate is _________. A. 5.6% B. 10% C. 14% D. 20% E. none of the above
A. 5.6% 14% X 0.40 = 5.6%.
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% 10% X 0.60 = 6.0%.
_________ 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
A. Book value per share 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.
Which of the following combinations will produce the highest growth rate? Assume that the firm's projects offer a higher expected return than the market capitalization rate. A. a high plowback ratio and a high P/E ratio B. a high plowback ratio and a low P/E ratio C. a low plowback ratio and a low P/E ratio D. a low plowback ratio and a high P/E ratio E. Neither the plowback ratio nor the P/E ratio is related to a firm's growth.
A. a high plowback ratio and a high P/E ratio The firm will grow more rapidly if it retains earnings to invest in positive NPV projects. As for the P/ E ratio's relationship to growth, the growth rate will increase as long as the projects' expected returns are higher than the market capitalization rates. If the expected returns are lower than the market capitalization rates, the growth rate will fall.
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
A. grow quickly 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.
The most appropriate discount rate to use when applying a FCFE valuation model is the ___________. A. required rate of return on equity B. WACCC. C. risk-free rate D. A or C depending on the debt level of the firm E. none of the above
A. required rate of return on equity The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity.
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.
A. will be greater than the intrinsic value of stock B PV0 = D1/(k-g); given that dividends are equal, the stock with the larger required return will have the lower value.
Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expectedto have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The total value of the equity of Utica Manufacturing Company should be A. $1,000,000 B. $2,000,000 C. $3,000,000 D. $4,000,000 E. none of the above
B. $2,000,000 Projected free cash flow = $180,000 (see test bank problem 18.73); V0 = 180,000 / (.15 - .06) = $2,000,000.
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.
B. $27.50 2.75 / .10 = 27.50
If a firm's required rate of return equals the firm's return on equity, there is no advantage to increasing the firm's growth. Suppose a no-growth firm had a required rate of return and a ROE of 12% and a stock price of $40. However, if the firm is able to increase the ROE to 15% with a plowback ratio of 50%, what is the present value of growth opportunities now? (Last year's dividends were $2.00/share). A. $9.78 B. $7.78 C. $10.78 D. $12.78 E. none of the above
B. $7.78 g = 0.50 x 15% = 7.5%; P0 = 2 (1.075) / (.12 - .075) = $47.78; $47.78 - $40.00 = $7.78.
According to James Tobin, the long run value of Tobin's Q should tend toward A. 0. B. 1. C. 2. D. infinity. E. none of the above.
B. 1. According to Tobin, in the long run the ratio of market price to replacement cost should tend toward 1.
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. 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
B. 13.9% k = 3.50 / 90 + .10; k = 13.9%
________ 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
B. Fundamental analysts Fundamentalists use all public information in an attempt to value stock (while hoping to identify undervalued securities).
_______ 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
B. Liquidation value per share 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.
If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces to A. V0 = (Expected Dividend Per Share in Year 1)/k B. V0 = (Expected EPS in Year 1)/k C. V0 = (Treasury Bond Yield in Year 1)/k D. V0 = (Market return in Year 1)/k E. none of the above
B. V0 = (Expected EPS in Year 1)/k If ROE = k, no growth is occurring; b = 0; EPS = DPS
A company whose stock is selling at a P/E ratio greater than the P/E ratio of a market index most likely has _________. A. an anticipated earnings growth rate which is less than that of the average firm B. a dividend yield which is less than that of the average firm C. less predictable earnings growth than that of the average firm D. greater cyclicality of earnings growth than that of the average firm E. none of the above.
B. a dividend yield which is less than that of the average firm Firms with lower than average dividend yields are usually growth firms, which have a higher P/E ratio than average.
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
B. intrinsic value 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.
Which of the following is the best measure of the floor for a stock price? A. book value B. liquidation value C. replacement cost D. market value E. Tobin's Q
B. liquidation value If the firm's market value drops below the liquidation value the firm will be a possible takeover target. It would be worth more liquidated than as a going concern.
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
B. lower when inflation has been high 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 "lower quality", i.e., artificially distorted by inflation, and warranting lower P/E ratios.
A version of earnings management that became common in the 1990s was A.when management makes changes in the operations of the firm to ensure that earning do not increase or decrease too rapidly. B. reporting "pro forma" earnings". C.when management makes changes in the operations of the firm to ensure that earning do not increase too rapidly. D.when management makes changes in the operations of the firm to ensure that earning do not decrease too rapidly. E. none of the above.
B. reporting "pro forma" earnings" A version of earnings management that became common in the 1990s was reporting "pro forma" earnings.
FCF and DDM valuations should be ____________ if the assumptions used are consistent. A. very different for all firms B. similar for all firms C. similar only for unlevered firms D. similar only for levered firms E. none of the above
B. similar for all firms FCF and DDM valuations should be similar for all firms if the assumptions used are consistent.
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. 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
C. $53.57 $115M - 40M/1.4M = $53.57.
J.C. Penney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of $1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A. $33.00 B. $40.67 C. $77.53 D. $66.00 E. none of the above
C. $77.53 P3 = $2.54(1.08) / (.11 - .08) = $91.44; PV of P3 = $91.44/(1.08)3 = $72.5880; PO = $4.94 + $72.59 = $77.53.
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. 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
C. 1.1 k = 13.9% from 18.64; 13.9 = 5% + b(13% - 5%) = 1.11.
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. 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
C. 16.5% 4% + 1.25(14% - 4%) = 16.5%.
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
C. 30% 6% + 3(14% - 6%) = 30%
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
C. 9.09 g = 13% X 0.5 = 6.5%; .5/(.12 - .065) = 9.09
The present value of growth opportunities (PVGO) is equal to I) the difference between a stock's price and its no-growth value per share. II) the stock's price III) zero if its return on equity equals the discount rate. IV) the net present value of favorable investment opportunities. A. I and IV B. II and IV C. I, III, and IV D. II, III, and IV E. III and IV
C. I, III, and IV
GAAP allows A. no leeway to manage earnings. B. minimal leeway to manage earnings. C. considerable leeway to manage earnings. D. earnings management if it is beneficial in increasing stock price. E. none of the above.
C. considerable leeway to manage earnings. GAAP allows considerable leeway to manage earnings.
Dividend discount models and P/E ratios are used by __________ to try to find mispriced securities. A. technical analysts B. statistical analysts C. fundamental analysts D. dividend analysts E. psychoanalysts
C. fundamental analysts Fundamental analysts look at the basic features of the firm to estimate firm value.
Low 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. P/E ratios are unrelated to growth E. none of the above
C. grow slowly Investors pay for growth; hence a relatively high P/E ratio for growth firms.
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
C. market capitalization rate 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.
Since 1955, Treasury bond yields and earnings yields on stocks were _______. A. identical B. negatively correlated C. positively correlated D. uncorrelated
C. positively correlated. 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.
In the dividend discount model, _______ which of the following are not incorporated into the discount rate? A. real risk-free rate B. risk premium for stocks C. return on assets D. expected inflation rate E. none of the above
C. return on assets A, B, and D are incorporated into the discount rate used in the dividend discount model.
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.
C. the level of uncertainty surrounding the forecast will always be quite high. 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.
The required rate of return on equity is the most appropriate discount rate to use when applying a ______ valuation model. A. FCFF B. FCFE C. DDM D. B or C E. P/E
D. B or C The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity.
________ 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.
D. Tobin's Q 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.
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.
D. the aggregate earnings multiplier. The earnings multiplier approach is the most popular approach to forecasting the overall stock market.
Assume that at the end of the next year, Bolton Company will pay a $2.00 dividend per share, an increase from the current dividend of $1.50 per share. After that, the dividend is expected to increase at a constant rate of 5%. If you require a 12% return on the stock, the value of the stock is ________. A. $28.57 B. $28.79 C. $30.00 D. $31.78 E. none of the above
P1 =2(1.05)/(.12-.05)=$30.00;PV ofP1 =$30/1.12=$26.78;PV ofD1 =2/1.12=1.79;PO = $26.78 + $1.79 = $28.57.
Other things being equal, a low ________ would be most consistent with a relatively high growth rate of firm earnings and dividends. A. dividend payout ratio B. degree of financial leverage C. variability of earnings D. inflation rate E. none of the above
A. dividend payout ratio Firms with high growth rates are retaining most of the earnings for growth; thus, the dividend payout ratio will be low.
A firm's earnings per share increased from $10 to $12, dividends increased from $4.00 to $4.80, and the share price increased from $80 to $90. Given this information, it follows that ________. A. the stock experienced a drop in the P/E ratio B. the firm had a decrease in dividend payout ratio C. the firm increased the number of shares outstanding D. the required rate of return decreased E. none of the above
A. the stock experienced a drop in the P/E ratio $80/$10 = 8; $90/$12 = 7.5
The most appropriate discount rate to use when applying a FCFF valuation model is the ___________. A. required rate of return on equity B. WACCC. risk-free rate D. A or C depending on the debt level of the firm E. none of the above
B. WACC The most appropriate discount rate to use when applying a FCFF valuation model is the WACC.
Which of the following would tend to reduce a firm's P/E ratio? A. The firm significantly decreases financial leverage B. The firm increases return on equity for the long term C. The level of inflation is expected to increase to double-digit levels D. The rate of return on Treasury bills decreases E. None of the above
C. The level of inflation is expected to increase to double-digit levels In times of high inflation, earnings are inflated; thus, P/E ratios decline.
The dividend discount model A. ignores capital gains. B. incorporates the after-tax value of capital gains. C. includes capital gains implicitly. D. restricts capital gains to a minimum. E. none of the above.
C. includes capital gains implicitly. The DDM includes capital gains implicitly, as the selling price at any point is based on the forecast of future dividends.
If a firm has a required rate of return equal to the ROE A. the firm can increase market price and P/E by retaining more earnings. B. the firm can increase market price and P/E by increasing the growth rate. C. the amount of earnings retained by the firm does not affect market price or the P/E. D. A and B. E. none of the above.
C. the amount of earnings retained by the firm does not affect market price or the P/E. If required return and ROE are equal, investors are indifferent as to whether the firm retains more earnings or increases dividends. Thus, retention rates and growth rates do not affect market price and P/ E.
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
D. $1.94 g = .155 X .75 = 10.875%; $1.75(1.10875) = $1.94
The growth in dividends of ABC, Inc. is expected to be 15%/year for the next three years, followed by a growth rate of 8%/year for two years; after this five year period, the growth in dividends is expected to be 3%/year, indefinitely. The required rate of return on ABC, Inc. is 13%. Last year's dividends per share were $1.85. What should the stock sell for today? A. $8.99 B. $25.21 C. $40.00 D. $27.74 E. none of the above
D. $27.74
Many stock analysts assume that a mispriced stock will A. immediately return to its intrinsic value. B. return to its intrinsic value within a few days. C. never return to its intrinsic value. D. gradually approach its intrinsic value over several years. E. none of the above.
D. gradually approach its intrinsic value over several years. Many analysts assume that mispricings may take several years to gradually correct.
If a firm follows a low-investment-rate plan (applies a low plowback ratio), its dividends will be _______ now and _______ in the future than a firm that follows a high-reinvestment-rate plan. A. higher, higher B. lower, lower C. lower, higher D. higher, lower E. It is not possible to tell.
D. higher, lower By retaining less of its income for plowback, the firm is able to pay more dividends initially. But this will lead to a lower growth rate for dividends and a lower level of dividends in the future relative to a firm with a high-reinvestment-rate plan. Figure 18.1 illustrates this graphically.
Earnings managements is A. when management makes changes in the operations of the firm to ensure that earning do not increase or decrease too rapidly. B. when management makes changes in the operations of the firm to ensure that earning do not increase too rapidly. C. when management makes changes in the operations of the firm to ensure that earning do not decrease too rapidly. D. the practice of using flexible accounting rules to improve the apparent profitability of the firm. E. none of the above.
D. the practice of using flexible accounting rules to improve the apparent profitability of the firm. Earnings managements is the practice of using flexible accounting rules to improve the apparent profitability of the firm.
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. 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%
E. 7% k = .04 + 1.25 (.14 - .04); k = .165; .165 = 2/21 + g; g = .07
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%
E. 8.75% 12.5% X 0.7 = 8.75%.
Stingy Corporation is expected have EBIT of $1.2M this year. Stingy Corporation is in the 30% tax bracket, will report $133,000 in depreciation, will make $76,000 in capital expenditures, and have a $24,000 increase in net working capital this year. What is Stingy's FCFF? A. 1,139,000 B. 1,200,000 C. 1,025,000 D. 921,000 E. 873,000
E. 873,000 FCFF = EBIT(1-T) + depreciation - capital expenditures - increase in NWC or 1,200,000(.7) + 133,000 - 76,000 - 24,000 = 873,000
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. BandC
E. B and C Retention rate, or plowback ratio, represents the earnings reinvested in the firm. The retention rate, or (1 - plowback) = dividend payout.
Who popularized the dividend discount model, which is sometimes referred to by his name? A. Burton Malkiel B. Frederick Macaulay C. Harry Markowitz D. Marshall Blume E. Myron Gordon
E. Myron Gordon The dividend discount model is also called the Gordon model.
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 .10 = (32 - P + 1.25) / P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.
The goal of fundamental analysts is to find securities A. whose intrinsic value exceeds market price. B. with a positive present value of growth opportunities. C. with high market capitalization rates. D. all of the above. E. none of the above.
A. whose intrinsic value exceeds market price.
Siri had a FCFE of $1.6M last year and has 3.2M shares outstanding. Siri's required return on equity is 12% and WACC is 9.8%. If FCFE is expected to grow at 9% forever, the intrinsic value of Siri's shares are ____________. A. $68.13 B. $18.67 C. $26.35 D. $14.76 E. none of the above
B. $18.67 $1.6M/3.2M = $0.50 FCFE per share; .50 * 1.09 = .545; .545/(.12 - .09) = 18.67
Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expectedto have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The projected free cash flow of Utica Manufacturing Company for the coming year is _______. A. $150,000 B. $180,000 C. $300,000 D. $380,000 E. none of the above
B. $180,000
Investors want high plowback ratios A. for all firms. B. whenever ROE > k. C. whenever k > ROE. D. only when they are in low tax brackets. E. whenever bank interest rates are high.
B. whenever ROE > k. Investors prefer that firms reinvest earnings when ROE exceeds k.
For most firms, P/E ratios and risk A. will be directly related. B. will have an inverse relationship. C. will be unrelated. D. will both increase as inflation increases. E. none of the above.
B. will have an inverse relationship. In the context of the constant growth model, the higher the risk of the firm the lower its P/E ratio.
Consider the free cash flow approach to stock valuation. F&G Manufacturing Company is expectedto have before-tax cash flow from operations of $750,000 in the coming year. The firm's corporate tax rate is 40%. It is expected that $250,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $125,000. After the coming year, cash flows are expected to grow at 7% per year. The appropriate market capitalization rate for unleveraged cash flow is 13% per year. The firm has no outstanding debt. The total value of the equity of F&G Manufacturing Company should be A. $1,615,156.50 B. $2,479,168.95 C. $3,333,333.33 D. $4,166,666.67 E. none of the above
D. $4,166,666.67 Projected free cash flow = $250,000; V0 = 250,000 / (.13 - .07) = $4,166,666.67.
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.
D. A and B. The Gordon model assumes constant growth indefinitely. Mathematically, g must be less than k; otherwise, the intrinsic value is undefined.
According to Peter Lynch, a rough rule of thumb for security analysis is that A. the growth rate should be equal to the plowback rate. B. the growth rate should be equal to the dividend payout rate. C. the growth rate should be low for emerging industries. D. the growth rate should be equal to the P/E ratio. E. none of the above.
D. the growth rate should be equal to the P/E ratio. A rough guideline is that P/E ratios should equal growth rates in dividends or earnings.
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.
D. will be less than the intrinsic value of stock Y PV0 = D1/(k-g); given k and g are equal, the stock with the larger dividend will have the higher value.
Because the DDM requires multiple estimates, investors should A. carefully examine inputs to the model. B. perform sensitivity analysis on price estimates. C. not use this model without expert assistance. D. feel confident that DDM estimates are correct. E. both A and B.
E. both A and B. Small errors in input estimates can result in large pricing errors using the DDM. Therefore, investors should carefully examine input estimates and perform sensitivity analysis on the results.
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. 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
E. none of the above The price of $90.
