Equity
Current Price per Share - $22.56 Current Annual dividend per share - $1.60 Annual dividend growth rate for Years 1-4 - 9.00% Annual dividend growth rate for Years 5+ - 4% Required rate of return - 12% Based on a dividend discount model, the stock is most likely: A. Undervalued B. Fairly valued C. Overvalued
Ans: A First step: Add the growth to each year. D1: $1.60(1.09)= 1.744 D2: $1.60(1.09)^2 = 1.900 D3: $1.60(1.09)^3 = 2.072 D4: $1.60(1.09)^4 =2.258 D5: $1.60(1.09)^4(1.04) = 2.349 Second step: find stock value of 1-5 years V0= 2.349/ (0.12-0.04) = $29.363 Third step: Use the req. rate of return for ea. dividend g 1.744/1.12 + 1.900/1.12^2 + 2.072/1.12^3 + 2.258/1.12^4 + 29.363/1.12^4 Fourth step: Add them all = 1.557 + 1.515 + 1.475 + 1.436 + 18.661 = $24.64 (greater than the current price of $22.56)
The primary difference btw P/E multiplies based on comparable and P/E multiples based on fundamentals is that fundamentals-based P/Es take into account: A. future expectations B. the law of one price C. historical information
Ans: A. Multiples based on comparable are grounded in the law of one price and take into account historical multiples values. In contrast, P/E multiples based on fundamentals can be based on the Gordon growth model, which takes into account future expected dividends.
The constant growth model requires which of the following? A. g<k B. g>k C. g =/ k
Ans: A. The required rate is greater than growth rate.
A Canadian life insurance company has an issue of 4.80 percent, $25 par value, perpetual, non-convertible, non-callable preferred shares outstanding. The required rate of return on similar issues is 4.49 percent. The intrinsic value of a preferred share is closest to: A. $25.00 B. $26.75 C. $28.50
Ans: B 4.80% * 25 =$1.20 $1.20/4.49% = $26.73
The Gordon Growth Model can be used to value dividend-paying companies that are: A. Expected to grow very fast B. In a mature phase of growth C. Very sensitive to the business cycle
Ans: B. Gordon Growth Model (constant growth) can be used to value dividend-paying companies in a mature phase of growth. A stable dividend growth rate is often a plausible assumption for such companies.
The analyst is estimating the intrinsic value of a new company. The analyst has one year of financial statements for the company and has calculated the avg values of a variety of price multiples for the industry in which the company operates. The analyst plans to use at least one model from each of the three categories of valuation models. The analyst is least likely to rely on an estimate from the: A. Multiplier Model(s) B. Present Value Model(s) C. Asset-Based Valuation Model(s)
Ans: B. Present Value Model - because the company has only one year of data available, the analyst is least likely to be confident in the inputs for a PV model. The values on the balance sheet, even before adjustment, are likely to be close to the market value because the asset are all relatively new. The multiplier models are based on avg multiplies from the industry.
Two analyst estimating the value of a non-convertible, non-callable, perpetual preferred stock with a constant dividend arrive at different estimated values. The most likely reason for the difference is that the analysts used different: A. Time horizons B. Required rates of return C. Estimated dividend growth rate
Ans: B. The req. rate of return, r/k, can vary widely depending on the inputs and is not unique. A preferred stock with a constant dividend would not have a growth rate to estimate, and the investor's time horizon would have no effect on the calculation of intrinsic value.
An analyst is attempting to calculate the intrinsic value of a company and has gathered the following data: EBITDA, total market value, MV of cash and short term investments, liabilities and preferred shares. The analyst is least likely to use: A. Multiplier Model B. Discounted Cash Flow Model C. An asset based valuation model
Ans: B. To use discounted CF model, analyst will require FCFE or dividend date. In addition, the analyst will need data to calculate an appropriate discount rate.
The best model to use when valuing a young divided-paying company that is just entering the growth phase is most likely the: A. Gordon Growth Model B. Two-Stage DDM C. Three-Stage DDM
Ans: C. The three stage model is appropriate for young companies just entering the growth stage. The two stage model is best for companies that are transitioning from a growth stage to a mature stage The Gordon Model is best suited for valuing mature companies
In asset-valuation models, the intrinsic value of a common share of stock is based on the: A. estimated MV of company's assets B. estimated MV of company's asset plus liabilities C. estimated MC of company's asset minus liabilities
Answer B
All else equal, an increase in a company's growth rate will most likely cause its P/E ratio to: A. Decrease B. Increase C. either increase or decrease
B. Increase : References Increase in g: As g increases, the spread between ke and g, or the P/E denominator, will decrease, and the P/E ratio will increase.
The risk of a preferred stock is based on the: A. Uncertainty of its dividends B. Uncertainty of its price C. Uncertainty of its total return
C. Uncertainty of its total return. The total return includes its dividends and price.
With respect to PV models
PV Models can be used for stocks that currently pay a dividend, are expected to pay a dividend, or are not expected to pay a dividend.
