Equity Valuation: R50

An analyst has determined that the appropriate EV/EBITDA for Rainbow Company is 10.2. The analyst has also collected the following forecasted information for Rainbow Company: EBITDA = $22,000,000 Market value of debt = $56,000,000 Cash = $1,500,000 The value of equity for Rainbow Company is closest to: $169 million. $224 million. $281 million.

A is correct. EV = 10.2 × 22,000,000 = $224,400,000 Equity value = EV - Debt + Cash = 224,400,000 - 56,000,000 + 1,500,000 = $169,900,000

Which of the following is most likely a reason for using asset-based valuation? The analyst is valuing a privately held company. The company has a relatively high level of intangible assets. The market values of assets and liabilities are different from the balance sheet values.

A is correct. Asset-based valuations are most often used when an analyst is valuing private enterprises. Both B and C are considerations in asset-based valuations but are more likely to be reasons to avoid that valuation model rather than reasons to use it.

The primary difference between P/E multiples based on comparables and P/E multiples based on fundamentals is that fundamentals-based P/Es take into account: future expectations. the law of one price. historical information.

A is correct. Multiples based on comparables are grounded in the law of one price and take into account historical multiple values. In contrast, P/E multiples based on fundamentals can be based on the Gordon growth model, which takes into account future expected dividends.

An equity analyst has been asked to estimate the intrinsic value of the common stock of Omega Corporation, a leading manufacturer of automobile seats. Omega is in a mature industry, and both its earnings and dividends are expected to grow at a rate of 3 percent annually. Which of the following is most likely to be the best model for determining the intrinsic value of an Omega share? Gordon growth model. Free cash flow to equity model. Multistage dividend discount model.

A is correct. The company is a mature company with a steadily growing dividend rate. The two-stage (or multistage) model is unnecessary because the dividend growth rate is expected to remain stable. Although an FCFE model could be used, that model is more often chosen for companies that currently pay no dividends.

An analyst makes the following statement: "Use of P/E and other multiples for analysis is not effective because the multiples are based on historical data and because not all companies have positive accounting earnings." The analyst's statement is most likely: inaccurate with respect to both historical data and earnings. accurate with respect to historical data and inaccurate with respect to earnings. inaccurate with respect to historical data and accurate with respect to earnings.

A is correct. The statement is inaccurate in both respects. Although multiples can be calculated from historical data, forecasted values can be used as well. For companies without accounting earnings, several other multiples can be used. These multiples are often specific to a company's industry or sector and include price-to-sales and price-to-cash flow.

Jason concludes that Violet Company's shares are accurately priced at their current market value of $55. Given that the company's current dividend of $4.80 is expected to grow at 10% forever, the required rate of return is closest to: 19.6% 8.73% 18.73%

Answer: A D1 = 4.8 (1 + 0.1) = $5.28 Required rate of return = (5.28 / 55) + 0.1 = 0.196 or 19.6%

An analyst gathered the following information regarding Venus Inc.: Current market share price = $6.25 Dividend payout ratio = 0.4 Cost of equity = 12% Given that dividends are expected to grow at a rate of 7% indefinitely, the company's P/E ratio is closest to: 8 125 52

Answer: A P/E = 0.4 / (0.12 - 0.07) = 8

Which stock valuation method would be most appropriate for a company that is expected to pay a high and growing rate of dividends to its shareholders? Dividend discount model Gordon growth model Multistage dividend discount model

Answer: B A multistage dividend discount model is best used for firms with abnormal levels of dividend payouts. The dividend discount model is generally ineffective in valuing equities with high and growing levels of dividends and can even be rendered useless if dividends grow faster than the discount rate.

Which of the following ratios is most likely to be used to compare two companies using different accounting methods that have just started their operations and are expected to experience losses for the first 2 years? Price-to-earnings ratio Price-to-cash flow ratio Price-to-book-value ratio

Answer: B Companies that make losses have negative P/E ratios. Negative P/E ratios are useless as far as relative valuation is concerned. Accounting differences can impair the comparability of P/BV ratios across companies. Price to cash flow is more stable than the P/E ratio. Using this ratio gets around the problems related to differences in accounting methods used by companies.

James is evaluating whether or not to invest in Gamma Corporation's stock. He gathered the following information regarding the company: Current market share price = $60.58 Cost of equity = 14.4% Dividend growth rate = 10.5% Given that the company's current dividend amounts to $2.35 per share, which of the following statements is most accurate? James should not invest in the company's stock as it is overvalued. James should invest in the company's stock as it is undervalued. James should not invest in the company's stock as it is undervalued.

Answer: B D1 = 2.35 × 1.105 = $2.59675 Intrinsic value = 2.59675 / (0.144 - 0.105) = $66.58

Which of the following statements regarding the estimation of intrinsic value is true? There are universally accepted methods to calculate intrinsic value. The methods of analysis include only objective factors. The methods of analysis are not straightforward.

Answer: C This type of analysis is not very straightforward because the estimation of intrinsic value requires numerous subjective factors.

An analyst who bases the calculation of intrinsic value on dividend-paying capacity rather than expected dividends will most likely use the: dividend discount model. free cash flow to equity model. cash flow from operations model.

B is correct. The FCFE model assumes that dividend-paying capacity is reflected in FCFE.

The Gordon growth model can be used to value dividend-paying companies that are: expected to grow very fast. in a mature phase of growth. very sensitive to the business cycle.

B is correct. The Gordon growth model (also known as the constant growth model) 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.

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: $25.00. $26.75. $28.50.

B is correct. The expected annual dividend is 4.80% × $25 = $1.20. The value of a preferred share is $1.20/0.0449 = $26.73.

Two analysts 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: time horizons. required rates of return. estimated dividend growth rates.

B is correct. The required rate of return, r, 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 investor is considering the purchase of a common stock with a $2.00 annual dividend. The dividend is expected to grow at a rate of 4 percent annually. If the investor's required rate of return is 7 percent, the intrinsic value of the stock is closest to: $50.00. $66.67. $69.33.

C is correct. According to the Gordon growth model, V0 = D1/(r - g). In this case, D1 = $2.00 × 1.04 = $2.08, so V0 = $2.08/(0.07 - 0.04) = $69.3333 = $69.33.

Which of the following is most likely used in a present value model? Enterprise value. Price to free cash flow. Free cash flow to equity.

C is correct. It is a form of present value, or discounted cash flow, model. Both EV and FCFE are forms of multiplier models.

The Beasley Corporation has just paid a dividend of $1.75 per share. If the required rate of return is 12.3 percent per year and dividends are expected to grow indefinitely at a constant rate of 9.2 percent per year, the intrinsic value of Beasley Corporation stock is closest to: $15.54. $56.45. $61.65.

C is correct. P0 = D1/(r - g) = 1.75(1.092)/(0.123 - 0.092) = $61.65.

A price earnings ratio that is derived from the Gordon growth model is inversely related to the: growth rate. dividend payout ratio. required rate of return.

C is correct. The justified forward P/E is calculated as follows: P0/E1= D1/E1/ (r−g)

A price earnings ratio that is derived from the Gordon growth model is inversely related to the: growth rate. dividend payout ratio. required rate of return.

C is correct. The justified forward P/E is calculated as follows: P0E1=(D1/E1)/r−g P/E is inversely related to the required rate of return, r, and directly related to the growth rate, g, and the dividend payout ratio, D/E.