Chapter 10: Equity Valuation

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.

$169 million.

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.

$26.75.

An analyst is attempting to value shares of the Dominion Company. The company has just paid a dividend of $0.58 per share. Dividends are expected to grow by 20 percent next year and 15 percent the year after that. From the third year onward, dividends are expected to grow at 5.6 percent per year indefinitely. If the required rate of return is 8.3 percent, the intrinsic value of the stock is closest to: $26.00. $27.00. $28.00.

$28.00.

Which type of equity valuation model is most likely to be preferable when one is comparing similar companies? A multiplier model. A present value model. An asset-based valuation model.

A multiplier model.

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.

Gordon growth model

A disadvantage of the EV method for valuing equity is that the following information may be difficult to obtain: Operating income. Market value of debt. Market value of equity.

Market value of debt.

An analyst gathers the following information about similar companies in the banking sector: First Bank Prime Bank Pioneer Trust P/B 1.10 0.60 0.60 P/E 8.40 11.10 8.30 Which of the companies is most likely to be undervalued? First Bank. Prime Bank. Pioneer Trust.

Pioneer Trust.

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

free cash flow to equity

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.

future expectations.

Asset-based valuation models are best suited to companies where the capital structure does not have a high proportion of: debt. intangible assets. current assets and liabilities.

intangible assets.

Enterprise value is most often determined as market capitalization of common equity and preferred stock minus the value of cash equivalents plus the: book value of debt. market value of debt. market value of long-term debt.

market value of debt.

An analyst has prepared a table of the average trailing twelve-month price-to-earning (P/E), price-to-cash flow (P/CF), and price-to-sales (P/S) for the Tanaka Corporation for the years 2005 to 2008. Year P/E P/CF P/S 2005 4.9 5.4 1.2 2006 6.1 8.6 1.5 2007 8.3 7.3 1.9 2008 9.2 7.9 2.3 As of the date of the valuation in 2009, the trailing twelve-month P/E, P/CF, and P/S are, respectively, 9.2, 8.0, and 2.5. Based on the information provided, the analyst may reasonably conclude that Tanaka shares are most likely: overvalued. undervalued. fairly valued.

overvalued.

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.

required rate of return.

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.

required rates of return.

In the free cash flow to equity (FCFE) model, the intrinsic value of a share of stock is calculated as: the present value of future expected FCFE. the present value of future expected FCFE plus net borrowing. the present value of future expected FCFE minus fixed capital investment.

the present value of future expected FCFE

The best model to use when valuing a young dividend-paying company that is just entering the growth phase is most likely the: Gordon growth model. two-stage dividend discount model. three-stage dividend discount model.

three-stage dividend discount model.

An analyst determines the intrinsic value of an equity security to be equal to $55. If the current price is $47, the equity is most likely: undervalued. fairly valued. overvalued.

undervalued

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.

$61.65.

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.

$69.33

An analyst has gathered the following information for the Oudin Corporation: Expected earnings per share = €5.70 Expected dividends per share = €2.70 Dividends are expected to grow at 2.75 percent per year indefinitely The required rate of return is 8.35 percent Based on the information provided, the price/earnings multiple for Oudin is closest to: 5.7. 8.5. 9.4.

8.5.

An analyst gathers the following information about two companies: Alpha Corp. Delta Co. Current price per share $57.32 $18.93 Last year's EPS $3.82 $1.35 Current year's estimated EPS $4.75 $1.40 Which of the following statements is most accurate? Delta has the higher trailing P/E multiple and lower current estimated P/E multiple. Alpha has the higher trailing P/E multiple and lower current estimated P/E multiple. Alpha has the higher trailing P/E multiple and higher current estimated P/E multiple.

Alpha has the higher trailing P/E multiple and lower current estimated P/E multiple.

Which of the following statements regarding the calculation of the enterprise value multiple is most likely correct? Operating income may be used instead of EBITDA. EBITDA may not be used if company earnings are negative. Book value of debt may be used instead of market value of debt.

Operating income may be used instead of EBITDA.

With respect to present value models, which of the following statements is most accurate? Present value models can be used only if a stock pays a dividend. Present value models can be used only if a stock pays a dividend or is expected to pay a dividend. Present value 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.

Present value 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.

Which of the following is most likely considered a weakness of present value models? Present value models cannot be used for companies that do not pay dividends. Small changes in model assumptions and inputs can result in large changes in the computed intrinsic value of the security. The value of the security depends on the investor's holding period; thus, comparing valuations of different companies for different investors is difficult.

Small changes in model assumptions and inputs can result in large changes in the computed intrinsic value of the security.

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.

The analyst is valuing a privately held company.

An analyst is attempting to calculate the intrinsic value of a company and has gathered the following company data: EBITDA, total market value, and market value of cash and short-term investments, liabilities, and preferred shares. The analyst is least likely to use: a multiplier model. a discounted cash flow model. an asset-based valuation model.

a discounted cash flow model

Book value is least likely to be considered when using: a multiplier model. an asset-based valuation model. a present value model.

a present value model

In asset-based valuation models, the intrinsic value of a common share of stock is based on the: estimated market value of the company's assets. estimated market value of the company's assets plus liabilities. estimated market value of the company's assets minus liabilities.

estimated market value of the company's assets minus liabilities

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.

free cash flow to equity model

An investor expects to purchase shares of common stock today and sell them after two years. The investor has estimated dividends for the next two years, D1 and D2, and the selling price of the stock two years from now, P2. According to the dividend discount model, the intrinsic value of the stock today is the present value of: next year's dividend, D1. future expected dividends, D1 and D2. future expected dividends and price—D1, D2 and P2.

future expected dividends and price- D1, D2 and P2

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.

in a mature phase of growth.

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.

inaccurate with respect to both historical data and earnings.

The market value of equity for a company can be calculated as enterprise value: minus market value of debt, preferred stock, and short-term investments. plus market value of debt and preferred stock minus short-term investments. minus market value of debt and preferred stock plus short-term investments.

minus market value of debt and preferred stock plus short-term investments.

An analyst estimates the intrinsic value of a stock to be in the range of €17.85 to €21.45. The current market price of the stock is €24.35. This stock is most likely: overvalued. undervalued. fairly valued.

overvalued

An analyst gathers or estimates the following information about a stock: 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+ 4.00% Required rate of return 12% Based on a dividend discount model, the stock is most likely: undervalued. fairly valued. overvalued.

undervalued.

Hideki Corporation has just paid a dividend of ¥450 per share. Annual dividends are expected to grow at the rate of 4 percent per year over the next four years. At the end of four years, shares of Hideki Corporation are expected to sell for ¥9000. If the required rate of return is 12 percent, the intrinsic value of a share of Hideki Corporation is closest to: ¥5,850. ¥7,220. ¥7,670.

¥7,220.