Equity Section (CFA Level II)
In what stage of growth would a firm most likely NOT pay dividends? A) Initial growth stage. B) Declining stage. C) Transition stage.
A is correct During the initial growth stage, the firm is able to exploit opportunities to earn greater than the required return. During this stage, earnings are reinvested in the growth opportunities rather than returned to the investors.
if a corporation has significant debt which of the following should be the preferred calculation? A.) FCFE B.) FCFF C.) Residual Income
B is correct FCFF is more useful then FCFE if a company has significant debt
which of the following is an example of economies of scale? A.) Average cost of production INCREASES as production INCREASES B.) Average cost of production DECREASES as production INCREASES C.) Average cost of production DECREASES as production DECREASES
B is correct
If the growth rate in dividends is too high, it should be replaced with: A) a growth rate closer to that of gross domestic product (GDP). B) the average growth rate of the industry. C) the growth rate in earnings per share.
A is correct A firm cannot, in the long term, grow at a rate significantly greater than the growth rate of the economy in which it operates. If the growth rate in dividends is too high, then it is best replaced by a growth rate closer to that of GDP.
What is the calculation for "traditional CF"? A.) CFO - preferred dividends B.) Net Income + Non Cash Charges (NCC) C.) CFO + Interest (1-Tc)
B is correct C is the calculation for adjusted CFO Double Check with formulA SHEET
Free cash flow to equity valuation uses which discount rate? A) Cost of equity. B) After-tax cost of debt. C) Weighted average cost of capital.
A is correct
Is the % of tax charged in the country where the firm is domiciled A.) Statutory Tax Rate B.) Effective Tax Rate C.) Cash Tax Rate
A is correct
The three-stage dividend discount model (DDM) allows for an initial period of: A) high growth, a transitional period of declining growth and a final stable growth phase. B) high growth, a transitional period of stable growth and a final declining growth phase. C) stable growth, a transitional period of high growth and a final declining growth phase.
A is correct
which of the following is NOT a primary determinant of interest expense A.) Quantity of SG&A B.) level of gross debt C.) Interest rate
A is correct
When using the two-stage FCFE model, if increases in working capital appear too high the analyst should: A) use changes that are based upon a working capital ratio that is closer to the industry average. B) switch to a three-stage model. C) normalize them to be equal to zero.
A is correct The best solution is to use changes that are based upon a working capital ratio that approximates the industry average. The problem will not be eliminated by switching to a three-stage FCFE model.
Most firms follow a pattern of growth that includes several stages. The second stage is most likely to be referred to as the: A) transitional stage. B) decline stage. C) maturity stage.
A is correct the stages in order are initial growth --> transition --> mature
Relative to traditional financial models like the dividend discount model, the biggest advantage of spreadsheet modeling is: A) quantity of computations. B) accuracy of computations. C)simplicity of computations.
A is correct Computations are no simpler or more complicated on a spreadsheet as opposed to a calculator. Accuracy tends to be improved with the use of a spreadsheet, because you don't have to punch numbers into a calculator at any stage. However, someone truly concerned with accuracy can do a fine job with a calculator. The spreadsheet stands out when it comes to quantity. Analysts can program many permutations and scenarios into a spreadsheet, using minutes to do what would take hours or even days or weeks with a calculator.
If an asset was fairly priced from an investor's point of view, the holding period return (HPR) would be: A) the same as the required return. B) equal to the alpha returns. C) lower than the required return.
A is correct A fairly priced asset would be one that has an expected HPR just equal to the investor's required return.
Given an equity risk premium of 3.5%, a forecasted dividend yield of 2.5% on the market index and a U.S. government bond yield of 4.5%, what is the consensus long-term earnings growth estimate? A) 5.5%. B) 8.0%. C) 10.5%.
A is correct Equity risk premium = forecasted dividend yield + consensus long term earnings growth rate - long-term government bond yield. Therefore, Consensus long term earnings growth rate = Equity risk premium - forecasted dividend yield + long-term government bond yield Consensus long term earnings growth rate = 3.5% + 4.5% - 2.5%= 5.5%
Which of the following is least likely a use of equity valuation? A) Assessing corporate governance. B)Issuing fairness opinions. C) Projecting the value of corporate actions.
A is correct Equity valuation has many uses including stock selection, reading the market, projecting the value of corporate actions, issuing fairness opinions, and valuing private businesses. Equity valuation is not specifically related to corporate governance.
When calculating the equity value of a firm what is the Free cash flow to equity by? A.) Required Return on Equity B.) Return on Capital C.) WACC
A is correct Equity value also is equal to Firm Value - Market Value of Debt
if the required return of the asset is 8% and the expected return is 10% the asset is? A.) Undervalued B.) overvalued C.) correctly valued
A is correct Expected > required = undervalued Expected < required = overvalued
An increase in growth will cause a price-to-earnings (P/E) multiple to: A) increase. B) decrease. C) there is insufficient information to tell.
A is correct P/E = (1-b) * (1 +G) / (R - G)
Which of the following is included in the Pastor-Stambaugh model? A) Liquidity premium. B) Control premium. C) Marketability premium.
A is correct The Pastor-Stambaugh model adds a liquidity factor to the Fama-French model. The average liquidity premium for equity should be zero. Less-liquid assets should have a positive liquidity beta, and more-liquid assets should have a negative beta.
When an analyst scrutinizes a firm's financial statements to try to discern how accurately the reported information reflects economic reality, and to evaluate the sustainability of the company's performance, the process is most likely to be referred to as a: A) quality of earnings analysis. B) reasonable assurance analysis. C) comprehensive basis of accounting analysis.
A is correct The accuracy and level of detail disclosed in financial reports is referred to as the quality of earnings. When we say "quality of earnings analysis" we are generally referring to scrutinizing all a firm's financial statements (including the balance sheet) to try to determine not only the sustainability of the companies' performance but also how accurately the financial statements reflect economic reality.
To determine which rate of return to use as a discount rate, an analyst should consider the: A) nature of the cash flows being discounted. B) length of the holding period. C) likely return of the stock market over the next year.
A is correct The discount rate should correspond to the type of cash flow being discounted. The holding period determines how we calculate the present value, but not the discount rate. Expected stock-market returns are a suitable discount rate for some investments, but not all.
The five elements of industry structure, as outlined by Michael Porter, include: A) threat of substitutes. B) rivalry among buyers. C) bargaining power of competitors.
A is correct The five elements of industry structure as developed by Professor Michael Porter are: - Threat of new entrants in the industry. - Threat of substitutes. - Bargaining power of buyers. - Bargaining power of suppliers. - Rivalry among existing competitors.
How can we account for different valuations for the same firm from several analysts even if they use the same required returns? A) Valuations are based on the analyst's expectations. B) Valuation models contain random errors. C) The analysts may be biased with personal opinions about management.
A is correct Valuation is based on expectations of future cash flows rather than known values. Each analyst will build expectations of cash flows from the fundamental data and from other factors, internal and external, that the analyst believes will affect the firm's performance.
With regards to CAPM the risk free that should be selected is the: A.) matches the investors time horizon B.) the long-term RF rate C.) the short-term RF rate
A is correct the long term RF rate is selected for the gordon growth model (GGM)
The residual income approach is appropriate for each of the following EXCEPT A.) Firms that have long dividend histories B.) Firms that have negative free cash flow for the foreseeable future C.) Firms that have no dividend histories D.) firms with transparent financial reporting and high quality earnings
A is incorrect Residual income approach is appropriate for firms with no dividend histories.
Net Borrowing from bond holders has an impact on _____________________- A.) Residual Income B.) Free Cash Flow to Equity C.) Free Cash Flow to the Firm
B is correct FCFF an be viewed as the cashflow generated from the firm's core business borrowing money is not generated from the business.
Empirical research shows that each of the following EXCEPT can help explain differences in long-run average stock returns. A.) P/E B.) trailing price multiple C.) P/B D.) P/CF
B is correct
Is the income tax expense as a % of pretax income on the income statement A.) Statutory Tax Rate B.) Effective Tax Rate C.) Cash Tax Rate
B is correct
__________________ is the percentage of new product sales that will replace existing product sales. A.) Deterioration rate B.) Cannibilization rate C.) Replacement rate
B is correct
companies currently experiencing economies of scale have A.) lower margins B.) higher margins
B is correct
if the Internal rate of return (IRR) is equal to the required return the market is A.) Overvalued B.) efficient C.) correctly valued
B is correct
return on capital employed, is similar to ROIC but uses _____________ in the numerator to facilitate comparison between companies that face different tax rates. A.) Invested Capital B.) Pretax operating earnings C.) Net Operating assets C.) EBIT
B --> pretax operating earnings is correct A is incorrect because........ROIC uses Invested capital as the denominator not the numerator.
Alpha Software (AS) recently reported annual earnings per share (EPS) of $1.75, which included an extraordinary loss of $0.19 and an expense of $0.10 related to acquisition costs during the accounting period, neither of which are expected to recur. Given that the most recent share price is $65.00, what is a useful AS's trailing price to earnings (P/E) for valuation purposes? A) 44.52. B) 31.86. C) 37.14.
B ia correct Using an underlying earnings concept, an analyst would add back the temporary charges against earnings: $1.75 + $0.19 + $0.10 = $2.04. The resulting trailing P/E = 65.00 / 2.04 = 31.86.
Once a firm has paid all short and long term debt the next group that the remainder of the money flows to is the A.) Common shareholders B.) bondholders
B is correct The bondholders are considered creditors and are always paid before equity investors.
Chase is running an regional bank in Southern Louisiana. From 2018 to 2019 the profit margin increases by 7%. What is the impact on the P/CF ratio from 2018 to 2019? A.) It decreases B.) It increases C.) it is unaffected
B is correct the P/CF ratios will increase because these two ratios have a direct relationship
The _____________________ model assumes the growth rate starts out high and then declines linearly over the high-growth stage until it reaches the long-run average growth rate A.) Two stage model B.) H-Model C.) The Gordon Growth Model
B is correct the two stage model assumes that a stock will experience high growth for a short period, then immediately fall back to a long-run level.
Which of the following are advantages of using EV/EBITDA? A) EV/EBITDA ignores how different revenue recognition policies affect CFO. B) EBITDA is useful for valuing capital-intensive businesses with high levels of depreciation and amortization. C) If working capital is growing, EBITDA will be larger than CFO.
B is correct A & C are disadvantages
Notes to financial statements contain: A) discussion of the firm's accounting practices and basis of presentation. B) important information about the firm's accounting practices and basis of presentation. C) a description of the firm's financial condition and future prospects.
B is correct A number of important disclosures regarding a firm's accounting practices and the basis on which income and expense are recognized are contained in the footnotes to the financial statements. An overview by management of the company's past, present, and future can be found in the Management discussion and analysis (MD&A) section of a financial statement.
The Dividend Discount Model (DDM) is appropriate for all of the following except? A.) The company has a history of dividend payments. B.) The perspective is that of a majority holder C.) The dividend policy is clear and related to the earnings of the firm. D.) The perspective is that of a minority shareholder.
B is correct DDM is appropriate for MINORITY shareholders but not majority shareholders. Majority holder would have conflict of interest with profitability
EBITDA is sometimes used as a proxy for? A.) Enterprise value B.) FCFF C.) FCFE
B is correct EBITDA is sometimes used as a proxy for FCFF
Free cash flow (FCF) approaches are the best source of value when: A) a firm has preferred stock. B) FCFs track profitability closely over the analyst's forecast horizon. C) a firm is paying a dividend that is higher than the industry average.
B is correct FCF approaches are best when those flows are a good indication of a firm's profitability over the analyst's forecast horizon.
The difference between free cash flow to equity (FCFE) and free cash flow to the firm (FCFF) is: A) before-tax interest and net borrowing. B) after-tax interest and net borrowing. C) earnings before interest and taxes (EBIT) less taxes.
B is correct FCFE = FCFF - [interest expense] (1 - tax rate) + net borrowing.
____________________________is the cash available to common shareholders after funding capital requirements, working capital needs, and debt financing requirements. A.) Residual Income B.) Free Cash Flow to Equity C.) Free Cash Flow to the Firm
B is correct FCFF is available for bond holders and common shareholders. FCFE is only for common shareholders.
Free cash flow to the firm is equal to cash flow from operations minus fixed capital investment: A) minus pre-tax interest expense. B) plus after-tax interest expense. C) minus after-tax interest expense.
B is correct Free cash flow to the firm is equal to cash flow from operations minus fixed capital investment plus after-tax interest expense.
The adjustments to cash flow from operations necessary to obtain free cash flow to the firm (FCFF) are: A) add noncash charges, subtract fixed capital investment, and subtract working capital investment. B) add after-tax interest expense and subtract fixed capital investment. C) add net borrowing and subtract fixed capital investment.
B is correct Free cash flow to the firm is equal to cash flow from operations plus after-tax interest expense [interest(1 − tax rate)] minus fixed capital investment.
If an investor had determined that an asset's market price was too high, (implying that it will soon fall) the expected holding period return (HPR) would be: A) higher than the required return. B) lower than the required return. C) equal to the required return.
B is correct If the investor determined that the asset's price was too high, then the expected HPR would be less than the required return, and the asset would have a negative alpha.
A firm is better valued using the discounted cash flow approach than the P/E multiples approach when: A) expected growth rate is very high. B) earnings per share are negative. C) dividend payout is low.
B is correct P/E multiples are not meaningful when the earnings per share are negative. While this problem can be partially offset by using normalized or average earnings per share, the problem cannot be eliminated.
Which of the following two ratios are likely to be used for determining value as a function of company peer benchmarks? A) Price-to-sales and debt/equity. B) Price-to-earnings and price-to-book. C) Return on equity and net profit margin.
B is correct Relative valuation looks at market-based ratios of comparable companies in the industry. Price-to-sales, price-to-book, price-to-earnings, and price-to-cash flow are examples of ratios used in relative valuation analysis.
The value of a conglomerate derived using a sum-of-the-parts valuation would least accurately be called the: A) breakup value. B) liquidation value. C) private market value.
B is correct Sum-of-the-parts valuation totals the estimated values of each of the company's business divisions as independent going concerns. The value derived using a sum-of-the-parts valuation is also sometimes called the private market value or the breakup value, even when such a restructuring is not necessarily expected.
Terminal value in a multi-stage free cash flow to equity (FCFE) valuation model is often calculated as the present value of: A) a two-stage valuation model's price. B) FCFE divided by the total of required rate on equity minus growth. C) free cash flow divided by the growth rate.
B is correct Terminal values are usually calculated as the present value of the price produced by a constant-growth model as of the beginning of the last stage, which is FCFE / (required rate on equity - growth).
Terminal value in multi-stage free cash flow valuation models is often calculated as the present value of: A) free cash flow divided by the growth rate. B) a constant growth model's price as of the beginning of the last stage. C) a two-stage valuation model's price.
B is correct Terminal values are usually calculated as the present value of the price produced by a constant-growth model as of the beginning of the last stage.
Analyst Charlie Howell, CFA, has constructed two models for determining the required return on equity for Yazz Jazz, a saxophone maker. One takes the company's size into account, the other takes the shares' liquidity into account. Which of the following pairs of equity-return models require the use of: -----------------Size ----------------------Liquidity A) Capital asset pricing model ------ Fama-French B) Build-up -----------------------Pastor Stambaugh C) Build-up ------------------------- Fama -rench
B is correct The build-up method takes into account a company's size and is usually applied to closely held companies for which beta is not available. The Pastor-Stambaugh method is a modified version of the Fama-French factor model that considers liquidity.
For an analyst seeking to value an entire company, the best tool is the: A) capital asset pricing model. B) weighted average cost of capital. C) Pastor-Stambaugh model.
B is correct The capital asset pricing model and Pastor-Stambaugh models are used to calculate the required return on equity. The weighted average cost of capital is used to value an entire company.
In an efficient market, a mutual fund's required return is the same as the: A) net asset value return. B) internal rate of return. C) holding period return.
B is correct The internal rate of return (IRR) is the rate that equates the value of the discounted cash flows to the current price of the security. In an efficient market, where securities are properly priced, the IRR and required return are the same.
With regards to the Gordon Growth Model (GGM) the risk free that should be selected is the: A.) matches the investors time horizon B.) the long-term RF rate C.) the short-term RF rate
B is correct The one matching the investors time horizon is appropriate for CAPM
If we increase the required rate of return used in a dividend discount model, the estimate of value produced by the model will: A) increase. B) decrease. C) remain the same.
B is correct The required rate of return is used in the denominator of the equation. Increasing this factor will decrease the resulting value.
The stable-growth free cash flow to the firm (FCFF) model is most useful in valuing firms that: A) have capital expenditures that are significantly higher than depreciation. B) have capital expenditures that are not significantly higher than depreciation. C) are growing at a rate significantly lower than that of the overall economy.
B is correct The stable-growth FCFF model is useful for valuing firms that are expected to have growth rates close to that of the overall economy. Since the rate of growth approximates that for the overall economy, these firms should have capital expenditures that are not significantly different than depreciation.
Which of the following statements regarding the FCFF models is most accurate? The two-stage FCFF model is more useful than the stable-growth FCFF model when the firm is growing at a rate: A) significantly lower than that of the overall economy. B) significantly higher than that of the overall economy. C) not significantly higher than that of the overall economy.
B is correct The two-stage FCFF model is more useful in valuing a firm that is growing at a rate significantly higher than the overall economy. Since this cannot persist indefinitely, growth will eventually slow to a stable growth rate consistent with that of the economy.
Which of the following is NOT an advantage of EV/EBITDA multiple A.) EBITDA is normally positive even if CF is negative B.) incorporates changes to Working capital investments. C.) it is helpful when comparing firms with varying capital structures D.) if EV/EBITDA for a firm is greater than the benchmark the firm is overvalued.
B is correct This ratio DOES NOT incorporate changes to working capital investments
Which of the following is not one of the three strategies a company can utilize in order to compete and generate profits? A.) Cost leadership B.) Reading the market C.) Product differentiation D.) Focus
B is correct the three strategies to compete and generate profits are: Cost leadership Product differentiation focus
Which model is appropriate when dealing with a privately owned or thinly traded company and you would like to determine how to identify a appropriate beta based on comparable public company's. A.) Farma French B.) Pure play model C.) Pastor Stambaugh
B is correct this model involves unlevering a comparable company's beta and applying the debt of the private thinly traded company. -------------------------------------------------------------- Farma french is a model used to identify the appropriate required return Pastor Stambaugh is a variation of the farma french model
what is the formula for dividend yield? A.) preferred dividend / market price per share B.) preferred dividend / book value price per share C.) common dividend / market price per share D.) common dividend / book value price per share
C is correct
what is the formula for tangible book value? A.) (Total Assets - Total Liabilities) - preferred stock B.) Current Assets - preferred stock - tangible liabilities C.) BV of Equity - intangible assets
BV - intangible assets
One of the key disadvantages of the _________ ratio is this ratio does not capture differences in cost structures across companies. A.) P/E B.) P/B C.) P/S
C is correct
The definition of a PEG ratio is price to earnings (P/E): A) divided by average historical earnings growth rate. B) divided by the average growth rate of the peer group. C) divided by the expected earnings growth rate.
C is correct
The stable-growth free cash flow to equity (FCFE) model is best suited for which of the following types of companies? Companies: A) with patents that will not expire for 20 or more years. B) with significant barriers to entry. C) growing at a rate similar or less than the nominal growth rate of the economy.
C is correct
What is the computation for Book value of equity? A.) (Current Assets - Current Liabilities) - L/T debt B.) Preferred Stock + owners equity C.) (Total Assets - Total Liabilities) - Preferred Stock
C is correct
When calculating the value of a firm what is the Free cash flow to the firm divided by? A.) Required Return on Equity B.) Return on Capital C.) WACC
C is correct
____________________ is the cash available to stockholders after funding capital requirements and expenses associated with debt financing. A.) Free Cash Flow to Firm (FCFF) B.) Dividends C.) Free Cash Flow to Equity (FCFE) D.) Residual Income
C is correct
_________________________ is what the multiple should be if the stock is fairly valued A.) Enterprise value multiple B.) Trailing P/E C.) justified price multiple
C is correct
Recent surveys of analysts report long-term earnings growth estimates as 5.5% and a forecasted dividend yield of 2.0% on the market index. At the time of the survey, the 20-year U.S. government bond yielded 4.8%. According to the Gordon growth model, what is the equity risk premium? A) 7.5%. B) 0.4%. C) 2.7%.
C is correct Equity risk premium = 2.0% + 5.5% - 4.8% = 2.7%
Which of the following models would be most appropriate for a firm that is expected to grow at an initial rate of 10%, declining steadily to 6% over a period of five years, and to remain steady at 6% thereafter? A) The Gordon growth model. B) A two-stage model. C) The H-model.
C is correct The H-model is the best answer, as it avoids an immediate drop to 6% like a two-stage would. The Gordon growth model would not be appropriate.
_________________ is the minimum return an investor requires given the asset's risk A.) expected return B.) Holding Period return C.) required return D.) Discount rate
C is correct required return is also known as cost of equity
One of the limitations of the dividend discount models (DDMs) is that they: A) can only be used for companies that are experiencing stable growth B) are conceptually difficult. C) are very sensitive to growth and required return assumptions.
C is correct DDMs are very sensitive to the growth and required return assumptions, and it is often wise to interpret the value as a range rather than a precise dollar amount. There are versions of DDM models that can be applied to companies transitioning from rapid growth to moderate growth, etc.
Free cash flow (FCF) approaches are the best source of value when: A) a firm has no preferred stock. B) a firm has significant minority interest. C) dividends are paid but do not reflect the company's capacity to pay dividends.
C is correct FCF approaches are best when dividends are paid but do not appear to be representative of the firm's capacity to pay them. Both remaining responses have nothing to do with the decision.
_____________________ is the price of an *arms length transaction* between what a seller would trade an asset to a willing, informed, and able buyer. A.) Market Value B.) Intrinsic Value C.) Fair Market Value D.) Salvage Value
C is correct Fair market value
Free Cash Flow models are appropriate for each of the following except? A.) For firms that do not have a dividend payment history or have a dividend payment history that is not clearly and appropriately related to earnings. B.) For firms with free cash flow that corresponds with their profitability. C.) When the valuation perspective is that of a minority shareholder. D.) When the valuation perspective is that of a controlling shareholder.
C is correct Free cash flow models are not appropriate for minority shareholders. A appears correct as well (Void Question)
The present value of expected future cash flows is the firm's: A) liquidation value. B) terminal value. C) going-concern value.
C is correct Going-concern value is the present worth of expected future cash flows generated by a business.
Joe Bates, CFA, has prepared a schedule of real cash flows for his company's plant expansion. Bates generally uses the weighted average cost of capital to discount such cash flows, but in order to accurately determine the present value of those real cash flows, he should adjust the discount rate to reflect: A) the company's cost of both debt and equity. B) expected changes in the market growth rate. C) expected inflation.
C is correct In the context of cash flows, "real" refers to inflation-adjusted cash flows. The weighted average cost of capital already takes the cost of both debt and equity into account, but this is a nominal, not a real, discount rate. The market's growth rate is rarely relevant to cash flows to the firm and is not part of the WACC calculation.
The ____________ ratio can be useful in valuing companies that are expected to go out of business. A.) P/E B.) trailing price multiple C.) P/B
C is correct P/B can be useful in valuing companies that are expected to go out of business.
One of the primary disadvantages of ________ multiple ratio is that it does not recognize/incorporate value of nonphysical assets A.) Price to sales (P/S) B.) Price to Cash Flow (P/CF) C.) Price to Book (P/B) D.) Price to Earnings (P/E)
C is correct P/B doesn't account for nonphysical assets
What is the preferred multiple for a firm that holds primarily liquid assets? A.) Price to sales (P/S) B.) Price to Cash Flow (P/CF) C.) Price to Book (P/B) D.) Price to Earnings (P/E)
C is correct P/B is used for companys who either have a high/low/volatile P/E ratio or predominately liquid assets.
If a company currently has a very high or very low P/E multiple an analyst should therefore use ______ for valuation purposes? A.) Price to sales (P/S) B.) Price to Cash Flow (P/CF) C.) Price to Book (P/B)
C is correct Price to book is more stable then EPS (Hence P/E ratio)
If a company currently has been having a very volatile P/E ratio over the last five years an analyst should therefore use ______ for valuation purposes? A.) Price to sales (P/S) B.) Price to Cash Flow (P/CF) C.) Price to Book (P/B)
C is correct Price to book is more stable then EPS (Hence P/E ratio)
_____________ is preferable to ROE in some circumstances because it allows comparisons across firms with different capital structures. A.) NOPLAT B.) Invested Capital C.) ROIC D.) quick ratio
C is correct ROIC is preferable to ROIC due to ability to compare across different capital structures
Restoration Software is a growth stock that has never paid a dividend. Free cash flow is forecasted to be negative for the next five years because of Restoration's aggressive expansion plans. Restoration has always received an unqualified opinion from its auditors and is generally considered to have high-quality earnings. Which of the following models is most appropriate to value Restoration? A) Free cash flow to the firm model. B) Free cash flow to equity model. C) Residual income model.
C is correct Residual income models are the best valuation method if the firm does not pay dividends, has negative free cash flow over the forecast horizon, and has transparent financial reporting and high earnings quality.
When attempting to build a risk premium into the required returns of stocks in a developing country, an analyst should use the: A) modified Gordon Growth model. B) country's weighted average cost of capital. C) country spread model.
C is correct The country spread model uses data from a developed market, then adjusts it using the difference between the bond yields for the emerging and developed markets. Neither a modified Gordon Growth model nor a weighted average cost of capital will do this job.
The equity risk premium is the difference between: A) the estimated equity return and the risk-free return. B) estimated equity returns and estimated bond returns. C) the required equity return and the risk-free return.
C is correct The equity risk premium reflects the return in excess of the risk-free rate that investors require for holding stocks. It is derived by subtracting the risk-free return from the required return.
For a company for which the going-concern assumption is not valid, the most appropriate valuation approach would be to calculate its: A) residual income model value. B) dividend discount model value. C) liquidation value.
C is correct The liquidation value is the estimate of what the assets of the firm will bring when sold separately, net of the company's liabilities. It is most appropriate when because the firm is not a going concern and will not pay dividends. The residual income model is based on the going concern assumption, and is not appropriate for valuing a firm that is expected to go out of business.
An analyst focusing mostly on financial stocks is likely to prefer valuing stocks via the: A) dividend yield. B) price/sales ratio. C) price/book ratio.
C is correct The price/book ratio is a preferred tool for valuing financial stocks. Book value is an appropriate measure of net asset value for firms that primarily hold liquid assets. Examples include finance, investment, insurance, and banking firms. P/B can be useful in valuing companies that are expected to go out of business.
Consider the steps in the top down valuation approach as it is applicable for Gold Star. Dentice should forecast the growth of: A) Gold Star, the growth of the oil industry, and then the growth of the overall economy. B) each firm in the oil industry, the growth rate of the oil industry, and the growth rate of the economy. C) the overall economy, growth of the industry, and the growth rate of Gold Star.
C is correct The top down model for valuation would begin with analysis of the overall economy and the expectation of the growth rate in the economy. Further, the impact of the expected growth rate of the economy on the oil industry needs to be ascertained. The second component is the analysis of the oil industry in which Gold Star operates
The equity risk premium is equal to? A.) The risk free rate B.) The expected return - the risk free rate C.) The required return D.) the required return - the risk free rate
D is correct
___________ is most often used for valuing indexes. A.) Price/ CF B.) P/E (Price to Earnings) C.) P/B (Price to book) D) D/P (Dividend Yield)
D is correct
________________________is the amount of earnings during the period that exceeds the investors' required return A.) Free Cash Flow to Firm (FCFF) B.) Dividends C.) Free Cash Flow to Equity (FCFE) D.) Residual Income
D is correct
What is the formula for invested capital? A.) current assets - current liabilities B.) Net operating profit - Operating expenses C.) PPE - Operating expenses D.) Operating Assets - Operating Liabilities
D is correct invested capital is the denominator in the ROIC formula NOPLAT / Invested capital
Consider the following: Current Assets = 970 Total Assets = 1350 Current Liabilities = 800 Total Liabilities = 1050 Dividends = 300 Preferred Stock = 150 MV of Equity = 10000 What is the computation for P/B ratio? A.) 5 B.) 6.66 C.) 7
P/B = MV/BV BV = (TA- TL) - preferred stock 300-150 = 150 1000/150 = 6.66
True or False CFO is preferable to FCFE?
This is False FCFE is preferred even through it is more volatile and more difficult to compute then CFO
What is the two components of total return?
capital appreciation (return or gains) + dividend yield
Out of the two components of total return capital appreciation (return) and dividend yield..... which is the more risky component/
capital appreciation is more risky
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