mouse123

Gwangwa Gold, a South African gold producer, has as its primary asset a mine which is shown on the balance sheet with a value of R100 million. An analyst estimates the market value of this mine to be 90% of book value. The company’s balance sheet shows other assets of R20 million and liabilities of R40 million, and the analyst feels that the book value of these items reflects their market values. Using the asset-based valuation approach, what should the analyst estimate the value of the company to be?

A) R80 million.

B) R70 million.

C) R110 million.

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Market value of assets = 0.9(R100 million) + R20 million = R110 million
Market value of liabilities = R40 million
Estimated net value of company = R110 million − R40 million = R70 million.

mouse123

Regarding the estimates required in the constant growth dividend discount model, which of the following statements is most accurate?

A) Dividend forecasts are less reliable than estimates of other inputs.

B) The variables "k" and "g" are easy to forecast.

C) The model is most influenced by the estimates of "k" and "g."

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The relationship between "k" and "g" is critical - small changes in the difference between these two variables results in large value fluctuations.

mouse123

Which of the following is NOT an advantage of using price-to-book value (PBV) multiples in stock valuation?

A) Book value is often positive, even when earnings are negative.

B) PBV ratios can be compared across similar firms if accounting standards are consistent.

C) Book values are very meaningful for firms in service industries.

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Book values are NOT very meaningful for firms in service industries.

mouse123

One advantage of price/sales (P/S) multiples over price to earnings (P/E) and price-to-book value (PBV) multiples is that:

A) P/S can be used for distressed firms.

B) P/S is easier to calculate.

C) Regression shows a strong relationship between stock prices and sales.

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Unlike the PBV and P/E multiples, which can become negative and not meaningful, the price/sales multiple is meaningful even for distressed firms (that may have negative earnings or book value).

mouse123

Which of the following is least likely an advantage of using price/sales (P/S) multiple?

A) P/S multiples are more reliable because sales data cannot be distorted by management.

B) P/S multiples provide a meaningful framework for evaluating distressed firms.

C) P/S multiples are not as volatile as P/E multiples and hence may be more reliable in valuation analysis.

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Accounting data on sales is used to calculate the P/S multiple. The P/S multiple is thought to be more reliable because sales figures are not as easy to manipulate as the earnings and book value, both of which are significantly affected by accounting conventions. However, it is not true that "sales data cannot be distorted by management" because aggressive revenue recognition practices can influence reported sales.

mouse123

An argument against using the price to cash flow (P/CF) valuation approach is that:

A) non-cash revenue and net changes in working capital are ignored when using earnings per share (EPS) plus non-cash charges as an estimate.

B) cash flows are not as easy to manipulate or distort as EPS and book value.

C) price to cash flow ratios are not as volatile as price-to-earnings (P/E) multiples.

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Items affecting actual cash flow from operations are ignored when the EPS plus non-cash charges estimate is used. For example, non-cash revenue and net changes in working capital are ignored. Both remaining responses are arguments in favor of using the price to cash flow approach.

mouse123

An argument against using the price-to-earnings (P/E) valuation approach is that:

A) earnings can be negative.

B) research shows that P/E differences are significantly related to long-run average stock returns.

C) earnings power is the primary determinant of investment value.

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Negative earnings render the P/E ratio useless. Both remaining factors increase the usefulness of the P/E approach.

mouse123

Which of the following is a disadvantage of using the price-to-book value (PBV) ratio?

A) Book value may not mean much for manufacturing firms with significant fixed costs.

B) Firms with negative earnings cannot be evaluated with the PBV ratios.

C) Book values are affected by accounting standards, which may vary across firms and countries.

The disadvantages of using PBV ratios are:

• Book values are affected by accounting standards, which may vary across firms and countries.
• Book value may not mean much for service firms without significant fixed costs.
• Book value of equity can be made negative by a series of negative earnings, which limits the usefulness of the variable.

mouse123

One advantage to using the price/book value (P/B) ratio over using the price/earnings (P/E) ratio is that P/B can be used when:

A) stock markets are volatile.

B) earnings or cash flows are negative.

C) the firm is in a slow growth phase.

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When earnings are negative, P/E ratios cannot be used but P/B ratios can be used. The firm's rate of growth and the volatility of markets do not suggest advantages of using P/B ratios rather than P/E ratios.