hariRaj

An investor is considering the purchase of Robust Econometrics, Inc., which has a price-to-book (P/B) value ratio of 4.50. Return on equity (ROE) is expected to be 14%, the current book value per share (BVPS) is Sf22.50, and the cost of equity is 12%. The growth rate implied by the current P/B ratio is closest to:

A) 11.43%.

B) 12.57%.

C) 8.00%.

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The P/B ratio of 4.50 and the current BVPS of Sf22.50 imply a market price of Sf101.25(4.5 × 22.5). This implies a growth rate of:

hariRaj

An analyst is considering the purchase of Rylinks, Inc., which has a price to book value (P/B) ratio of 6.00. Return on equity (ROE) is expected to be 13%, current book value per share is $13.00, and the cost of equity is 11%. What growth rate is implied by the current P/B rate?

A) 0.40%.

B) 10.60%.

C) 11.00%.

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The P/B ratio of 6.00 and the current book value per share of $13.00 imply a current market price of $78.00. This implies a growth rate of:
g = r – [{B0(ROE – r)} / {V0 – B0}] = 0.11 – [{13.00(0.13 – 0.11)} / {78.00 – 13.00}] = 0.1060 = 10.60%.
Note that the reading in the curriculum does not provide this expression directly

hariRaj

An investor is considering the purchase of Microscopics, which has a price to book value (P/B) ratio of 4.00. Return on equity (ROE) is expected to be 12%, current book value per share is $12.00, and the cost of equity is 10%. What growth rate is implied by the current P/B rate?

A) 9.33%.

B) 10.00%.

C) 0.67%.

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The P/B ratio of 4.00 and the current book value per share of $12.00 imply a current market price of $48.00. This implies a growth rate of:
g = r – [{B0(ROE – r)} / {V0 – B0}] = 0.10 – [{12.00(0.12 – 0.10)} / {48.00 – 12.00}] = 0.0933 = 9.33%.
Note that the reading in the curriculum does not provide this expression directly.

hariRaj

An analyst is considering the purchase of Delphos Machinery, which has a price-to-book value (P/B) ratio of 8.00. Return on equity (ROE) is expected to be 14%, current book value per share is $12.00, and the cost of equity is 11%. What growth rate is implied by the current P/B rate?

A) 10.57%.

B) 8.43%.

C) 11.00%.

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The P/B ratio of 8.00 and the current book value per share of $12.00 imply a current market price of $96.00. This implies a growth rate of:
g = r − [B0(ROE − r)] / (V0 − B0) = 0.11 − [12.00(0.14 − 0.11)] / (96.00 − 12.00) = 0.1057 = 10.57%.
(Note: the curriculum does not provide this expression directly.)

invic

Continuing residual income is defined as the:

A) permanent as opposed to the transitory part of residual income.

B) residual income that forces the net present value to zero.

C) residual income that is expected beyond the initial forecast time horizon.

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Continuing residual income is defined as the residual income that is expected beyond the initial forecast time horizon. It comes into play when RI is forecast for a defined time horizon and a terminal value based on continuing RI is estimated at the end of that time frame.

invic

A common assumption regarding continuing residual income (RI) is that RI:

A) falls to the average industry level.

B) declines to zero as return on equity (ROE) drops to the cost of equity over time.

C) manifests a generally increasing trend indefinitely.

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It is common to assume that RI declines to zero as ROE drops to the cost of equity over time. Other assumptions analysts may make include RI continues indefinitely at a positive level or RI reflects a decline in ROE to a long-run average level.

invic

The present value of Raver Industries’ projected residual income (RI) for the next five years is £60 per share. Beyond that time horizon, a key analyst projects that the firm will sustain a RI of £11 per share, which is the RI for year 5. Given a cost of equity of 12%, what is the terminal value of the stock as of year 5?

A) £500.00.

B) £560.00.

C) £91.67.

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The stock’s terminal value as of year 5 is:

TV = 11.00 / 0.12 = 91.67

invic

The present value of GB Industries’ projected residual income (RI) for the next five years is 70 per share. Beyond that time horizon, a key analyst projects that the firm will sustain a RI of 15 per share, which is the RI for year 5. Given a cost of equity of 12%, what is the terminal value of the stock as of year 5?

A) £500.00.

B) £560.00.

C) £125.00.

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The stock’s terminal value as of year 5 is:

TV = 15.00/0.12 = 125.00

invic

The present value of Forman Electronics’ projected residual income (RI) for the next five years is £80 per share. Beyond that time horizon a key analyst projects that the firm will sustain a RI of £17 per share, which is the RI for year 5. Given a cost of equity of 13%, what is the terminal value of the stock as of year 5?

A) £130.77.

B) £500.00.

C) £19.96.

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The stock’s terminal value as of year 5 is:

TV = 17.00 / 0.13 = 130.77

invic

Which of the following statements least accurately explains the relationship between the residual income (RI) model, the dividend discount model (DDM), and free cash flow to equity (FCFE):

A) All the models discount future cash flows or income at the required rate of return.

B) FCFE models use historical cash flows.

C) RI models use an equity value from the balance sheet plus the present value of expected future residual income.

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In theory, the same value or total present value should be derived using expected dividends, expected FCFE, or book value plus expected residual income if the underlying assumptions are the same. However, the recognition of value is different because FCFE and DDM models forecast future cash flows, while residual income models start with a balance sheet measure of equity and add the present value of expected future residual income. A residual income model can be used along with other models to assess the consistency of results.