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标题: Equity Valuation【Reading 42】Sample [打印本页]
作者: hariRaj    时间: 2012-3-31 17:52     标题: [2012 L2] Equity Valuation【Session 12- Reading 42】Sample

Market value added is calculated as:
A)
net operating profit after taxes minus a charge for total capital.
B)
market value of the company minus a charge for equity capital.
C)
market value of the company minus total capital.


Market value added is the market value of the company minus total capital. It is used to measure the effect on value of management’s decisions since the firm’s inception.
作者: hariRaj    时间: 2012-3-31 17:52

Economic value added (EVA®) is calculated as net operating profit after taxes minus:
A)
a charge for total capital.
B)
a charge for equity capital.
C)
capital expenditures.


EVA = NOPAT – (C% × TC), where NOPAT is a firm’s net operating profit after taxes, C% is the cost of capital, and TC is total capital.
作者: hariRaj    时间: 2012-3-31 17:53

A common adjustment in calculating economic value added (EVA®) is to:
A)
add back deferred taxes.
B)
capitalize and amortize research and development expenses.
C)
treat capital leases as operating leases.


It is common to capitalize and amortize research and development (R&D) expenses and add R&D expenses back to earnings. Deferred taxes are eliminated to pick up only cash taxes. Operating leases are treated as capital leases.
作者: hariRaj    时间: 2012-3-31 18:13

Which of the following is the most appropriate tool to measure managerial effectiveness, goodwill impairment, and equity value?
A)
Residual income.
B)
Gordon growth model.
C)
Free cash flow to the firm.


Residual income is commonly used to measure managerial effectiveness, goodwill impairment and equity value. The Gordon Growth Model (GGM) would not be appropriate in instances where the underlying assumptions (such as stable growth in perpetuity) do not apply. Free cash flow to the firm and price to sales would often not be appropriate tools to measure goodwill impairment.
作者: hariRaj    时间: 2012-3-31 18:13

A residual income model would be least appropriate as a tool to measure which of the following?
A)
Economic income.
B)
Goodwill impairment.
C)
Operating leverage.


Operating leverage is not measured directly by residual income models, although operating leverage may have an effect on the residual income measured. Residual income models are intended as a measure of economic income, and are often used to measure goodwill impairment
作者: hariRaj    时间: 2012-3-31 18:14

The residual income approach is appropriate when:
A)
a firm pays high dividends that are quite stable.
B)
the clean surplus accounting relation is violated significantly.
C)
a firm does not pay dividends or the payments are too volatile to be sufficiently predictable.


The residual income approach is appropriate when a firm does not pay dividends or the payments are too volatile to be sufficiently predictable. It is not appropriate when the clean surplus accounting relation is violated significantly. A firm that pays high dividends that are quite stable is also a poor candidate for the approach.
作者: hariRaj    时间: 2012-3-31 18:14

Creative Gardening is expected to have a return on equity (ROE) of 13% for the next five years and 10% thereafter, indefinitely. Its current book value per share as of the beginning of year 1 (i.e., the end of year 0) is $7.50 per share and its required rate of return is 10%. The premium over book value at the end of five years is expected to be 30%. All earnings are reinvested. The sum of the present values of the residual income estimates over the next five years is $1.10. The projected ending book value in year 5 is $13.83. What is the value of Creative Gardening using these inputs?
A)
$11.18.
B)
$13.83.
C)
$8.60.


Applying the finite horizon residual income valuation model:
V0 = B0 + sum of discounted RIs + discounted premium

= 7.50 + 1.10 + [(0.30)(13.83)/(1.10)5] = $11.18
作者: hariRaj    时间: 2012-3-31 18:14

Red Shoes’s recent financial statements reported a book value of $11.00 per share; its required rate of return is 9%. Analyst Tony Giancola, CFA, wants to calculate the company’s intrinsic value using a multistage residual income with a high-growth RI for the next 5 years. Giancola creates the following estimates: PV of interim high-growth RI for the next 5 years is $ 2.90 At the end of year 5, the PV of continuing RI is $7.00 Estimated Book Value in 5 years is $14.00
Which of the following is closest to the current intrinsic value of Red Shoes?
A)
$18.45.
B)
$20.90.
C)
$9.90.


Applying the multistage residual income model:

V0 = B0 + PV of interim high-growth RI + PV of continuing RI
= 11.00 + 2.90 + [(7.00) / (1.09)5] = $18.45
作者: hariRaj    时间: 2012-3-31 18:15

Brown Manufacturing’s recent financial statements reported a book value of $9.50 per share; its required rate of return is 10%. Analyst Tony Giancola, CFA, wants to calculate the company’s intrinsic value using a multistage residual income with a high-growth RI for the next 5 years. Giancola creates the following estimates: PV of interim high-growth RI for the next 5 years is $3.10 At the end of year 5, the PV of continuing RI is $10.00 Estimated Book Value in 5 years is $25.00
Which of the following is closest to the current intrinsic value of Brown Manufacturing?
A)
$18.81.
B)
$22.60.
C)
$13.10.


Applying the multistage residual income model:

V0 = B0 + PV of interim high-growth RI + PV of continuing RI
= 9.50 + 3.10 + [(10.00) / (1.10)5] = $18.81
作者: hariRaj    时间: 2012-3-31 18:15

If a multistage residual income model does not consider a persistence factor, the analyst using the model is most likely assuming that residual income:
A)
falls to an industry norm.
B)
falls to zero over time.
C)
falls to zero immediately.


The assumption that residual income declines to a long-run level in a mature industry allows for the use of a simpler formula that does not require a persistence factor. Both of the other assumptions listed require an equation that uses the persistence factor.
作者: hariRaj    时间: 2012-3-31 18:16

Krieger String & Twine expects to generate a return on equity (ROE) of 13.6% in each of the next five years. The required ROE is 8.7%. Current book value is $12.40 per share and the firm pays no dividends. Krieger previously assumed residual income falls to zero immediately after five years, but has now decided to recalculate its estimated value using a persistence factor of 35%. The difference between the new valuation and the old one is closest to:
A)
$0.32 per share.
B)
$0.16 per share.
C)
$0.64 per share.


To answer this question, we need to establish the residual values using the following equations:
Earnings = prior year book value × ROE
Equity charge = prior year book value × required ROE
Residual income = earnings − equity charge
Here is a table containing the relevant values.
YearEarnings (ROE = 13.60%)Book ValueEquity Charge (Required ROE = 8.70%)Residual IncomePV of Residual Income
0 $12.40
1$1.69$14.09$1.08$0.61$0.56
2$1.92$16.00$1.23$0.69$0.58
3$2.18$18.18$1.39$0.78$0.61
4$2.47$20.65$1.58$0.89$0.64
5$2.81$23.46$1.80$1.01$0.67

Company value = $12.40 + the sum of the residual incomes
Assuming residual value drops to zero after year five, the company is valued at $15.46 per share.
Now, we modify the model to reflect the persistence factor of 35%. The only value that persistence factor effects is the terminal value. Instead of discounting the Year 5 residual income by 1 + required ROE, we discount it by 1 + required ROE − persistence factor. The new values are as follows:
Book ValueYear 1Year 2Year 3Year 4/5
Value$12.40$0.56$0.58$0.61$1.62

For a total value of $15.78 per share, or $0.32 higher than the original value.
作者: hariRaj    时间: 2012-3-31 18:16

Assuming that the growth rate is less than the required rate of return (r), an increase in return on equity (ROE) will cause value in a residual income (RI) model to:
A)
there is insufficient information to derive the effects of increasing ROE on RI.
B)
decrease if ROE is greater than the required rate of return.
C)
increase if ROE is greater than the required rate of return.


An increase (decrease) in ROE increases (decreases) value if the ROE exceeds the required rate of return. This is revealed by the RI valuation expression
作者: hariRaj    时间: 2012-3-31 18:16

Professor Cliff Webley made the following statements in his asset-valuation class:
Statement 1: “Over time, a company’s residual income growth tends to approach the industry average.”
Statement 2: “If actual return on equity equals required return on equity, the residual income model sets the company’s proper market value equal to its book value.”
Statement 3: “The single-stage residual income model should give you the same valuation as the Gordon Growth model.”
Which of Webley’s statements is least accurate?
A)
Statement 2.
B)
Statement 3.
C)
Statement 1.


Over time, a company’s residual income growth tends to approach zero. It is unlikely that an industry’s average growth rate is zero, so Statement 1 is questionable. The other two statements are accurate.
作者: hariRaj    时间: 2012-3-31 18:17

The single-stage residual income model values a company at:
A)
book value plus the present value of the firm’s expected economic profits.
B)
book value times a factor determined by the discount rate.
C)
book value plus the terminal value discounted at the weighted average cost of capital.


The single-stage residual income model values a company at book value plus the present value of the firm’s economic profits, or the additional value generated by the firm’s ability to produce returns higher than the cost of equity.
作者: hariRaj    时间: 2012-3-31 18:17

In a single-stage residual income model for a firm with return on equity (ROE) greater than the required rate of return, which statement is least accurate?
A)
Market value will be greater than book value.
B)
The justified price-to-book value (P/B) ratio will be greater than one.
C)
Free cash flow to equity will be positive.


In a single-stage residual income model with ROE greater than the required rate of return, justified P/B will be greater than one and market value will be greater than book. There is no clear relationship with free cash flow to equity.
作者: hariRaj    时间: 2012-3-31 18:17

In a single-stage residual income model for a firm with return on equity (ROE) greater than the required rate of return, which statement is least accurate?
A)
Market value will be greater than book value.
B)
The justified price-to-book value (P/B) ratio will be greater than one.
C)
Free cash flow to equity will be positive.


In a single-stage residual income model with ROE greater than the required rate of return, justified P/B will be greater than one and market value will be greater than book. There is no clear relationship with free cash flow to equity.
作者: hariRaj    时间: 2012-3-31 18:18

Assuming that the growth rate is less than the required rate of return (r), a decrease in initial book value will cause value in a residual income (RI) model to:
A)
decrease.
B)
increase.
C)
there is insufficient information to determine the effect on RI.


A decrease (increase) in initial book value decreases (increases) value. This is revealed by the RI valuation expression:
V0 = B0 + [(ROE – r) / (r – g)]B0
作者: hariRaj    时间: 2012-3-31 18:19

Advanced Instruments reported the following for the end of its fiscal year:
If the required rate of return is 15%, what is the value of the shares using a single-stage residual income model?
A)
$12.77.
B)
$7.56.
C)
$4.78.


Retention ratio = (0.68 – 0.17) / 0.68 = 0.75 or 75%
Equity = Assets – liabilities = $33.8 million − $13.8 million = $20 million
Book value per share = Total equity / shares outstanding = $20 million / 5 million = $4.00
ROE = $0.68 / $4.00 = 0.17 or 17%
g = retention ratio × ROE = (0.75) × 0.17 = 0.1275 or 12.75%
作者: hariRaj    时间: 2012-3-31 18:19

Midland Semiconductor has a book value of $10.50 per share. The company’s return on equity is 20%, and its required return on equity is 17%. The dividend payout ratio is 30%. What is the value of the shares using a single-stage residual income model?
A)
$10.50.
B)
$21.00.
C)
$31.50.


g = retention ratio × ROE = (1 − 0.30) × 0.20 = 0.14 or 14%


作者: hariRaj    时间: 2012-3-31 18:20

Big Sky Ranches reported the following for the end of its fiscal year:
The beta for Big Sky Ranches is 1.2, the current risk-free rate is 4.5%, and the expected return on the market is 12.5%.  What is the value of the shares using a single-stage residual income model?
A)
$11.28.
B)
$23.23.
C)
$8.10.


After tax earnings = Pretax earnings × (1 − T) = 8.6 million × (1 − 0.35) = $5.59 million
EPS = After tax earnings/shares outstanding = $5.59 million / 8 million = $0.70
Retention ratio = (0.70 − 0.35) / 0.70 = 0.50 or 50%
Equity = Assets − liabilities = $53.2 million − $27.8 million = $25.4 million
Book value per share = Total equity/shares outstanding = $25.4 million / 8 million = $3.18
ROE = $0.70 / $3.18 = 0.22 or 22%
g = retention ratio × ROE = (0.50) × 0.22 = 0.11 or 11.00%
Expected return = 0.045 + [0.125 − 0.045]1.2 = 0.1410 or 14.10 %
作者: hariRaj    时间: 2012-3-31 18:20

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%.


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:
作者: hariRaj    时间: 2012-3-31 18:20

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%.


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
作者: hariRaj    时间: 2012-3-31 18:21

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%.


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.
作者: hariRaj    时间: 2012-3-31 18:21

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%.


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.)
作者: invic    时间: 2012-4-2 16:38

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.


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.
作者: invic    时间: 2012-4-2 16:39

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.


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.
作者: invic    时间: 2012-4-2 16:39

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.


The stock’s terminal value as of year 5 is:
TV = 11.00 / 0.12 = 91.67
作者: invic    时间: 2012-4-2 16:39

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.


The stock’s terminal value as of year 5 is:
TV = 15.00/0.12 = 125.00
作者: invic    时间: 2012-4-2 16:40

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.


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

TV = 17.00 / 0.13 = 130.77
作者: invic    时间: 2012-4-2 16:41

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.


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.
作者: invic    时间: 2012-4-2 16:41

Which description of the relationship among residual income, dividend discount (DDM) and free cash flow to equity (FCFE) models is least accurate?
A)
Residual income differs from DDM and FCFE in that residual income starts with book value.
B)
The different models should result in different intrinsic values because of the theoretical differences in the models.
C)
Residual income differs from DDM and FCFE in that it discounts income rather than cash.


The three models should all produce the same intrinsic value as long as the underlying assumptions are the same. The differences in intrinsic values arise from difficulty in estimating the inputs, not from theoretical differences in the models. Since they should produce the same results, they can be used to assess consistency. Residual income differs from DDM and FCFE in the use of accounting assumptions, including book value and discounting income.
作者: invic    时间: 2012-4-2 16:49

Which statement best describes the relationship between the residual income model and the free cash flow to equity model?
A)
Intrinsic value calculated by both should be the same if the assumptions are the same.
B)
They do not rely on accounting assumptions.
C)
They both discount a future stream of cash flows.


Theoretically the intrinsic value calculated by both should be the same, but since they use different approaches the values are often different in practice. Residual income relies on book value and discounts income, not cash flow.
作者: invic    时间: 2012-4-2 16:49

A use of the residual income (RI) valuation approach is:
A)
deferring value more than in competing valuation approaches.
B)
providing more reliable estimates of terminal value.
C)
providing a check of consistency between competing approaches like free cash flow of equity (FCFE) and dividend discount model (DDM) .


A RI model can be used along with other models to assess the consistency of results. FCFE and DDM models forecast future cash flows while RI models start with a balance sheet measure of equity and add the present value of expected future RI.
作者: invic    时间: 2012-4-2 16:57

An argument against using the residual income (RI) valuation approach is that:
A)
terminal value does not dominate total present value as is the case in dividend and free cash flow valuation models.
B)
the models rely on accounting data that can be manipulated by management.
C)
the models focus on economic rather than just on accounting profitability.


An argument against using the RI approach is that the models rely on accounting data that can be manipulated by management. Both remaining responses are arguments in favor of the approach.
作者: invic    时间: 2012-4-2 17:13

The residual income approach is appropriate when:
A)
expected free cash flows are negative for the foreseeable future.
B)
a firm pays high dividends that are quite stable.
C)
the clean surplus accounting relation is violated significantly.


The residual income approach is appropriate when expected free cash flows are negative for the foreseeable future. It is not appropriate when the clean surplus accounting relation is violated significantly. A firm that pays high dividends that are quite stable is also a poor candidate for the approach.
作者: invic    时间: 2012-4-2 17:14

The residual income approach is NOT appropriate when:
A)
a firm does not pay dividends or the stream of payments is too volatile to be sufficiently predictable.
B)
the clean surplus accounting relation is violated significantly.
C)
expected free cash flows are negative for the foreseeable future.


The residual income approach is not appropriate when the clean surplus accounting relation is violated significantly. Both remaining responses describe circumstances in which the approach is appropriate.
作者: invic    时间: 2012-4-2 17:14

Analyst Brett Melton, CFA, is looking at two companies. Happy Cow Dairies has volatile cash flows, and its free cash flow is often negative. The company pays no dividends. Glitter and Gold, a maker of girls’ clothing, has a fairly steady stream of earnings and cash flows but takes a lot of charges against equity. Is the residual income model suitable for valuing the two companies?
Happy Cow DairiesGlitter and Gold
A)
NoYes
B)
YesNo
C)
NoNo


Residual income models work for companies with no dividends and volatile or negative cash flows. They do not work, however, when the clean surplus relation does not hold, as is the case when companies take charges against equity.
作者: invic    时间: 2012-4-2 17:14

Which of the following characteristics of a company would make it unsuitable for residual income valuation analysis?
A)
Book-value estimates are not reliable.
B)
The forecast of terminal value is not reliable.
C)
Free cash flows are negative and likely to remain so for some time.


Residual income models can handle negative free cash flows and poor forecasts for terminal value. However, poor book-value estimates render the statistic less useful.
作者: invic    时间: 2012-4-2 17:15

Reported accounting data are most likely to bias an estimate of residual income when:
A)
the clean surplus relation holds.
B)
standards allow charges directly to stockholders' equity while bypassing the income statement.
C)
standards allow charges directly to stockholders' equity that are also reflected on the income statement.


Bias is likely when standards allow charges directly to stockholders’ equity while bypassing the income statement. Both remaining responses are consistent with the use of data that will not introduce a bias.
作者: invic    时间: 2012-4-2 17:15

general, firms making aggressive accounting decisions will report future earnings that are:
A)
lower.
B)
higher.
C)
inflation-adjusted.


In general, firms making aggressive (conservative) accounting decisions will report higher (lower) book values and lower (higher) future earnings.
Firms may adopt aggressive accounting practices that overstate the value of earnings by, for example, accelerating revenues to the current period or deferring expenses to a later period. Current earnings will be higher, but future earnings will be lower.
作者: invic    时间: 2012-4-2 17:17

Big Sky Ranches reported the following for the end of its fiscal year:
The current share price is $11.28 per share. The shares (relative to a single-stage residual income model) are most likely:
A)
undervalued.
B)
overvalued.
C)
correctly valued.


g = retention ratio × ROE = (0.50) × 0.22 = 0.11 or 11.00%




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