Reading 56: An Introduction to Security Valuation LOSf习题精 2010, suppliers, products, required, company

honeycfa

LOS f: Estimate the dividend growth rate, given the components of the required rate of return incorporating the earnings retention rate and current stock price.

If a company can convince its suppliers to offer better terms on their products leading to a higher profit margin, the return on equity (ROE) will most likely:

A) increase and the stock price will increase

B) increase and the stock price will decline.

C) decrease and the stock price will increase.

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Better supplier terms lead to increased profitability. Better profit margins lead to an increase in ROE. This leads to an increase in the dividend growth rate. The difference between the cost of equity and the dividend growth rate will decline, causing the stock price to increase.

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Assuming past investments are stable and earnings are calculated to allow for maintenance of past earnings power, the firm’s expected dividend growth rate can be estimated by its:

A) sustainable growth rate.

B) price to earnings ratio.

C) risk premium.

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Assuming past investments are stable and earnings are calculated to allow for maintenance of past earnings power, then the firm’s expected dividend growth rate (g) can be defined as the firm’s earnings plowback or retention rate (RR) times the return on the equity (ROE) portion of new investment. RR is equal to 1 minus the dividend payout ratio, and ROE equals profit margin times total asset turnover times financial leverage. This growth rate is also called the sustainable growth rate.

honeycfa

All else equal, the price-to-earnings (P/E) ratio of a stable firm will increase if the:

A) ROE is increased.

B) dividend payout is decreased.

C) long-term growth rate is decreased.

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The increase in growth rate will increase the P/E ratio of a stable firm and growth rate can be calculated by the formula g = ROE * retention ratio. All else being equal an increase in ROE will therefore increase the P/E ratio. Note that decreasing the dividend payout ratio and decreasing the long term growth rate will both serve to decrease the P/E ratio.

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Which of the following is NOT an assumption of the constant growth dividend discount model (DDM)?

A) The growth rate of the firm is higher than the overall growth rate of the economy.

B) Dividend payout is constant.

C) ROE is constant.

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Other assumptions of the DDM are: dividends grow at a constant rate and the growth rate continues for an infinite period.

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REM Corp.’s return on equity (ROE) is 19.5% and its dividend payout rate is 45%. What is the company’s implied dividend growth rate?

A) 19.5%.

B) 10.73%.

C) 8.78%.

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g = (ROE)(RR)

g = (19.5)(1 - 0.45)

g = (0.195)(0.55)

= 0.1073 or 10.73%

honeycfa

In its latest annual report, a company reported the following:

Net income	= $1,000,000
Total equity	= $5,000,000
Total assets	= $10,000,000
Dividend payout ratio	= 40%

Based on the sustainable growth model, the most likely forecast of the company’s future earnings growth rate is:

A) 6%.

B) 12%.

C) 8%.

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g = (RR)(ROE)

RR = 1 ? dividend payout ratio = 1 ? 0.4 = 0.6

ROE = NI / Total Equity = 1,000,000 / 5,000,000 = 1 / 5 = 0.2
Note: This is the "simple" calculation of ROE. Since we are only given these inputs, these are what you should use. Also, if given beginning and ending equity balances, use the average in the denominator.

g = (0.6)(0.2) = 0.12 or 12%

[此贴子已经被作者于2010-4-22 22:42:51编辑过]

honeycfa

Which of the following statements concerning security valuation is least accurate?

A) An investor may determine the required rate of return for the dividend discount model (DDM) by adding a risk premium to the nominal risk-free rate.

B) An investor can estimate the growth rate for the dividend discount model (DDM) by multiplying the firm's return on equity (ROE) by the firm's dividend payout ratio.

C) Business risk is a component of a country's risk premium.

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An investor can estimate the growth rate for the DDM by multiplying the firm’s ROE by the retention rate, which is one minus the firm’s dividend payout ratio.

honeycfa

Given the following information, compute the implied dividend growth rate.

• Profit margin = 10.0%
• Total asset turnover = 2.0 times
• Financial leverage = 1.5 times
• Dividend payout ratio = 40.0%

A) 18.0%.

B) 4.5%.

C) 12.0%.

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Retention ratio equals 1 – 0.40, or 0.60.
Return on equity equals (10.0%)(2.0)(1.5) = 30.0%.
Dividend growth rate equals (0.60)(30.0%) = 18.0%.

honeycfa

If the return on equity for a firm is 15% and the retention rate is 40%, the firm’s sustainable growth rate is closest to:

A) 6%.

B) 15%.

C) 9%.

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g = (RR)(ROE)

= (0.15)(0.40)

= 0.06 or 6%

honeycfa

Which of the following statements concerning security valuation is least accurate?

A) The top-down approach to security valuation starts with an examination of the economy of each country.

B) A common stock with no growth in the dividend is valued like preferred stock.

C) The retention rate in the dividend discount model is one minus the growth rate.

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The retention rate is one minus the dividend payout ratio.