Equity Valuation【 Reading 39】Sample 2012

HuskyGrad2010

Multi-stage growth models can become computationally intensive. For this reason they are often referred to as:

A) spreadsheet models.

B) quadratic models.

C) R-squared models.

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The computationally intensive nature of these models make them a perfect application for a spreadsheet program, hence the name spreadsheet models.

RobertA

The current market price per share for Burton, Inc. is $33.33, and an analyst is using the Gordon Growth model to determine whether this is a fair price. The company paid a dividend of $2.00 last year on earnings of $2.50 a share. If the required rate of return is 12.00% and the expected grown rate in earnings and in dividends is 6%, the current market price is most likely:

A) correctly valued.

B) undervalued.

C) overvalued.

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The value per share using the estimates is $35.33 = [$2.00(1.06) / 0.12 − 0.06)]. This is higher than the current share price.

RobertA

In its most recent quarterly earnings report, Smith Brothers Garden Supplies said it planned to increase its dividend at an annual rate of 5% for the foreseeable future. Analyst Anton Spears is using a required return of 9.5% for Smith Brothers stock. Smith Brothers stock trades for $52.17 per share and earned $3.01 per share over the last 12 months. The company paid a dividend of $2.15 per share during the last 12-month period, and its dividend-growth rate for the last five years was 9.2%. Using the Gordon Growth model, the share price for Smith Brothers stock is most likely:

A) correctly valued.

B) overvalued.

C) undervalued.

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The Gordon Growth model is as follows:
Value = [dividend × (1 + dividend growth rate)] / [required return − growth rate]

Value	= [2.15 × 1.05] / [0.095 − 0.05]
	= 2.2575 / [0.095 − 0.05]
	= 50.17

RobertA

The current market price per share for High-on-the-Hog, Inc. is $52.50, and an analyst is using the Gordon Growth model to determine whether this is a fair price. The company paid a dividend of $3.00 last year on earnings of $4.50 a share. If the required rate of return is 11.00% and the expected grown rate in earnings and in dividends is 5%, the current market price is most likely:

A) correctly valued.

B) undervalued.

C) overvalued.

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The value per share using the estimates is $52.50 = [$3.00(1.05) / 0.11 − 0.05)].

RobertA

Which of the following actions will be least helpful for an analyst attempting to improve the predictive power of his scenario analysis?

A) Acquiring more precise inputs.

B) Limiting deviations from the core model.

C) Using a spreadsheet rather than a calculator.

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The whole point of scenario analysis is the flexibility to modify the inputs to see how changes in one factor affect others. In order to perform scenario analysis, you must deviate from the core model. Increased precision on the inputs will increase the predictive power of almost any model. Spreadsheets reduce the likelihood of computational inaccuracies and allow analysts to more easily modify models to reflect many scenarios.

RobertA

Relative to traditional financial models like the dividend discount model, the biggest advantage of spreadsheet modeling is:

A) accuracy of computations.

B) simplicity of computations.

C) quantity of computations.

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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.

RobertA

Financial models such as the DDM represent a cornerstone of equity valuation from an academic standpoint. But in the real life, many analysts do not use the DDM. The least likely reason for this is:

A) some of the assumptions required are impractical.

B) the model lacks the flexibility required to model values in the real world.

C) modern research has shown that many of the old standbys do not work.

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The DDM requires assumptions that many analysts find impractical. In addition, the model lacks the flexibility to adapt to changing circumstances. Both of these problems can be overcome, to a large extent, by using spreadsheet modeling to forecast cash flows and other variables.

RobertA

In the five-part DuPont model ROE = (NI/EBT)(EBT/EBIT)(EBIT/sales)(sales/assets)(assets/equity), the product of the first three terms is:

A) net profit margin.

B) gross profit margin.

C) operating profit margin.

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(NI/EBT)(EBT/EBIT)(EBIT/sales) = (NI/sales) = net profit margin.

RobertA

If Cantel, Inc., has current earnings of $17, dividends of $3.50, and a sustainable growth rate of 11%, what is its return on equity (ROE)?

A) 13.85%.

B) 17.64%.

C) 11.91%.

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Cantel’s ROE is 13.85%:

ROE = 11% / [1 – ($3.50/$17.00)] = 13.85%

RobertA

Supergro has current dividends of $1, current earnings of $3, and a sustainable growth rate of 10%. What is Supergro’s return on equity?

A) 12%.

B) 15%.

C) 20%.

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The ROE for Supergro can be determined by solving for ROE in the sustainable growth formula:

ROE = 10% / [1 – ($1/$3)] = 15%