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标题: Equity Investments【Reading 52】Sample [打印本页]
作者: prashantsahni    时间: 2012-3-30 10:56     标题: [2012 L1] Equity Investments【Session 14 - Reading 52】Sample

An analyst gathered the following information about a company:
The stock is undervalued by approximately:
A)
$15.70.
B)
$0.00.
C)
$6.40.


The high “supernormal” growth in the first three years and the decrease in growth thereafter signals that we should use a combination of the multi-period and finite dividend growth models (DDM) to value the stock.
Step 1: Determine the dividend stream through year 4
Step 2: Calculate the value of the stock at the end of year 3 (using D4)
Step 3: Calculate the PV of each cash flow stream at ke = 15%, and sum the cash flows. Note: We suggest you clear the financial calculator memory registers before calculating the value. The present value of:
Note: Future values are entered in a financial calculator as negatives to ensure that the PV result is positive. It does not mean that the cash flows are negative. Also, your calculations may differ slightly due to rounding. Remember that the question asks you to select the closest answer.
作者: prashantsahni    时间: 2012-3-30 10:56

If an analyst estimates the intrinsic value for a security that is different from its market value, the analyst should most likely take an investment position based on this difference if:
A)
many analysts independently evaluate the security.
B)
the security lacks a liquid market and trades infrequently.
C)
the model used is not highly sensitive to its input values.


In general, an analyst can be more confident about an estimate of intrinsic value if the model used is not highly sensitive to changes in its inputs. If a large number of analysts follow a security, its market value is more likely to be a reliable estimate of its intrinsic value. A security that does not trade frequently or in a liquid market may remain mispriced for an extended time, and thus may not result in a profit within the investment horizon even if the analyst’s estimate of intrinsic value is correct.
作者: prashantsahni    时间: 2012-3-30 10:57

An equity valuation model that values a firm based on the market value of its outstanding debt and equity securities, relative to a firm fundamental, is a(n):
A)
enterprise value model.
B)
asset-based model.
C)
market multiple model.


An enterprise value model relates a firm’s enterprise value (the market value of its outstanding equity and debt securities minus its cash and marketable securities holdings) to its EBITDA, operating earnings, or revenue.
作者: prashantsahni    时间: 2012-3-30 10:57

Witronix is a rapidly growing U.S. company that has increased free cash flow to equity and dividends at an average rate of 25% per year for the last four years. The present value model that is most appropriate for estimating the value of this company is a:
A)
multistage dividend discount model.
B)
Gordon growth model.
C)
single stage free cash flow to equity model.


A multistage model is the most appropriate model because the company is growing dividends at a higher rate than can be sustained in the long run. Though the company may be able to grow dividends at a higher-than-sustainable 25% annual rate for a finite period, at some point dividend growth will have to slow to a lower, more sustainable rate. The Gordon growth model is appropriate to use for mature companies that have a history of increasing their dividend at a steady and sustainable rate. A single stage free cash flow to equity model is similar to the Gordon growth model, but values future free cash flow to equity rather than dividends.
作者: prashantsahni    时间: 2012-3-30 10:58

A valuation model based on the cash flows that a firm will have available to pay dividends in the future is best characterized as a(n):
A)
free cash flow to equity model.
B)
free cash flow to the firm model.
C)
infinite period dividend discount model.


Free cash flow to equity represents a firm’s capacity to pay future dividends. A free cash flow to equity model estimates the firm’s FCFE for future periods and values the stock as the present value of the firm’s future FCFE per share.
作者: prashantsahni    时间: 2012-3-30 10:58

The yield on a company’s 7.5%, $50 par preferred stock is 6%. The value of the preferred stock is closest to:
A)
$12.50.
B)
$50.00.
C)
$62.50.


The preferred dividend is 0.075($50) = $3.75. The value of the preferred = $3.75 / 0.06 = $62.50.
作者: prashantsahni    时间: 2012-3-30 10:59

A preferred stock’s dividend is $5 and the firm’s bonds currently yield 6.25%. The preferred shares are priced to yield 75 basis points below the bond yield. The price of the preferred is closest to:
A)
$5.00.
B)
$80.00.
C)
$90.91.


Preferred stock yield (Kp) = bond yield – 0.75% = 6.25% − 0.75% = 5.5%
Value = dividend / Kp = $5 / 0.055 = $90.91.
作者: prashantsahni    时间: 2012-3-30 10:59

Assuming a discount rate of 15%, a preferred stock with a perpetual dividend of $10 is valued at approximately:
A)
$1.50.
B)
$66.67.
C)
$8.70.


The formula for the value of preferred stock with a perpetual dividend is: D / kp, or 10.0 / 0.15 = $66.67.
作者: prashantsahni    时间: 2012-3-30 11:00

Calculate the value of a preferred stock that pays an annual dividend of $5.50 if the current market yield on AAA rated preferred stock is 75 basis points above the current T-Bond rate of 7%.
A)
$42.63.
B)
$70.97.
C)
$78.57.


kpreferred = base yield + risk premium = 0.07 + 0.0075 = 0.00775
ValuePreferred = Dividend / kpreferred
Value = 5.50 / 0.0775 = $70.97
作者: prashantsahni    时间: 2012-3-30 11:00

A company has 8 percent preferred stock outstanding with a par value of $100. The required return on the preferred is 5 percent. What is the value of the preferred stock?
A)
$152.81.
B)
$160.00.
C)
$100.00.


The annual dividend on the preferred is $100(.08) = $8.00. The value of the preferred is $8.00/0.05 = $160.00.
作者: prashantsahni    时间: 2012-3-30 11:00

If a preferred stock that pays a $11.50 dividend is trading at $88.46, what is the market’s required rate of return for this security?
A)
11.76%.
B)
13.00%.
C)
7.69%.


From the formula: ValuePreferred Stock = D / kp, we derive kp = D / ValuePreferred Stock = 11.50 / 88.46 = 0.1300, or 13.00%.
作者: prashantsahni    时间: 2012-3-30 11:01

A company has 6% preferred stock outstanding with a par value of $100. The required return on the preferred is 8%. What is the value of the preferred stock?
A)
$92.59.
B)
$100.00.
C)
$75.00.


The annual dividend on the preferred is $100(.06) = $6.00. The value of the preferred is $6.00/0.08 = $75.00.
作者: prashantsahni    时间: 2012-3-30 11:02

What is the value of a preferred stock that is expected to pay a $5.00 annual dividend per year forever if similar risk securities are now yielding 8%?
A)
$40.00.
B)
$60.00.
C)
$62.50.


$5.00/0.08 = $62.50.
作者: prashantsahni    时间: 2012-3-30 11:02

The preferred stock of the Delco Investments Company has a par value of $150 and a dividend of $11.50. A shareholder’s required return on this stock is 14%. What is the maximum price he would pay?
A)
$150.00.
B)
$54.76.
C)
$82.14.


Value of preferred = D / kp = $11.50 / 0.14 = $82.14
作者: prashantsahni    时间: 2012-3-30 11:02


An analyst projects the following pro forma financial results for Magic Holdings, Inc., in the next year:

If the analyst assumes Magic Holdings, Inc. will produce a constant rate of dividend growth, the value of the stock is closest to:

A)
$19
B)
$104
C)
$44

Infinite period DDM: P0 = D1 / (ke – g)

D1

= (Earnings × Payout ratio) / average number of shares outstanding

= ($200,000 × 0.625) / 50,000 = $2.50.

ke

=  risk free rate + [beta × (expected market return – risk free rate)]

ke

=  7.5% + [1.8 × (13.0% - 7.5%)] = 17.4%.

g

=    (retention rate × ROE)

Retention = (1 – Payout) = 1 – 0.625 = 0.375.

ROE  = net income/equity

= 200,000/500,000 = 0.4

g

= 0.375 × 0.4 = 0.15.


P0 = D1 / (ke – g) = $2.50 / (0.174 - 0.15) = 104.17.
作者: prashantsahni    时间: 2012-3-30 11:03

A firm pays an annual dividend of $1.15. The risk-free rate (RF) is 2.5%, and the total risk premium (RP) for the stock is 7%. What is the value of the stock, if the dividend is expected to remain constant?
A)
$25.00.
B)
$12.10.
C)
$16.03.


If the dividend remains constant, g = 0.
P = D1 / (k-g) = 1.15 / (0.095 - 0) = $12.10
作者: kim226    时间: 2012-3-30 11:04

Given the following estimated financial results, value the stock of FishnChips, Inc., using the infinite period dividend discount model (DDM).
The per share value of FishnChips stock is approximately: (Note: Carry calculations out to at least 3 decimal places.)
A)
$26.86.
B)
Unable to calculate stock value because ke < g.
C)
$17.91.


Here, we are given all the inputs we need. Use the following steps to calculate the value of the stock:First, expand the infinite period DDM:
DDM formula: P0 = D1 / (ke – g)

D1

= (Earnings × Payout ratio) / average number of shares outstanding

= ($150,000 × 0.60) / 75,000 = $1.20

ke

= nominal risk free rate + [beta × (expected market return – nominal risk free rate)]

Note: Nominal risk-free rate

= (1 + real risk free rate) × (1 + expected inflation) – 1


= (1.04)×(1.03) – 1 = 0.0712, or 7.12%.


ke

= 7.12% + [2.1 × (13.0% − 7.12%)] = 0.19468

g

= (retention rate × ROE)

Retention

= (1 – Payout) = 1 – 0.60 = 0.40.


ROE

= (net income / sales)(sales / total assets)(total assets / equity)


= (150,000 / 1,000,000)(1,000,000 / 800,000)(800,000 / 400,000)


= 0.375


g

= 0.375 × 0.40 = 0.15


Then, calculate: P0 = D1 / (ke – g) = $1.20 / (0.19468 − 0.15) = 26.86.
作者: kim226    时间: 2012-3-30 11:05

Which of the following statements concerning security valuation is least accurate?
A)
A stock to be held for two years with a year-end dividend of $2.20 per share, an estimated value of $20.00 at the end of two years, and a required return of 15% is estimated to be worth $18.70 currently.
B)
A stock with a dividend last year of $3.25 per share, an expected dividend growth rate of 3.5%, and a required return of 12.5% is estimated to be worth $36.11.
C)
A stock with an expected dividend payout ratio of 30%, a required return of 8%, an expected dividend growth rate of 4%, and expected earnings of $4.15 per share is estimated to be worth $31.13 currently.

A stock with a dividend last year of $3.25 per share, an expected dividend growth rate of 3.5%, and a required return of 12.5% is estimated to be worth $37.33 using the DDM where Po = D1 / (k − g). We are given Do = $3.25, g = 3.5%, and k = 12.5%. What we need to find is D1 which equals Do × (1 + g) therefore D1 = $3.25 × 1.035 = $3.36 thus Po = 3.36 / (0.125 − 0.035) = $37.33.
In the answer choice where the stock value is $18.70, discounting the future cash flows back to the present gives the present value of the stock. the future cash flows are the dividend in year 1 plus the dividend and value of the stock in year 2 thus the equation becomes: Vo = 2.2 / 1.15 + (2.2 + 20) / 1.152 = $18.70
For the answer choice where the stock value is $31.13 use the DDM which is Po = D1 / (k − g). We are given k = 0.08, g = 0.04, and what we need to find is next year’s dividend or D1. D1 = Expected earnings × payout ratio = $4.15 × 0.3 = $1.245 thus Po = $1.245 / (0.08 − 0.04) = $31.13
作者: kim226    时间: 2012-3-30 11:05

Use the following information and the dividend discount model to find the value of GoFlower, Inc.’s, common stock.
A)
$34.95.
B)
$121.79.
C)
$26.64.


The required return for GoFlower is 0.04 + 1.1(0.12 – 0.04) = 0.128 or 12.8%. The expect dividend is ($3.10)(1.10) = $3.41. GoFlower’s common stock is then valued using the infinite period dividend discount model (DDM) as ($3.41) / (0.128 – 0.10) = $121.79.
作者: kim226    时间: 2012-3-30 11:06

What is the value of a stock that paid a $0.25 dividend last year, if dividends are expected to grow at a rate of 6% forever? Assume that the risk-free rate is 5%, the expected return on the market is 10%, and the stock's beta is 0.5.
A)
$16.67.
B)
$3.53.
C)
$17.67.


The discount rate is ke = 0.05 + 0.5(0.10 − 0.05) = 0.075. Use the infinite period dividend discount model to value the stock. The stock value = D1 / (ke – g) = (0.25 × 1.06) / (0.075 – 0.06) = $17.67.
作者: kim226    时间: 2012-3-30 11:06

Assuming the risk-free rate is 5% and the expected return on the market is 12%, what is the value of a stock with a beta of 1.5 that paid a $2 dividend last year if dividends are expected to grow at a 5% rate forever?
A)
$20.00.
B)
$12.50.
C)
$17.50.


P0 = D1 / (k − g)
Rs = Rf + β(RM − Rf) = 0.05 + 1.5(0.12 − 0.05) = 0.155
D1 = D0(1 + g) = 2 × (1.05) = 2.10
P0 = 2.10 / (0.155 − 0.05) = $20.00
作者: kim226    时间: 2012-3-30 11:07

If a stock sells for $50 that has an expected annual dividend of $2 and has a sustainable growth rate of 5%, what is the market discount rate for this stock?
A)
7.5%.
B)
10.0%.
C)
9.0%.


k = [(D1 / P) + g] = [(2/50) + 0.05] = 0.09, or 9.00%.
作者: kim226    时间: 2012-3-30 11:07

All else equal, if there is an increase in the required rate of return, a stock’s value as estimated by the constant growth dividend discount model (DDM) will:
A)
increase or decrease, depending upon the relationship between ke and ROE.
B)
decrease.
C)
increase.


If ke increases, the spread between ke and g widens (increasing the denominator), resulting in a lower valuation.
作者: karoliukas    时间: 2012-3-30 11:16

An analyst has gathered the following data for Webco, Inc:
Using the infinite period, or constant growth, dividend discount model, calculate the price of Webco’s stock assuming that next years earnings will be $4.25.
A)
$63.75.
B)
$55.00.
C)
$125.00.


g = (ROE)(RR) = (0.25)(0.4) = 10%
V = D1 / (k – g)
D1 = 4.25 (1 − 0.4) = 2.55
G = 0.10
K – g = 0.14 − 0.10 = 0.04
V = 2.55 / 0.04 = 63.75
作者: karoliukas    时间: 2012-3-30 11:16

Which of the following statements about the constant growth dividend discount model (DDM) is least accurate?
A)
For the constant growth DDM to work, the growth rate must exceed the required return on equity.
B)
The constant growth DDM is used primarily for stable mature stocks.
C)
In the constant growth DDM dividends are assumed to grow at a constant rate forever.


Dividends grow at constant rate forever.
Constant growth DDM is used for mature firms.
k must be greater than g.
作者: karoliukas    时间: 2012-3-30 11:28

Which of the following statements about the constant growth dividend discount model (DDM) is least accurate?
A)
For the constant growth DDM to work, the growth rate must exceed the required return on equity.
B)
The constant growth DDM is used primarily for stable mature stocks.
C)
In the constant growth DDM dividends are assumed to grow at a constant rate forever.


Dividends grow at constant rate forever.
Constant growth DDM is used for mature firms.
k must be greater than g.
作者: karoliukas    时间: 2012-3-30 11:33

A stock is expected to pay a dividend of $1.50 at the end of each of the next three years. At the end of three years the stock price is expected to be $25. The equity discount rate is 16 percent. What is the current stock price?
A)
$19.39.
B)
$24.92.
C)
$17.18.


The value of the stock today is the present value of the dividends and the expected stock price, discounted at the equity discount rate:
$1.50/1.16 + $1.50/1.162 + $1.50/1.163 + $25.00/1.163 = $19.39
作者: karoliukas    时间: 2012-3-30 11:33

Use the following information on Brown Partners, Inc. to compute the current stock price.
A)
$59.55.
B)
$57.48.
C)
$57.70.


The current stock price is equal to (D1 + P1) / (1 + ke). D1 equals $6.10(1.04) = $6.34. The equity discount rate is 3% + 12% = 15%. Therefore the current stock price is ($6.34 + $60)/(1.15) = $57.70
作者: karoliukas    时间: 2012-3-30 11:33

An investor is considering acquiring a common stock that he would like to hold for one year. He expects to receive both $1.50 in dividends and $26 from the sale of the stock at the end of the year. What is the maximum price he should pay for the stock today to earn a 15 percent return?
A)
$23.91.
B)
$27.30.
C)
$24.11.


By discounting the cash flows for one period at the required return of 15% we get: x = (26 + 1.50) / (1+.15)1
(x)(1.15) = 26 + 1.50
x = 27.50 / 1.15
x = $23.91
作者: karoliukas    时间: 2012-3-30 11:34

Assume that a stock paid a dividend of $1.50 last year. Next year, an investor believes that the dividend will be 20% higher and that the stock will be selling for $50 at year-end. Assume a beta of 2.0, a risk-free rate of 6%, and an expected market return of 15%. What is the value of the stock?
A)
$45.00.
B)
$41.77.
C)
$40.32.


Using the Capital Asset Pricing Model, we can determine the discount rate equal to 0.06 + 2(0.15 – 0.06) = 0.24. The dividends next year are expected to be $1.50 × 1.2 = $1.80. The present value of the future stock price and the future dividend are determined by discounting the expected cash flows at the discount rate of 24%: (50 + 1.8) / 1.24 = $41.77.
作者: karoliukas    时间: 2012-3-30 11:34

The following data pertains to a common stock:
If an investor requires a 17% return on this stock, what will they be willing to pay for this stock now?
A)
$10.00.
B)
$ 7.30.
C)
$ 6.24.


time line = $0 now; $0 in yr 1; $0 in yr 2; $1 in yr 3.
P2 = D3/(k - g) = 1/(.17 - .07) = $10
Note the math. The price is always one year before the dividend date.
Solve for the PV of $10 to be received in two years.
FV = 10; n = 2; i = 17; compute PV = $7.30
作者: karoliukas    时间: 2012-3-30 11:35

A firm will not pay dividends until four years from now. Starting in year four dividends will be $2.20 per share, the retention ratio will be 40%, and ROE will be 15%. If k = 10%, what should be the value of the stock?
A)
$55.25.
B)
$41.32.
C)
$58.89.


g = ROE × retention ratio = ROE × b = 15 × 0.4 = 6%
Based on the growth rate we can calculate the expected price in year 3:
P3 = D4 / (k − g) = 2.2 / (0.10 − 0.06) = $55
The stock value today is: P0 = PV (55) at 10% for 3 periods = $41.32
作者: karoliukas    时间: 2012-3-30 11:35

Utilizing the infinite period dividend discount model, all else held equal, if the required rate of return (Ke) decreases, the model yields a price that is:
A)
increased, due to a smaller spread between required return and growth.
B)
reduced, due to increased spread between growth and required return.
C)
reduced, due to the reduction in discount rate.


The denominator of the single-stage DDM is the spread between required return Ke, and expected growth rate, g. The smaller the denominator, all else held equal, the larger the computed value.
作者: karoliukas    时间: 2012-3-30 11:35

A stock has the following elements: last year’s dividend = $1, next year’s dividend is 10% higher, the price will be $25 at year-end, the risk-free rate is 5%, the market premium is 5%, and the stock’s beta is 1.2.What happens to the price of the stock if the beta of the stock increases to 1.5? It will:
A)
increase.
B)
remain unchanged.
C)
decrease.


When the beta of a stock increases, its required return will increase. The increase in the discount rate leads to a decrease in the PV of the future cash flows.
What will be the current price of the stock with a beta of 1.5?
A)
$23.51.
B)
$23.20.
C)
$20.23.


k = 5 + 1.5(5) = 12.5%
P0 = (1.1 / 1.125) + (25 / 1.125) = $23.20
作者: karoliukas    时间: 2012-3-30 11:36

What value would be placed on a stock that currently pays no dividend but is expected to start paying a $1 dividend five years from now? Once the stock starts paying dividends, the dividend is expected to grow at a 5 percent annual rate. The appropriate discount rate is 12 percent.
A)
$9.08.
B)
$8.11.
C)
$14.29.

P4 = D5/(k-g) = 1/(.12-.05) = 14.29
P0 = [FV = 14.29; n = 4; i = 12] = $9.08.
作者: karoliukas    时间: 2012-3-30 11:37

Assume a company has earnings per share of $5 and this year paid out 40% in dividends. The earnings and dividend growth rate for the next 3 years will be 20%. At the end of the third year the company will start paying out 100% of earnings in dividends and earnings will increase at an annual rate of 5% thereafter. If a 12% rate of return is required, the value of the company is approximately:
A)
$92.92.
B)
$55.69.
C)
$102.80.


First, calculate the dividends in years 0 through 4: (We need D4 to calculate the value in Year 3)
D0 = (0.4)(5) = 2
D1 = (2)(1.2) = 2.40
D2 = (2.4)(1.2) = 2.88
D3 = E3 = 5(1.2)3 = 8.64
g after year 3 will be 5%, so
D4 = 8.64 × 1.05 = 9.07
Then, solve for the terminal value at the end of period 3 = D4 / (k − g) = 9.07 / (0.12 − 0.05) = $129.57
Present value of the cash flows = value of stock = 2.4 / (1.12)1 + 2.88 / (1.12)2 + 8.64 / (1.12)3 + 129.57 / (1.12)3 = 2.14 + 2.29 + 6.15 + 92.22 = 102.80
作者: karoliukas    时间: 2012-3-30 11:37

Use the following information and the multi-period dividend discount model to find the value of Computech’s common stock.
Which of the following statements about Computech's stock is least accurate?
A)
Computech's stock is currently worth $17.46.
B)
At the end of two years, Computech's stock will sell for $20.64.
C)
The dividend at the end of year three is expected to be $2.27.


The dividends for years 1, 2, and 3 are expected to be ($1.62)(1.12) = $1.81; ($1.81)(1.12) = $2.03; and ($2.03)(1.12) = $2.27. At the end of year 2, the stock should sell for $2.27 / (0.15 – 0.04) = $20.64. The stock should sell currently for ($20.64 + $2.03) / (1.15)2 + ($1.81) / (1.15) = $18.71.
作者: karoliukas    时间: 2012-3-30 11:37

The last dividend paid on a common stock was $2.00, the growth rate is 5% and investors require a 10% return. Using the infinite period dividend discount model, calculate the value of the stock.
A)
$42.00.
B)
$40.00.
C)
$13.33.


2(1.05) / (0.10 - 0.05) = $42.00
作者: karoliukas    时间: 2012-3-30 11:38

Day and Associates is experiencing a period of abnormal growth. The last dividend paid by Day was $0.75. Next year, they anticipate growth in dividends and earnings of 25% followed by negative 5% growth in the second year. The company will level off to a normal growth rate of 8% in year three and is expected to maintain an 8% growth rate for the foreseeable future. Investors require a 12% rate of return on Day.What is the approximate amount that an investor would be willing to pay today for the two years of abnormal dividends?
A)
$1.62.
B)
$1.55.
C)
$1.83.


First find the abnormal dividends and then discount them back to the present.
$0.75 × 1.25 = $0.9375 × 0.95 = $0.89.
D1 = $0.9375; D2 = $0.89.
At this point you can use the cash flow keys with CF0 = 0, CF1 = $0.9375 and CF2 = $0.89.
Compute for NPV with I/Y = 12. NPV = $1.547.
Alternatively, you can put the dividends in as future values, solve for present values and add the two together.

What would an investor pay for Day and Associates today?
A)
$24.03.
B)
$18.65.
C)
$20.71.


Here we find P2 using the constant growth dividend discount model.
P2 = $0.89 × 1.08 / (0.12 – 0.08) = $24.03.
Discount that back to the present at 12% for 2 periods and add it to the answer in the previous question.
N = 2; I/Y = 12; PMT = 0; FV = $24.03; CPT &rarr PV = $19.16.
Add $1.55 (the present value of the abnormal dividends) to $19.16 and you get $20.71.
作者: karoliukas    时间: 2012-3-30 11:38

Calculate the value of a common stock that last paid a $2.00 dividend if the required rate of return on the stock is 14 percent and the expected growth rate of dividends and earnings is 6 percent.  What growth model is an example of this calculation?
Value of stockGrowth model
A)
$26.50   Gordon growth
B)
$26.50   Supernormal growth
C)
$25.00   Gordon growth


$2(1.06)/0.14 - 0.06 = $26.50.
This calculation is an example of the Gordon Growth Model also known as the constant growth model.
作者: karoliukas    时间: 2012-3-30 11:39

A company last paid a $1.00 dividend, the current market price of the stock is $20 per share and the dividends are expected to grow at 5 percent forever. What is the required rate of return on the stock?
A)
10.25%.
B)
10.00%.
C)
9.78%.


D0 (1 + g) / P0 + g = k
1.00 (1.05) / 20 + 0.05 = 10.25%.
作者: karoliukas    时间: 2012-3-30 11:39

Using the one-year holding period and multiple-year holding period dividend discount model (DDM), calculate the change in value of the stock of Monster Burger Place under the following scenarios. First, assume that an investor holds the stock for only one year. Second, assume that the investor intends to hold the stock for two years. Information on the stock is as follows:
The value of the stock if held for one year and the value if held for two years are:
Year oneYear two
A)
$25.22   $29.80
B)
$25.22   $35.25
C)
$27.50   $35.25


First, we need to calculate the required rate of return. When a stock’s beta equals 1, the required return is equal to the market return, or 10.0%. Thus, ke = 0.10. Alternative: Using the capital asset pricing model (CAPM), ke = Rf + Beta * (Rm – Rf) = 4.5% + 1 * (10.0% - 4.5%) = 4.5% + 5.5% = 10.0%.
Next, we need to calculate the dividends for years 1 and 2.
Then, we use the one-year holding period DDM to calculate the present value of the expected stock cash flows (assuming the one-year hold).
Finally, we use the multi-period DDM to calculate the return for the stock if held for two years.
作者: karoliukas    时间: 2012-3-30 11:39

Baker Computer earned $6.00 per share last year, has a retention ratio of 55%, and a return on equity (ROE) of 20%. Assuming their required rate of return is 15%, how much would an investor pay for Baker on the basis of the earnings multiplier model?
A)
$40.00.
B)
$74.93.
C)
$173.90.


g = Retention × ROE = (0.55) × (0.2) = 0.11
P0/E1 = 0.45 / (0.15 − 0.11) = 11.25
Next year's earnings E1 = E0 × (1 + g) = (6.00) × (1.11) = $6.66
P0 = 11.25($6.66) = $74.93
作者: karoliukas    时间: 2012-3-30 11:40

Assume that at the end of the next year, Company A will pay a $2.00 dividend per share, an increase from the current dividend of $1.50 per share. After that, the dividend is expected to increase at a constant rate of 5%. If an investor requires a 12% return on the stock, what is the value of the stock?
A)
$28.57.
B)
$30.00.
C)
$31.78.


P0 = D1 / k − g
D1 = $2
g = 0.05
k = 0.12
P0 = 2 / 0.12 − 0.05 = 2 / 0.07 = $28.57
作者: karoliukas    时间: 2012-3-30 11:40

Company B paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of its earnings as dividends for the foreseeable future. If the firm is expected to earn a 10% return on equity in the future, and if an investor requires a 12% return on the stock, the stock’s value is closest to:
A)
$12.50.
B)
$17.67.
C)
$16.67.


P0 = Value of the stock = D1 / (k − g)
g = (RR)(ROE)
RR = 1 − dividend payout = 1 − 0.4 = 0.6
ROE = 0.1
g = (0.6)(0.1) = 0.06
D1 = (D0)(1 + g) = (1)(1 + 0.06) = $1.06
P0 = 1.06 / (0.12 − 0.06) = 1.06 / 0.06 = $17.67
作者: karoliukas    时间: 2012-3-30 11:40

Using an infinite period dividend discount model, find the value of a stock that last paid a dividend of $1.50. Dividends are expected to grow at 6 percent forever, the expected return on the market is 12 percent and the stock’s beta is 0.8. The risk-free rate of return is 5 percent.
A)
$26.50.
B)
$32.61.
C)
$34.57.


First find the required rate of return using the CAPM equation.
k = 0.05 + 0.8(0.12 - 0.05) = 10.6%
$1.50(1.06) /(0.106 - 0.06) = $34.57
作者: karoliukas    时间: 2012-3-30 11:41

A company has just paid a $2.00 dividend per share and dividends are expected to grow at a rate of 6% indefinitely. If the required return is 13%, what is the value of the stock today?
A)
$34.16.
B)
$32.25.
C)
$30.29.


P0 = D1 / (k - g) = 2.12 / (0.13 - 0.06) = $30.29
作者: karoliukas    时间: 2012-3-30 11:41

A firm is expected to have four years of growth with a retention ratio of 100%. Afterwards the firm’s dividends are expected to grow 4% annually, and the dividend payout ratio will be set at 50%. If earnings per share (EPS) = $2.4 in year 5 and the required return on equity is 10%, what is the stock’s value today?
A)
$30.00.
B)
$13.66.
C)
$20.00.


Dividend in year 5 = (EPS)(payout ratio) = 2.4 × 0.5 = 1.2
P4 = 1.2 / (0.1 − 0.04) = 1.2 / 0.06 = $20
P0 = PV (P4) = $20 / (1.10)4 = $13.66
作者: karoliukas    时间: 2012-3-30 11:41

Bybee is expected to have a temporary supernormal growth period and then level off to a “normal,” sustainable growth rate forever. The supernormal growth is expected to be 25 percent for 2 years, 20 percent for one year and then level off to a normal growth rate of 8 percent forever. The market requires a 14 percent return on the company and the company last paid a $2.00 dividend. What would the market be willing to pay for the stock today?
A)
$67.50.
B)
$52.68.
C)
$47.09.

First, find the future dividends at the supernormal growth rate(s). Next, use the infinite period dividend discount model to find the expected price after the supernormal growth period ends. Third, find the present value of the cash flow stream.

D1 = 2.00 (1.25) = 2.50 (1.25) = D2 = 3.125 (1.20) = D3 = 3.75
P2 = 3.75/(0.14 - 0.08) = 62.50
N = 1; I/Y = 14; FV = 2.50; compute PV = 2.19.
N = 2; I/Y = 14; FV = 3.125; compute PV = 2.40.
N = 2; I/Y = 14; FV = 62.50; compute PV = 48.09.
Now sum the PV’s: 2.19 + 2.40 + 48.09 = $52.68.
作者: karoliukas    时间: 2012-3-30 11:42

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.


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.
作者: karoliukas    时间: 2012-3-30 11:42

When a company’s return on equity (ROE) is 12% and the dividend payout ratio is 60%, what is the implied sustainable growth rate of earnings and dividends?
A)
4.0%.
B)
7.8%.
C)
4.8%.


g = ROE × retention ratio = ROE × (1 – payout ratio) = 12 (0.4) = 4.8%
作者: karoliukas    时间: 2012-3-30 11:43

A company’s payout ratio is 0.45 and its expected return on equity (ROE) is 23%. What is the company’s implied growth rate in dividends?
A)
12.65%.
B)
10.35%.
C)
4.16%.


Growth Rate = (ROE)(1 – Payout Ratio) = (0.23)(0.55) = 12.65%
作者: karoliukas    时间: 2012-3-30 11:43

A company’s required return on equity is 15% and its dividend payout ratio is 55%. If its return on equity (ROE) is 17% and its beta is 1.40, then its sustainable growth rate is closest to:
A)
6.75%.
B)
7.65%.
C)
9.35%.


Growth rate = (ROE)(Retention Ratio)
= (0.17)(0.45)
= 0.0765 or 7.65%
作者: karoliukas    时间: 2012-3-30 11:44

If a firm’s growth rate is 12% and its dividend payout ratio is 30%, its current return on equity (ROE) is closest to:
A)
40.00%.
B)
17.14%.
C)
36.00%.


g = (RR)(ROE)
g / RR = ROE
0.12 / (1 - 0.30) = 0.12 / 0.70 = 0.1714 or 17.14%
作者: karoliukas    时间: 2012-3-30 11:44

A company with a return on equity (ROE) of 27%, required return on equity (ke) of 20%, and a dividend payout ratio of 40% has an implied sustainable growth rate closest to:
A)
12.00%.
B)
10.80%.
C)
16.20%.


g = (RR)(ROE)
= (.60)(.27)
= 0.162 or 16.2%
作者: karoliukas    时间: 2012-3-30 11:45

A firm has a return on equity (ROE) of 15% and a dividend payout rate of 80%. If last year's dividend was $0.80 and the required return on equity is 10%, what is the firm's estimated dividend growth rate and what is the current stock price?
[td=1,1,130]Dividend growth rate   Stock price
A)
12.00%  $11.77
B)
3.00%  $9.96
C)
3.00%  $11.77


The expected growth rate of dividends is the retention rate (RR) times the return on the equity portion of new investments (ROE), g = (RR)(ROE). The retention rate is 1 minus the payout rate. RR = (1 - 0.80) = 0.20. g = (0.20)(0.15)= 3.00%.
The value of the stock will be the dividend paid next year divided by the required rate of return minus the growth rate.  Next year's dividend is $0.80 × 1.03 = $0.824.  So the value is 0.824 / (.10 - 0.03) = 0.824 / 0.07 =  $11.77
作者: karoliukas    时间: 2012-3-30 11:45

The Sustainable Growth Rate is equal to:
A)
(ROE) x (1+RR).
B)
(ROE) x (RR).
C)
(ROE) x (1-RR).


The Sustainable Growth Rate is equal to the return on the equity portion of new investments (ROE) multiplied by the firm's retention rate (RR).
作者: karoliukas    时间: 2012-3-30 11:45

A high growth rate would be consistent with:
A)
a high dividend payout rate.
B)
a low retention rate.
C)
a high ROE.


Since g = retention rate * ROE, or (1 - payout ratio) * ROE, the only choice that would result in a higher g is a higher ROE. A low ROE, or a high dividend payout rate (which is the same as a low retention rate) would result in a low growth rate.
作者: karoliukas    时间: 2012-3-30 11:46

A firm has a profit margin of 10%, an asset turnover of 1.2, an equity multiplier of 1.3, and an earnings retention ratio of 0.5. What is the firm's internal growth rate?
A)
6.7%.
B)
7.8%.
C)
4.5%.


ROE = (Net Income / Sales)(Sales / Total Assets)(Total Assets / Total Equity)
ROE = (0.1)(1.2)(1.3) = 0.156
g = (retention ratio)(ROE) = 0.5(0.156) = 0.078 or 7.8%
作者: karoliukas    时间: 2012-3-30 11:46

Given the following information, compute the implied dividend growth rate.
A)
18.0%.
B)
4.5%.
C)
12.0%.


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%.
作者: karoliukas    时间: 2012-3-30 11:47

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)
15%.
B)
9%.
C)
6%.


g = (RR)(ROE)
= (0.15)(0.40)
= 0.06 or 6%
作者: karoliukas    时间: 2012-3-30 11:47

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)
10.73%.
B)
19.5%.
C)
8.78%.


g = (ROE)(RR)
g = (19.5)(1 − 0.45)
g = (0.195)(0.55)
= 0.1073 or 10.73%
作者: karoliukas    时间: 2012-3-30 11:48

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%.


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%
作者: Kingpin804    时间: 2012-3-30 11:49

The required rate of return on equity used as an input to the dividend discount model is influenced by each of the following factors EXCEPT:
A)
the stock's appropriate risk premium.
B)
the expected inflation rate.
C)
the stock's dividend payout ratio.


A stock’s required rate of return is equal to the nominal risk-free rate plus a risk premium. The nominal risk-free rate is approximately equal the real risk-free rate plus expected inflation.
作者: Kingpin804    时间: 2012-3-30 11:49

The capital asset pricing model can be used to estimate which of the following inputs to the dividend discount model?
A)
The expected inflation rate.
B)
The expected growth rate in dividends.
C)
The required return on equity.


The capital asset pricing model is a rate of return model that can be used to estimate a stock’s required rate of return, given the nominal risk-free rate, the market risk premium, and the stock’s beta:
k = Rnominal risk free rate + (beta)(Rmarket - Rnominal risk free rate).
作者: Kingpin804    时间: 2012-3-30 11:49

Which of the following statements about the constant growth dividend discount model (DDM) in its application to investment analysis is least accurate? The model:
A)
can’t be applied when g > K.
B)
is best applied to young, rapidly growing firms.
C)
is inappropriate for firms with variable dividend growth.


The model is most appropriately used when the firm is mature, with a moderate growth rate, paying a constant stream of dividends. In order for the model to produce a finite result, the company’s growth rate must not exceed the required rate of return.
作者: Kingpin804    时间: 2012-3-30 13:00

The constant-growth dividend discount model would typically be most appropriate in valuing a stock of a:
A)
rapidly growing company.
B)
moderate growth, "mature" company.
C)
new venture expected to retain all earnings for several years.


Remember, the infinite period DDM has the following assumptions:
If any one of these assumptions is not met, the model breaks down. The infinite period DDM doesn’t work with growth companies. Growth companies are firms that currently have the ability to earn rates of return on investments that are currently above their required rates of return. The infinite period DDM assumes the dividend stream grows at a constant rate forever while growth companies have high growth rates in the early years that level out at some future time. The high early or supernormal growth rates will also generally exceed the required rate of return. Since the assumptions (constant g and k > g) don’t hold, the infinite period DDM cannot be used to value growth companies.
作者: Kingpin804    时间: 2012-3-30 13:01

Which of the following statements concerning security valuation is least accurate?
A)
The best way to value a company with no current dividend but who is expected to pay dividends in three years is to use the temporary supernormal growth (multistage) model.
B)
A firm with a $1.50 dividend last year, a dividend payout ratio of 40%, a return on equity of 12%, and a 15% required return is worth $18.24.
C)
The best way to value a company with high and unsustainable growth that exceeds the required return is to use the temporary supernormal growth (multistage) model.


A firm with a $1.50 dividend last year, a dividend payout ratio of 40%, a return on new investment of 12%, and a 15% required return is worth $20.64. The growth rate is (1 – 0.40) × 0.12 = 7.2%. The expected dividend is then ($1.50)(1.072) = $1.61. The value is then (1.61) / (0.15 – 0.072) = $20.64.
作者: Kingpin804    时间: 2012-3-30 13:04

Which of the following is NOT an assumption of the constant growth dividend discount model (DDM)?
A)
Dividend payout is constant.
B)
ROE is constant.
C)
The growth rate of the firm is higher than the overall growth rate of the economy.


Other assumptions of the DDM are: dividends grow at a constant rate and the growth rate continues for an infinite period.
作者: Kingpin804    时间: 2012-3-30 13:04

Which of the following statements regarding price multiples is most accurate?
A)
An advantage of the price/sales ratio is that it is meaningful even for distressed firms.
B)
A disadvantage of the price/book value ratio is that it is not an appropriate measure for firms that primarily hold liquid assets.
C)
A rationale for using the price/cash flow ratio is that there is only one clear definition of cash flow.

The P/S ratio is meaningful even for distressed firms, since sales revenue is always positive. This is not the case for the P/E and P/BV ratios, which can be negative. In the P/BV ratio book value is an appropriate measure of net asset value for firms that primarily hold liquid assets. Analysts use several different definitions of cash flow (CFO, adjusted CFO, FCFE, EBITDA, etc.) to calculate P/CF ratios.
When earnings are negative, the P/E ratio is meaningless.
作者: Kingpin804    时间: 2012-3-30 13:06

One advantage of using price-to-book value (PBV) multiples for stock valuation is that:
A)
it is a stable and simple benchmark for comparison to the market price.
B)
most of the time it is close to the market value.
C)
book value of a firm can never be negative.


Book value provides a relatively stable measure of value that can be compared to the market price. For investors who mistrust the discounted cash flow estimates of value, it provides a much simpler benchmark for comparison. Book value may or may not be closer to the market value. A firm may have negative book value if it shows accounting losses consistently.
作者: Kingpin804    时间: 2012-3-30 13:09

Of the following types of firm, which is most suitable for P/B ratio analysis?
A)
A firm with accounting standards different from other firms.
B)
A firm with accounting standards consistent to other firms.
C)
A service industry firm without significant fixed assets.


Assuming consistent accounting standards across firms, P/B ratios can reveal signs of misvaluation across firms.
作者: Kingpin804    时间: 2012-3-30 13:11

Which of the following is least likely a reason the price to cash flow (P/CF) model has grown in popularity?
A)
CFs are generally more difficult to manipulate than earnings.
B)
CFs are used extensively in valuation models.
C)
CFs are more easily estimated than future dividends.


CFs are not easier to estimate than dividends.
作者: Kingpin804    时间: 2012-3-30 13:11

Which of the following is a disadvantage of using price-to-sales (P/S) multiples in stock valuations?
A)
The use of P/S multiples can miss problems associated with cost control.
B)
It is difficult to capture the effects of changes in pricing policies using P/S ratios.
C)
P/S multiples are more volatile than price-to-earnings (P/E) multiples.


Due to the stability of using sales relative to earnings in the P/S multiple, an analyst may miss problems of troubled firms concerning its cost control. P/S multiples are actually less volatile than P/E ratios, which is an advantage in using the P/S multiple. Also, P/S ratios provide a useful framework for evaluating effects of pricing changes on firm value.
作者: Kingpin804    时间: 2012-3-30 13:12

The price to book value ratio (P/BV) is a helpful valuation technique when examining firms:
A)
with older assets compared to those with newer assets.
B)
with the same stock prices.
C)
that hold primarily liquid assets.


P/BV analysis works best for firms that hold primarily liquid assets.
作者: Kingpin804    时间: 2012-3-30 13:12

Assume that the expected dividend growth rate (g) for a firm decreased from 5% to zero. Further, assume that the firm's cost of equity (k) and dividend payout ratio will maintain their historic levels. The firm's P/E ratio will most likely:
A)
decrease.
B)
become undefined.
C)
increase.


The P/E ratio may be defined as: Payout ratio / (k - g), so if k is constant and g goes to zero, the P/E will decrease.
作者: Kingpin804    时间: 2012-3-30 13:12

According to the earnings multiplier model, all else equal, as the required rate of return on a stock increases, the:
A)
P/E ratio will increase.
B)
P/E ratio will decrease.
C)
earnings per share will increase.


According to the earnings multiplier model, the P/E ratio is equal to P0/E1 = (D1/E1)/(ke − g). As ke increases, P0/E1 will decrease, all else equal.
作者: Kingpin804    时间: 2012-3-30 13:13

According to the earnings multiplier model, a stock’s P/E ratio (P0/E1) is affected by all of the following EXCEPT the:
A)
required return on equity.
B)
expected dividend payout ratio.
C)
expected stock price in one year.


According to the earnings multiplier model, the P/E ratio is equal to P0/E1 = (D1/E1)/(ke - g).
Thus, the P/E ratio is determined by:
作者: Kingpin804    时间: 2012-3-30 13:13

The earnings multiplier model, derived from the dividend discount model, expresses a stock’s P/E ratio (P0/E1) as the :
A)
expected dividend payout ratio divided by the difference between the required return on equity and the expected dividend growth rate.
B)
expected dividend payout ratio divided by the sum of the expected dividend growth rate and the required return on equity.
C)
expected dividend in one year divided by the difference between the required return on equity and the expected dividend growth rate.

Starting with the dividend discount model P0 = D1/(ke − g), and dividing both sides by E1 yields: P0/E1 = (D1/E1)/(ke − g) Thus, the P/E ratio is determined by:
作者: Kingpin804    时间: 2012-3-30 13:14

If the payout ratio increases, the P/E multiple will:
A)
decrease, if we assume that the growth rate remains constant.
B)
always increase.
C)
increase, if we assume that the growth rate remains constant.


When payout ratio increases, the P/E multiple increases only if we assume that the growth rate will not change as a result.
作者: Kingpin804    时间: 2012-3-30 13:14

An analyst gathered the following information about an industry. The industry beta is 0.9. The industry profit margin is 8%, the total asset turnover ratio is 1.5, and the leverage multiplier is 2. The dividend payout ratio of the industry is 50%. The risk-free rate is 7% and the expected market return is 15%. The industry P/E is closest to:
A)
12.00.
B)
22.73.
C)
14.20.


Using the CAPM: ki = 7% + 0.9(0.15 − 0.07) = 14.2%.
Using the DuPont equation: ROE = 8% × 1.5 × 2 = 24%.
g = retention ratio × ROE = 0.50 × 24% = 12%.
P/E = 0.5/(0.142 − 0.12) = 22.73.
作者: Kingpin804    时间: 2012-3-30 13:14

A firm has an expected dividend payout ratio of 48 percent and an expected future growth rate of 8 percent. What should the firm's price to earnings ratio (P/E) be if the required rate of return on stocks of this type is 14 percent and what is the retention ratio of the firm?
P/E ratioRetention ratio
A)
8.0   52%
B)
6.5   52%
C)
6.5   48%


P/E = (dividend payout ratio)/(k - g)
P/E = 0.48/(0.14 - 0.08) = 8
The retention ratio = (1 - dividend payout) = (1 - 0.48) = 52%
作者: Kingpin804    时间: 2012-3-30 13:15

All of the following factors affects the firm’s P/E ratio EXCEPT:
A)
the required rate of return.
B)
growth rates of dividends.
C)
the expected interest rate on the bonds of the firm.


The factors that affect the P/E ratio are the same factors that affect the value of a firm in the infinite growth dividend discount model. The expected interest rate on the bonds is not a significant factor affecting the P/E ratio.
作者: Kingpin804    时间: 2012-3-30 13:15

Assuming all other factors remain unchanged, which of the following would most likely lead to a decrease in the market P/E ratio?
A)
A decline in the risk-free rate.
B)
An increase in the dividend payout ratio.
C)
A rise in the stock risk premium.

P/E = (1 - RR)/(k - g)
To lower P/E: RR increases, g decreases and or k increases. Both a decline in the RF rate and a decline in the rate of inflation will reduce k. An increase in the stock's risk premium will increase k.
作者: Kingpin804    时间: 2012-3-30 13:16

A stock has a required return of 14% percent, a constant growth rate of 5% and a retention rate of 60%. The firm’s P/E ratio should be:
A)
4.44.
B)
6.66.
C)
5.55.


P/E = (1 - RR) / (k - g) = 0.4 / (0.14 - 0.05) = 4.44
作者: Kingpin804    时间: 2012-3-30 13:16

If the expected dividend payout ratio of a firm is expected to rise from 50 percent to 55 percent, the cost of equity is expected to increase from 10 percent to 11 percent, and the firm’s growth rate remains at 5 percent, what will happen to the firm’s price-to-equity (P/E) ratio? It will:
A)
be unchanged.
B)
increase.
C)
decline.


Payout increases from 50% to 55%, cost of equity increases from 10% to 11%, and dividend growth rate stays at 5%, the P/E will change from 10 to 9.16:
P/E = (D/E) / (k – g).

P/E0 = 0.50 / (0.10 – 0.05) = 10.
P/E1 = 0.55 / (0.11 – 0.05) = 9.16.
作者: Kingpin804    时间: 2012-3-30 13:16

A firm has an expected dividend payout ratio of 50 percent, a required rate of return of 18 percent, and an expected dividend growth rate of 3 percent. The firm’s price to earnings ratio (P/E) is:
A)
6.66.
B)
3.33.
C)
2.78.


P/E = .5 / (18%-3%) = 3.33.
作者: Kingpin804    时间: 2012-3-30 13:17

Which of the following is NOT a determinant of the expected price/earnings (P/E) ratio?
A)
Expected dividend payout ratio (D/E).
B)
Expected growth rate in dividends (g).
C)
Average debt to capital ratio (D/C).


The P/E ratio is determined by payout ratio D/E, required return Ke, and expected growth g.
作者: Kingpin804    时间: 2012-3-30 13:17

According to the earnings multiplier model, which of the following factors is the least important in estimating a stock’s price-to-earnings ratio? The:
A)
historical dividend payout ratio.
B)
estimated required rate of return on the stock.
C)
expected dividend payout ratio.

P/E = (D1/E1)/(k - g)
where:
D1/E1 = the expected dividend payout ratio
k = estimated required rate of return on the stock
g =  expected growth rate of dividends for the stock

The P/E is most sensitive to movements in the denominator.
作者: Kingpin804    时间: 2012-3-30 13:17

Use the following information to determine the value of River Gardens’ common stock:
A)
$24.80.
B)
$30.12.
C)
$27.25.


First, estimate the price to earnings (P/E) ratio as: (0.45) / (0.124 – 0.065) = 7.63. Then, multiply the expected earnings by the estimated P/E ratio: ($3.25)(7.63) = $24.80.
作者: Kingpin804    时间: 2012-3-30 13:17

An analyst gathered the following data:
Assuming next year's earnings will be $4 per share, the stock’s current value is closest to:
A)
$26.67.
B)
$33.32.
C)
$45.45.


Dividend payout = 1 − earnings retention rate = 1 − 0.4 = 0.6
RS = Rf + β(RM − Rf) = 0.06 + 1.2(0.11 − 0.06) = 0.12
g = (retention rate)(ROE) = (0.4)(0.12) = 0.048
D1 = E1 × payout ratio = $4.00 × 0.60 = $2.40
Price = D1 / (k – g) = $2.40 / (0.12 – 0.048) = $33.32
作者: Kingpin804    时间: 2012-3-30 13:18

Assume that a firm has an expected dividend payout ratio of 20%, a required rate of return of 9%, and an expected dividend growth of 5%. What is the firm's estimated price-to-earnings (P/E) ratio?
A)
5.00.
B)
2.22.
C)
20.00.


The price-to-earnings (P/E) ratio is equal to (D1/E1)/(k – g) = 0.2/(.09 – 0.05) = 5.00.
作者: Kingpin804    时间: 2012-3-30 13:18

Assuming that a company's return on equity (ROE) is 12% and the required rate of return is 10%, which of the following would most likely cause the company's P/E ratio to rise?
A)
The inflation rate falls.
B)
The firm's ROE falls.
C)
The firm's dividend payout rises.


(An increase in the stock risk premium would have the opposite effect.)
作者: Kingpin804    时间: 2012-3-30 13:19

If a company has a "0" earnings retention rate, the firm's P/E ratio will equal:
A)
k + g
B)
1 / k
C)
D/P + g


P/E = div payout ratio / (k − g)
where g = (retention rate)(ROE) = (0)(ROE) = 0
Dividend payout = 1 − retention ratio = 1 − 0 = 1
P/E = 1 / (k − 0) = 1 / k
作者: Kingpin804    时间: 2012-3-30 13:19

A company currently has a required return on equity of 14% and an ROE of 12%. All else equal, if there is an increase in a firm’s dividend payout ratio, the stock's value will most likely:
A)
either increase or decrease.
B)
decrease.
C)
increase.


Increase in dividend payout/reduction in earnings retention.In this case, an increase in the dividend payout will likely increase the P/E ratio because a decrease in earnings retention will likely increase the P/E ratio. The logic is as follows: Because earnings retention impacts both the numerator (dividend payout) and denominator (g) of the P/E ratio, the impact of a change in earnings retention depends upon the relationship of ke and ROE. If the company is earning a lower rate on new projects than the rate required by the market (ROE < ke), investors will likely prefer that the company pay out earnings rather than investing in lower-yield projects. Since an increase in the dividend payout would decrease earnings retention, the P/E ratio would rise, as investors will value the company higher if it retains a lower percentage of earnings.
作者: Kingpin804    时间: 2012-3-30 13:20

All else equal, if a firm’s return on equity (ROE) increases, the stock’s value as estimated by the constant growth dividend discount model (DDM) will most likely:
A)
not change.
B)
decrease.
C)
increase.


Increase in ROE: ROE is a component of g. As g increases, the spread between ke and g, or the P/E denominator, will decrease, and the P/E ratio will increase.
作者: Kingpin804    时间: 2012-3-30 13:20

Assume a company's ROE is 14% and the required return on equity is 13%. All else remaining equal, if there is a decrease in a firm’s retention rate, a stock’s value as estimated by the constant growth dividend discount model (DDM) will most likely:
A)
increase.
B)
either increase or decrease.
C)
decrease.


Increase in dividend payout/reduction in earnings retention. In this case, reduction in earnings retention will likely lower the P/E ratio. The logic is as follows: Because earnings retention impacts both the numerator (dividend payout) and denominator (g) of the P/E ratio, the impact of a change in earnings retention depends upon the relationship of ke and ROE. If the company is earning a higher rate on new projects than the rate required by the market (ROE > ke), investors will likely prefer that the company retain more earnings. Since an increase in the dividend payout would decrease earnings retention, the P/E ratio would fall, as investors will value the company lower if it retains a lower percentage of earnings.
作者: Kingpin804    时间: 2012-3-30 13:21

All else equal, an increase in a company’s growth rate will most likely cause its P/E ratio to:
A)
decrease.
B)
either increase or decrease.
C)
increase.


Increase in g: As g increases, the spread between ke and g, or the P/E denominator, will decrease, and the P/E ratio will increase.
作者: Kingpin804    时间: 2012-3-30 13:21

According to the earnings multiplier model, all else equal, as the dividend payout ratio on a stock increases, the:
A)
P/E ratio will decrease.
B)
required return on the stock will decrease.
C)
P/E ratio will increase.


According to the earnings multiplier model, the P/E ratio is equal to P0/E1 = (D1/E1)/(ke - g). As D1/E1 increases, P0/E1 will increase, all else equal.
作者: Kingpin804    时间: 2012-3-30 13:22

All else equal, the price-to-earnings (P/E) ratio of a stable firm will increase if the:
A)
dividend payout is decreased.
B)
ROE is increased.
C)
long-term growth rate is decreased.


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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