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Q8. All of the following factors affects the firm’s P/E ratio EXCEPT:
A) the required rate of return.
B) the expected interest rate on the bonds of the firm.
C) growth rates of dividends.
Q9. 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 rise in the stock risk premium.
B) A decline in the risk-free rate.
C) An increase in the dividend payout ratio.
Q10. 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) 6.66.
B) 4.44.
C) 5.55.
Q11. 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) decline.
B) be unchanged.
C) increase.
Q12. 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) 3.33.
B) 6.66.
C) 2.78.
Q13. 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).
Q14. 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) estimated required rate of return on the stock.
B) historical dividend payout ratio.
C) expected dividend payout ratio.
Q15. Use the following information to determine the value of River Gardens’ common stock:
A) $30.12.
B) $27.25.
C) $24.80.
Q16. 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.
Q8. All of the following factors affects the firm’s P/E ratio EXCEPT: fficeffice" />
A) the required rate of return.
B) the expected interest rate on the bonds of the firm.
C) growth rates of dividends.
Correct answer is B)
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.
Q9. 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 rise in the stock risk premium.
B) A decline in the risk-free rate.
C) An increase in the dividend payout ratio.
Correct answer is A)
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.
Q10. 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) 6.66.
B) 4.44.
C) 5.55.
Correct answer is B)
P/E = (1 - RR) / (k - g) = 0.4 / (0.14 - 0.05) = 4.44
Q11. 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) decline.
B) be unchanged.
C) increase.
Correct answer is A)
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.
Q12. 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) 3.33.
B) 6.66.
C) 2.78.
Correct answer is A)
P/E = .5 / (18%-3%) = 3.33.
Q13. 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).
Correct answer is C)
The P/E ratio is determined by payout ratio D/E, required return Ke, and expected growth g.
Q14. 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) estimated required rate of return on the stock.
B) historical dividend payout ratio.
C) expected dividend payout ratio.
Correct answer is B)
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.
Q15. Use the following information to determine the value of ffice:smarttags" />
A) $30.12.
B) $27.25.
C) $24.80.
Correct answer is C)
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.
Q16. 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.
Correct answer is B)
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
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