Reading 58: Company Analysis and Stock Selection - LOS b～ investment, following, regarding, expected

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LOS b: Describe and estimate the expected earnings per share (EPS) and earnings multiplier for a company and use the multiple to make an investment decision regarding the company.

Q1. Assume the following information for a stock:

Beta coefficient                                  = 1.50

Risk-free rate                                     = 6%

Expected rate of return on market = 14%

Dividend payout ratio                       = 30%

Expected dividend growth rate       = 11%

The estimated earnings multiplier (P/E ratio) is closest to:

A)   4.29.

B)   3.33.

C)   10.00

 

Q2. Given a beta of 1.55 and a risk-ree rate of 8%, what is the expected rate of return, assuming a 14% market return?

A)   17.3%.

B)   12.4%.

C)   20.4%.

 

Q3. An analyst gathered the following data for the Parker Corp. for the year ended December 31, 2005:

• EPS₂₀₀₅ = $ 1.75
• Dividends₂₀₀₅ = $ 1.40
• Beta _Parker = 1.17
• Long-term bond rate = 6.75%
• Rate of return S&₅₀₀ = 12.00%

The firm is expected to continue their dividend policy in future. If the long-term growth rate in earnings and dividends is expected to be 6%, the appropriate P/E ratio for Parker Corp. will be:

A)   21.54.

B)   12.31.

C)   11.61.

 

Q4. An analyst gathered the following data for the Parker Corp. for the year ended December 31, 2005:

• EPS₂₀₀₅ = $1.75
• Dividends₂₀₀₅ = $1.40
• Beta _Parker = 1.17
• Long-term bond rate = 6.75%
• Rate of return S&₅₀₀ = 12.00%

The firm has changed its dividend policy and now plans to pay out 60% of its earnings as dividends in the future. If the long-term growth rate in earnings and dividends is expected to be 5%, the appropriate price to earnings (P/E) ratio for Parker will be:

A)   7.60.

B)   9.14.

C)   7.98.

 

Q5. All else equal, a firm will have a higher Price-to-Earnings (P/E) multiple if:

A)   the stock’s beta is lower.

B)   return on equity (ROE) is lower.

C)   retention ratio is higher.

 

Q6. Use the following data to analyze a stock's price earnings ratio (P/E ratio):

• The stock's beta is 1.2.
• The dividend payout ratio is 60%.
• The stock's expected growth rate is 7%.
• The risk free rate is 6% and the expected rate of return on the market is 13%.

Using the dividend discount model, the expected P/E ratio of the stock is closest to:

A)   5.4.

B)   8.1.

C)   10.0.

 

Q7. An analyst gathered the following information about Weston Chemical’s stock:

• Estimated sales per share = $12.19
• Earnings before interest, taxes, depreciation, and amortization (EBITDA) = 73%
• Interest expense per share = $2.07
• Depreciation expense per share = $6.21
• The tax rate = 35%

Weston’s estimated earnings per share (EPS) is closest to:

A)   $2.54.

B)   $3.11.

C)   $0.40.

 

Q8. An analyst gathered the following information on Roan Mountain Amusement Park:

• Sales per share = $9.29
• Earnings before interest, taxes, depreciation, and amortization (EBITDA) = 65%
• Interest expense per share = $1.26
• Depreciation expense per share = $4.12
• Marginal tax rate = 43%

Roan Mountain’s expected earnings per share is closest to:

A)   $0.22.

B)   $0.38.

C)   $0.47.

 

Q9. A stock has a required rate of return of 15%, a constant growth rate of 10%, and a dividend payout ratio of 45%. The stock’s price-earnings ratio should be:

A)   4.5 times.

B)   3.0 times.

C)   9.0 times.

 

yangh

 

LOS b: Describe and estimate the expected earnings per share (EPS) and earnings multiplier for a company and use the multiple to make an investment decision regarding the company.fficeffice" />

Q1. Assume the following information for a stock:

Beta coefficient                                  = 1.50

Risk-free rate                                     = 6%

 

Expected rate of return on market = 14%

Dividend payout ratio                       = 30%

Expected dividend growth rate       = 11%

The estimated earnings multiplier (P/E ratio) is closest to:

A)   4.29.

B)   3.33.

C)   10.00

Correct answer is A)

P/E = D/E₁ / (k ? g)

D/E₁ = Dividend payout ratio = 0.3

g = 0.11

k = 6 + (1.5)(14 ? 6) = 18%

P/E = 0.3 / (0.18 ? 0.11) = 0.3 / 0.07 = 4.29

 

Q2. Given a beta of 1.55 and a risk-ree rate of 8%, what is the expected rate of return, assuming a 14% market return?

A)   17.3%.

B)   12.4%.

C)   20.4%.

Correct answer is A)

k = 8 + 1.55(14-8)
= 8 + 1.55(6)
= 8 + 9.3
= 17.3

 

Q3. An analyst gathered the following data for the Parker Corp. for the year ended December 31, 2005:

• EPS₂₀₀₅ = $ 1.75
• Dividends₂₀₀₅ = $ 1.40
• Beta _Parker = 1.17
• Long-term bond rate = 6.75%
• Rate of return S&₅₀₀ = 12.00%

The firm is expected to continue their dividend policy in future. If the long-term growth rate in earnings and dividends is expected to be 6%, the appropriate P/E ratio for Parker Corp. will be:

A)   21.54.

B)   12.31.

C)   11.61.

Correct answer is C)

The appropriate P/E ratio for Parker will be 11.61.

P/E ratio = .80/(.1289 - .0600) = 11.61

Where r = required rate of return on equity, g_n = growth rate in dividends (forever).

The required rate of return on equity for Parker will be 12.89% = 6.75% + 1.17(12.00% - 6.75%) and the firm pays 80% (1.40/1.75) of its earnings as dividends.

 

Q4. An analyst gathered the following data for the Parker Corp. for the year ended December 31, 2005:

• EPS₂₀₀₅ = $1.75
• Dividends₂₀₀₅ = $1.40
• Beta _Parker = 1.17
• Long-term bond rate = 6.75%
• Rate of return S&₅₀₀ = 12.00%

The firm has changed its dividend policy and now plans to pay out 60% of its earnings as dividends in the future. If the long-term growth rate in earnings and dividends is expected to be 5%, the appropriate price to earnings (P/E) ratio for Parker will be:

A)   7.60.

B)   9.14.

C)   7.98.

Correct answer is A)

P/E Ratio = 0.60/(.1289 - .0500) = 7.60.

Required rate of return on equity will be 12.89 percent = 6.75% + 1.17(12.00% - 6.75).

 

Q5. All else equal, a firm will have a higher Price-to-Earnings (P/E) multiple if:

A)   the stock’s beta is lower.

B)   return on equity (ROE) is lower.

C)   retention ratio is higher.

Correct answer is A)

To increase P/E ratio, lower the retention ratio, lower k and or increase g. A lower beta would lead to a lower stock risk premium and a lower k.

 

Q6. Use the following data to analyze a stock's price earnings ratio (P/E ratio):

• The stock's beta is 1.2.
• The dividend payout ratio is 60%.
• The stock's expected growth rate is 7%.
• The risk free rate is 6% and the expected rate of return on the market is 13%.

Using the dividend discount model, the expected P/E ratio of the stock is closest to:

A)   5.4.

B)   8.1.

C)   10.0.

Correct answer is B)        

k = ER = Rf + Beta(RM ? Rf) = 0.06 + (1.2)(0.13 ? 0.06) = 0.144

Dividend payout ratio = 0.60

P/E = div payout / (k ? g) = 0.6 / (0.144 ? 0.07) = 8.1

 

Q7. An analyst gathered the following information about Weston Chemical’s stock:

• Estimated sales per share = $12.19
• Earnings before interest, taxes, depreciation, and amortization (EBITDA) = 73%
• Interest expense per share = $2.07
• Depreciation expense per share = $6.21
• The tax rate = 35%

Weston’s estimated earnings per share (EPS) is closest to:

A)   $2.54.

B)   $3.11.

C)   $0.40.

Correct answer is C)        

Estimate EPS as: [(sales per share)(EBITDA %) – depreciation per share – interest per share][1 – tax rate] = [($12.19)(0.73) – $6.21 – $2.07][1 – 0.35] = $0.4022 = $0.40.

 

Q8. An analyst gathered the following information on ffice:smarttags" />laceName w:st="on">RoanlaceName> laceType w:st="on">MountainlaceType> laceType w:st="on">Amusement ParklaceType>:

• Sales per share = $9.29
• Earnings before interest, taxes, depreciation, and amortization (EBITDA) = 65%
• Interest expense per share = $1.26
• Depreciation expense per share = $4.12
• Marginal tax rate = 43%

laceName w:st="on">RoanlaceName> laceType w:st="on">MountainlaceType>’s expected earnings per share is closest to:

A)   $0.22.

B)   $0.38.

C)   $0.47.

Correct answer is B)

Earnings per share is [(sales per share)(EBITDA %) – depreciation per share – interest per share][1 – tax rate]
= [($9.29)(0.65) – $4.12 – $1.26][1 – 0.43] = $0.3753 = $0.38.

 

Q9. A stock has a required rate of return of 15%, a constant growth rate of 10%, and a dividend payout ratio of 45%. The stock’s price-earnings ratio should be:

A)   4.5 times.

B)   3.0 times.

C)   9.0 times.

Correct answer is C)        

P/E = D/E₁/ (k - g)
D/E₁ = Dividend Payout Ratio = .45
k = .15
g = .10
P/E = .45 / (.15 - .10) 
= .45 / .05 = 9

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