Deck 9: Security Valuation Principles

Question 1

Which of the following statements regarding fundamental and relative valuation techniques is true?

A) Both techniques require an appropriate estimate of the required rate of return and the growth rate.
B) Both techniques require an estimate of future cash flows and a discount rate.
C) Both techniques require an estimate of future cash flows and a growth rate.
D) Both techniques require an estimate of future cash flows, the required rate of return and a growth estimate.
E) All of the above are true.

Answer 1

A

Question 2

The value of a corporate bond can be derived by calculating the present value of the interest payments and the present value of the face value at the bond's

A) current yield.
B) coupon rate.
C) required rate of return.
D) effective rate.
E) prime rate.

Answer 2

C

Question 3

Which securities can be valued by dividing the annual dividend by the required rate of return?

A) Low coupon bonds
B) Junk bonds
C) Common stocks
D) Preferred stocks
E) Constant growth common stocks

Answer 3

D

Question 4

The process of fundamental valuation requires estimates of all the following factors, except

A) the time pattern of returns.
B) the economy's real risk-free rate.
C) the risk premium for the asset.
D) the times series of stock prices.
E) the expected rate of inflation.

Question 5

In 2014, Swisten Inc. issued a €150 par value preferred stock that pays an 8 per cent annual dividend. Due to changes in the overall economy and in the company's financial condition investors are now requiring a 15 per cent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?

A) €80
B) €75
C) €59
D) €95
E) €110

Question 6

Refer to the previous question. What will be the value of these securities in one year if the required return is 6 per cent?

A) £1151.92
B) £972.52
C) £1100.15
D) £900.18
E) £936.72

Question 7

Growth rates of the (1) labour force, (2) average number of hours worked and (3) labour productivity are the main determinants of a foreign country's

A) dividend payout ratio.
B) beta.
C) real risk free rate.
D) nominal risk free rate.
E) risk premium.

Question 8

Which of the following factors influence an investor's required rate of return?

A) The economy's real risk-free rate (RFR)
B) The expected rate of inflation (I)
C) A risk premium
D) All of the above
E) None of the above

Question 9

The most appropriate discount rate to use when applying the Operating Free Cash Flows model is the firm's

A) Required rate of return based on the capital asset pricing model (CAPM)
B) Required rate of return based on the dividend discount model (DDM)
C) Weighted average cost of capital (WACC)
D) Historical cost of debt and equity
E) All of the above are appropriate depending on the situation

Question 10

Refer to the previous question. How much should you be willing to pay for the stock if you feel that the 5 per cent growth rate can be maintained indefinitely and you require a 17 per cent return?

A) £22.16
B) £19.28
C) £21.32
D) £23.63
E) £25.46

Question 11

Using the constant growth model, a decrease in the required rate of return from 15 to 13 per cent combined with an increase in the growth rate from 5 to 6 per cent would cause the price to

A) rise more than 50 per cent.
B) rise less than 50 per cent.
C) remain constant.
D) fall more than 50 per cent.
E) fall less than 50 per cent.

Question 12

A major manufacturer is re-evaluating its bonds since it is planning to issue a new bond in the current market. The firm's outstanding bond issue has 7 years remaining till maturity. The bonds were issued with an 8 per cent coupon rate (paid quarterly) and a par value of £1000. The required rate of return is 10 per cent. What is the current value of these securities?

A) £900.17
B) £1151.92
C) £972.52
D) £1113.63
E) £904.00

Question 13

Which of the following is not considered a basic economic force?

A) Fiscal policy
B) Monetary policy
C) Inflation
D) P/E ratio
E) None of the above (that is, all are basic economic forces)

Question 14

Davenport Corporation's last dividend was £2.70 and the directors expect to maintain the historic 3 per cent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 5 per cent for the next three years and the stock will then reach £25 per share. How much should you be willing to pay for the stock if you require a 17 per cent return?

A) £16.97
B) £22.16
C) £21.32
D) £32.63
E) £23.63

Question 15

Dividend growth is a function of

A) return on equity.
B) the retention rate.
C) the payout ratio.
D) all of the above.
E) none of the above.