Question 1

Seaside Boats currently earns $4.00 per share and has a retention ratio of 75%. It is expected to have a constant growth rate of 5 percent per year. The required return is 15 percent. What is the intrinsic value of this stock?

Accepted Answer

The answer of Seaside Boats currently earns $4.00 per share...

Question 2

Sometimes analysts use other ratios such as price-to-book or price-to-sales ratio. Which of the following is a weakness of the use of these ratios?

Accepted Answer

Different industries have varying capital structures and business models, making it difficult to compare these ratios across different sectors.

Question 3

Economic value added (EVA) indicates the amount by which a company's operating profit exceeds its cost of capital.

Accepted Answer

Economic Value Added (EVA) is a financial performance metric that calculates the value created beyond the required return of the company's shareholders, essentially measuring the surplus generated after covering the cost of capital.

Question 4

Technology stocks generally have P/E ratios that are higher than the market average.

Accepted Answer

Technology stocks often have higher P/E ratios because investors expect higher growth rates compared to the market average.

Question 5

The P/E ratio is one of the most widely used measures to assess the financial attractiveness of potential stock investments.

Accepted Answer

The Price-to-Earnings (P/E) ratio is a common metric used by investors to evaluate the relative value of a company's shares, comparing its current share price to its per-share earnings.

Question 6

Rita has calculated the discounted value of the free cash flows to the firm (FCFFs) for a company that has no preferred stock. What additional adjustment(s) does she have to make to her calculated discounted value to derive an estimate of the firm's stock price?

Accepted Answer

To estimate the firm's stock price, Rita needs to subtract the value of debt from the discounted value of FCFFs and then divide by the number of shares outstanding. This is because the FCFF represents the value available to all capital holders, and subtracting debt gives the equity value.

Question 7

Tanex Inc. has a return on assets (ROA) of 12%, a return on equity (ROE) of 15%, and a dividend payout ratio of 60%. Based on the sustainable growth formula, Tanex's estimated growth is:

Accepted Answer

The answer of Tanex Inc. has a return on assets...

Question 8

No one knows with precision which valuation model to apply for any particular stock.

Accepted Answer

Valuation models are based on assumptions and estimates, and different models may be appropriate depending on the context and available information.

Question 9

Sara estimated the revenue per share for Firm A as $5.50 and estimated the appropriate P/B ratio, P/E ratio, and P/S ratio as 1.9, 14.5, and 2.6, respectively. What is the estimated intrinsic value for Firm A?

Accepted Answer

The answer of Sara estimated the revenue per share for...

Question 10

Which factor is least likely to explain why a company has a higher P/E than another?

Accepted Answer

The answer of Which factor is least likely to explain...

Question 11

Investors will arrive at the same intrinsic valuation for common stocks because valuation is based on an objective approach.

Accepted Answer

Valuation involves subjective judgments and assumptions, leading to different intrinsic values for the same stock among different investors.

Question 12

If a stock's dividend growth rate or discount rate changes even a small amount, the change in the price calculated by the constant growth model can be very large.

Accepted Answer

The constant growth model is highly sensitive to changes in the dividend growth rate or discount rate, as these factors are used in the denominator of the formula, which can significantly impact the calculated stock price.

Question 13

Stan expects Terta Corp. to pay its first dividend of $3 in five years. He expects the dividend to grow at 6% thereafter, and his required return on the stock is 9.5%. The largest amount that Stan should pay for the stock is closest to:

Accepted Answer

The answer of Stan expects Terta Corp. to pay its...

Question 14

Many analysts prefer to use a relative valuation technique, such as comparing P/E ratios, because these techniques are more grounded in theory than the DCF approaches.

Accepted Answer

Relative valuation techniques like P/E ratios are often preferred for their simplicity and ease of comparison, but they are not necessarily more grounded in theory than DCF approaches, which are based on the fundamental principle of valuing an asset by its expected future cash flows.

Question 15

The only reliable way to value a common stock is to discount the future flow of dividends at a discount rate appropriate to the riskiness of the company.

Accepted Answer

While the dividend discount model is one method to value a stock, other methods like the discounted cash flow model, price-to-earnings ratio, and market comparables are also widely used and can be reliable depending on the context.

Question 16

The required return needed to discount a stock's future cash flows can be determined using the CAPM.

Accepted Answer

The Capital Asset Pricing Model (CAPM) is used to determine the expected return on an asset, which can be used as the discount rate for valuing future cash flows of a stock.

Question 17

Which of the following is most likely to increase a company's P/E ratio?

Accepted Answer

A new product that increases sales and profits can lead to higher expected future earnings, which can increase the P/E ratio as investors are willing to pay more for the company's stock based on its growth prospects.

Question 18

To estimate the intrinsic value of a security, investors should rely on:

Accepted Answer

Using more than one approach allows investors to cross-verify results and gain a comprehensive understanding of the security's intrinsic value.

Question 19

Which of the following is a component of a firm's enterprise value?

Accepted Answer

Enterprise value includes the market value of a company's equity, debt, and cash equivalents. Bonds, as a form of debt, are part of this calculation.

Question 20

Riza Corporation's preferred stock has a par value of $100 and a dividend rate of 6%. If the required return on the stock is 8%, its intrinsic value is closest to:

Accepted Answer

The intrinsic value of preferred stock is calculated by dividing the annual dividend by the required return. The annual dividend is 6% of $100, which is $6. The intrinsic value is $6 / 0.08 = $75.

Quiz 10: Common Stock Valuation