# Quiz 8: Share Valuation

Business

Q 1Q 1

Which of the following will most directly influence a company's market value?
A) The book value of its assets.
B) The use of financial leverage.
C) Its future cash flows.
D) The state of the economy.

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Multiple Choice

C

Q 2Q 2

When using the constant- growth dividend valuation model, which of the following will lower the value of the share?
A) An increase in the required rate of return.
B) A decrease in the required rate of return.
C) An increase in the growth rate of the dividends.
D) An increase in the dividend payout ratio.

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Multiple Choice

A

Q 3Q 3

Which one of the following is a correct equation to calculate earnings per share?
A) (ROA)(book value per share)
B) (profit margin)(equity multiplier)(book value per share)
C) (profit margin)(total asset turnover)(equity multiplier)(book value per share)
D) (profit margin)(book value per share)

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Multiple Choice

C

Q 4Q 4

A firm with a price- to- sales ratio of 1 would usually be considered
A) undervalued.
B) overvalued.
C) near bankruptcy.
D) correctly valued.

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Multiple Choice

Q 5Q 5

Which one of the following is most likely to increase the price of a share?
A) Rapid growth in sales.
B) Rapid growth in dividends.
C) Rapid increases in bond interest rates.
D) Rapid growth in earnings.

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Multiple Choice

Q 6Q 6

The dividends- and- earnings (D&E) approach to share valuation and the variable- growth DVM approach are similar in that both approaches
A) use the historical dividend growth rate as the key input figure.
B) consider the future selling price of the share but ignore future dividends.
C) consider dividends only and ignore the future selling price of the share.
D) are present- value based.

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Multiple Choice

Q 7Q 7

A company has an annual dividend growth rate of 5% and a retention rate of 40%. The company's dividend payout ratio is
A) 45%.
B) 35%.
C) 40%.
D) 60%.

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Multiple Choice

Q 8Q 8

The intrinsic value of a share provides a purchase price for the share
A) that is reasonable given the associated level of risk.
B) which will assuredly yield the anticipated capital gain.
C) that is always below the market value but yet yields the expected rate of return.
D) which will guarantee the expected rate of return.

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Multiple Choice

Q 9Q 9

Winifred, Inc. paid $1.64 as an annual dividend per share last year. The company is expected to increase their annual dividends by 3% each year. How much should you pay to purchase one share of this stock if you require a 9% rate of return on this investment?
A) $27.33
B) $18.22
C) $18.77
D) $28.15

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Multiple Choice

Q 10Q 10

The price- to- cash- flow method of share valuation generally
A) uses EBITDA as the cash flow value.
B) applies the P/E multiple to the cash flow per share value.
C) produces a cash flow multiple that is greater than the P/E multiple.
D) relies on historical cash flows.

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Multiple Choice

Q 11Q 11

A company that wants to maintain both a constant-growth rate in dividends and a constant payout ratio will have to
A) increase assets at the same rate as dividends.
B) grow earnings faster than dividends.
C) increase shareholders' equity at the same rate as dividends.
D) grow earnings at the same rate as dividends.

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Multiple Choice

Q 12Q 12

P/E ratios could rise even as earnings fall if
A) earnings fall at a faster rate than share prices.
B) investors expect lower share prices to be permanent.
C) earnings fall at a slower rate than share prices.
D) investors expect lower earnings to be permanent.

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Multiple Choice

Q 13Q 13

The Highlight Company has a book value of $56.50 per share, and is currently trading at a price of $59.00 per share. You are interested in investing in Highlight, and have just used a present- value based share valuation model to calculate a present (intrinsic) value of $55.00 per share. Assuming that your calculations are correct you should
A) buy the share, because the book value and the current trading price are very close to one another in value.
B) not buy the share, because the present value is less than the market price per share.
C) buy the share, because the current market price per share is higher than the present value.
D) buy the share, because the book value per share is greater than the present value.

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Multiple Choice

Q 14Q 14

Which of the following contributes to high P/E ratios?
A) Periods of high inflation.
B) High dividend payout ratios.
C) High debt ratios.
D) High rate of earnings growth.

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Multiple Choice

Q 15Q 15

Even if a company does not officially follow a fixed- dividend policy, dividend payments are
A) directly tied to a company's P/E ratio.
B) fairly stable from one time period to another.
C) extremely difficult to predict.
D) very volatile and subject to economic conditions.

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Multiple Choice

Q 16Q 16

Over the last year, a firm's earnings per share increased from $1.20 to $1.40, its dividends per share increased from $0.50 to $0.60, and its share price increased from $21 to $24. The firm maintained a relative P/E of 1.10 over the entire time period. Given this information, it follows that the
A) shares experienced an increase in its P/E ratio.
B) overall market P/E is declining.
C) current P/E of the overall market is 26.4.
D) company had a decrease in its dividend payout ratio.

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Multiple Choice

Q 17Q 17

Stephanie is an investor who believes that the real key to a company's future share price lies in its future earnings. When investing in a company, she carefully studies its future earnings potential, and sells a company's share at the first sign of any trouble. This information indicates that Stephanie would correctly be classified as
A) a growth investor.
B) a buy- and- hold investor.
C) an index investor.
D) a value investor.

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Multiple Choice

Q 18Q 18

Markhem Enterprises is expected to earn $1.34 per share this year. The company has a dividend payout ratio of 40% and a P/E ratio of 18. What should the shares of ordinary shares in Markhem Enterprises be selling for in the market?
A) $14.47
B) $24.12
C) $33.77
D) $9.65

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Multiple Choice

Q 19Q 19

The single most important variable in the dividends- and- earnings approach is the
A) applicable beta.
B) amount of the future dividends.
C) appropriate P/E multiple.
D) rate of growth.

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Multiple Choice

Q 20Q 20

The ordinary shares of Jennifer's Furniture Outlet is currently selling at $32.60 a share. The company adheres to a 60% dividend payout ratio and has a P/E ratio of 19. There are 21,000 shares of stock outstanding. What is the amount of the annual net income for the firm?
A) $21,619
B) $48,327
C) $60,053
D) $36,032

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Multiple Choice

Q 21Q 21

One common method of estimating the growth rate of dividends is to
A) multiply the return on equity by the dividend payout ratio.
B) randomly assign an annual growth rate of 4% to the latest dividend amount.
C) multiply the return on equity by the firm's retention rate.
D) multiply the return on assets by the dividend payout ratio.

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Multiple Choice

Q 22Q 22

If the market multiple is 23.0 and the P/E ratio of a company is 27.4, then the share's relative P/E is
A) 3.21.
B) 4.40.
C) 1.19.
D) 0.84.

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Multiple Choice

Q 23Q 23

In applying the variable- growth dividend valuation model to a company's share, analysts frequently define the growth rate, g, as equal to
A) ROE divided by the dividend payout ratio.
B) ROE multiplied by the firm's retention rate.
C) the dividend payout ratio multiplied by the firm's retention rate.
D) P/E multiplied by the dividend payout ratio.

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Multiple Choice

Q 24Q 24

The single most important issue in the share valuation process is a company's
A) historic dividend growth rate.
B) expected future returns.
C) capital structure.
D) past earnings record.

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Multiple Choice

Q 25Q 25

Martin's Inc. is expected to pay annual dividends of $2.50 a share for the next three years. After that, dividends are expected to increase by 3% annually. What is the current value of this share to you if you require a 9% rate of return on this investment?
A) $42.92
B) $40.11
C) $41.81
D) $39.47

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Multiple Choice

Q 26Q 26

The Merry Co. has current annual sales of $350,000 and a net profit margin of 6%. Sales are expected to increase by 5% annually while the profit margin is expected to remain constant. What is the projected after- tax earnings for two years from now?
A) $23,100
B) $23,153
C) $19,294
D) $22,050

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Multiple Choice

Q 27Q 27

An internal rate of return (IRR) is the discount rate that
A) produces a present value of future benefits equal to the market price of a share.
B) is the minimal rate of return an investor will accept.
C) provides an investor with their required return.
D) represents the minimal rate required to create a positive net present value.

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Multiple Choice

Q 28Q 28

One share valuation model holds that the value of a share is a function of its future dividends, and that the dividends will increase at an annual rate which will remain unchanged over time. This share valuation model is known as the
A) constant- growth dividend valuation model.
B) dividend reinvestment model.
C) holding period return model.
D) approximate yield model.

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Multiple Choice

Q 29Q 29

GLOO stock's P/E ratio is 45 at a time when the market's P/E ratio is 15. GLOO's realtive P/E ratio is
A) - 30.
B) 3.
C) 30.
D) )33.

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Multiple Choice

Q 30Q 30

The current annual sales of Flower Bud, Inc. are $178,000. Sales are expected to increase by 4% next year. The company has a net profit margin of 5% which is expected to remain constant for the next couple of years. There are 10,000 shares outstanding. The market multiple is 16.4 and the relative P/E of the firm is 1.21. What is the expected market price per share for next year?
A) $19.29
B) $18.37
C) $17.66
D) $15.18

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Multiple Choice

Q 31Q 31

The major forces behind earnings per share are
A) return on assets and total asset turnover.
B) return on equity and the equity multiplier.
C) return on equity and book value.
D) return on assets and book value.

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Multiple Choice

Q 32Q 32

The value of a share is a function of
A) past returns.
B) historic dividend growth rate.
C) future returns.
D) most recent earnings per share.

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Multiple Choice

Q 33Q 33

James is willing to settle for a 10% rate of return on EG shares at a time when investors, on average, are requiring an 11% rate of return on the same shares. Which of the following will happen?
A) James will be have to pay more for the shares than he was willing to pay.
B) James will be happy to buy the shares for less than he was willing to pay.
C) Investors with different required rates of return will pay different prices for the shares.
D) James will not be able to buy the shares unless the price changes.

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Multiple Choice

Q 34Q 34

What is the required rate of return on a ordinary share that is expected to pay a $0.75 annual dividend next year if dividends are expected to grow at 2 percent annually and the current share price is $8.59?
A) 8.73%.
B) 8.91%.
C) 11.38%.
D) 10.73%.

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Multiple Choice

Q 35Q 35

Michelak's Maritime Industries has relatively stable earnings and pays an annual dividend of $2.50 per share. This dividend has remained constant over the past few years and is expected to remain constant for some time to come. If you want to earn 12% on an investment in the company's shares, how much should you pay to purchase each share?
A) $20.83
B) $25.00
C) $18.88
D) $12.50

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Multiple Choice

Q 36Q 36

The constant- growth dividend valuation model is best suited for use with
A) small- cap shares within growing industries.
B) shares of new or emerging companies.
C) the shares of mature, dividend- paying companies.
D) the shares of cyclical companies.

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Multiple Choice

Q 37Q 37

ABC Company share currently has a market value equivalent to its intrinsic value. Marco perceives that ABC Company is increasing its level of risk and therefore Marco increases his required rate of return on ABC share. This change in the required rate of return
A) will change the intrinsic value but the direction of the change cannot be determined.
B) will reduce the intrinsic value of ABC share to Marco.
C) is a signal to Marco that he should buy more ABC Company share.
D) will increase the intrinsic value of ABC share to Marco.

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Multiple Choice

Q 38Q 38

William is the type of share market investor who focuses on factors such as a company's book value, debt load, return on equity, and cash flow. In searching for share investments, he looks at a company's historical performance and attempts to find undervalued shares. This information indicates that William is the type of investor known as
A) a value investor.
B) a growth investor.
C) a premium investor.
D) an earnings investor.

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Multiple Choice

Q 39Q 39

The Frisco Company just paid $2.20 as its annual dividend. The dividends have been increasing at a rate of 4% annually and this trend is expected to continue. The share is currently selling for $63.60 a share. What is the rate of return on this share?
A) 7.60%.
B) 3.60%.
C) 3.46%.
D) 7.46%.

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Multiple Choice

Q 40Q 40

Zephyr Inc. sells wind based systems for generating electricity. The company pays no dividends, but you estimate the share will be worth $50 per share 5 years from now and you require a 15% rate of return for share investments of this type. What price should you be willing to pay for this share?
A) $57.50
B) $24.86
C) $12.50
D) $43.48

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Multiple Choice

Q 41Q 41

According to the price/earnings approach to share valuation, if the dividend growth rate is expected to drop or if the required return goes up, the net effect is a
A) higher P/E ratio.
B) higher share price.
C) lower P/E ratio.
D) higher retention rate.

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Multiple Choice

Q 42Q 42

In general, the higher the retention ratio
A) the lower the future book value per share.
B) the higher the future growth rate of the company.
C) the higher the dividends per share of ordinary share.
D) the higher the future debt- equity ratio.

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Multiple Choice

Q 43Q 43

The risk- free rate of return is 4.2 percent, the expected market return is 9 percent, and the beta for Lea, Inc. is 1.12. What is Lea's required rate of return?
A) 13.70%.
B) 9.58%.
C) 14.28%.
D) 10.08%.

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Multiple Choice

Q 44Q 44

Which of the following approaches to share valuation is not based on a multiple of some figure from the financial statements?
A) The price to earnings approach.
B) The price-to-cash-flow approach.
C) The price-to-sales approach.
D) The dividends- and- earnings approach.

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Multiple Choice

Q 45Q 45

An investor should purchase a share when
A) the market price is greater than the justified price.
B) the expected rate of return equals or exceeds the required return.
C) the capital gains rate is less than the required return and no dividends are paid.
D) the market price exceeds the intrinsic value.

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Multiple Choice

Q 46Q 46

Ivonne has bought shares of RIO, Inc. for $25.00 per share. She expects a $1.00 dividend at the end of this year. After 2 years, she expects to receive a dividend of $1.25 and to sell the share for $28.75. What is Ivonne's required rate of return?
A) 24.0%.
B) 15.2%.
C) 4.0%.
D) 11.6%.

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Multiple Choice

Q 47Q 47

Newton, Inc. just paid an annual dividend of $0.95. Their dividends are expected to increase by 4% annually. Newton Company share is selling for $11.54 a share. What is the capitalisation rate on this share?
A) 12.2%.
B) 13.9%.
C) 8.23%.
D) 12.6%.

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Multiple Choice

Q 48Q 48

In the price/earnings approach to share valuation,
A) the P/E ratio is computed by multiplying the share price by the earnings per share.
B) the market P/E ratio, adjusted by beta, is used to value individual shares.
C) forecasted EPS are typically used.
D) historical share prices are utilised.

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Multiple Choice

Q 49Q 49

High P/E ratios can be expected when investors expect
A) high interest rates.
B) a high rate of growth in earnings.
C) a bear market.
D) low earnings. relative to market prices.

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Multiple Choice

Q 50Q 50

EBITDA is an acronym for
A) Earnings Based Information, Total Development Approach.
B) Earnings Before Interest, Taxes, Dividends, and Asset replacement.
C) Earnings Before Interest, Taxes, Depreciation, and Amortisation.
D) Ernst, Bostwick, Davenport, Innes Approach.

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Multiple Choice

Q 51Q 51

Lindell, Inc. has 8%, $100 par value preference shares outstanding. To earn 12% on an investment in this share, you need to purchase the shares at a per share price of
A) $66.67.
B) $150.00.
C) $9.60.
D) $96.00.

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Multiple Choice

Q 52Q 52

For which one of the following situations will the price- to- sales valuation model work but the dividend and cash flow models will not?
A) Top- performing firm in a mature industry.
B) Newly- formed biotechnology company with negative earnings.
C) Water- powered electric utility company.
D) Mature firm with minimal growth opportunities.

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Multiple Choice

Q 53Q 53

The variable- growth dividend valuation model
A) assumes the rate of dividend growth will vary indefinitely.
B) is valuable because it accounts for the general growth patterns of most companies.
C) develops the value of a share using the future value of dividends minus a rate of capital gain growth.
D) is invalid if at any point in time the growth rate exceeds the required rate of return.

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Multiple Choice

Q 54Q 54

The risk-free rate is 2%. The expected rate of return on the market is 12%. Beta and the expected rate of return for four shares are as follows.: ABC .8, 10%; DEF 1, 12%; GHI 1.2, 13%, and JKL 2, 22%. Which of these shares should not be purchased?
A) GHI.
B) JKL.
C) DEF.
D) ABC.

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Multiple Choice

Q 55Q 55

The dividend valuation model (DVM) is very sensitive to the growth rate (g) being used, because it affects both the model's numerator and its denominator.

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True False

Q 56Q 56

The estimated price of a share in the future is important because it includes the projected capital gain on the share.

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True False

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True False

Q 58Q 58

There is no assurance that the actual rate of return on an asset will be similar to the projected rate of return.

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True False

Q 59Q 59

A share's internal rate of return (IRR) is the discount rate that cause the present value of future dividends to equal the price of the share.

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True False

Q 60Q 60

The dividend valuation model estimates the value of a share as the future value of all dividends.

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True False

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True False

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True False

Q 63Q 63

One of the easiest aspects of the dividend valuation model (DVM) is specifying the appropriate growth rate for a firm's dividends over time.

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True False

Q 64Q 64

The approach to share valuation which holds that the value of a share is a function of its future dividends is known as the dividend valuation model (DVM).

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True False

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True False

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True False

Q 67Q 67

A drawback to the price- to- cash- flow method of valuation is that there is no generally accepted cash flow measure.

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True False

Q 68Q 68

One method of estimating the dividend growth rate is to calculate the discount rate that equates today's dividend with the dividend paid ten years ago.

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True False

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True False

Q 70Q 70

The key to the future behaviour of a company lies in the sales growth and the net profit margin.

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True False

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True False

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True False

Q 73Q 73

As a company's beta rises, the required return on the share should fall, all other things being equal.

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True False

Q 74Q 74

The rate of dividend growth can be estimated by multiplying the return on equity rate by the dividend payout ratio.

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True False

Q 75Q 75

When an investor multiplies future estimated earnings per share by a price/earnings ratio to compute the value of a share that investor is using the price/earnings approach to valuation.

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True False

Q 76Q 76

The primary reason an investor should look at the past performance of a company is to gain insight into the future direction and profitability of the firm.

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True False

Q 77Q 77

A temporary decline in earnings per share usually results in a temporary reduction of dividends.

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True False

Q 78Q 78

The common- size income statement expresses every item on the income statement as a percentage of sales.

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True False

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True False

Q 80Q 80

The price of a share with a low relative P/E will tend to be more volatile than the price of a share with a high relative P/E.

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True False

Q 81Q 81

The constant-growth dividend valuation model works best for mature companies with a long record of paying dividends.

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True False

Q 82Q 82

Overall, professional analysts have an outstanding record of predicting changes in market direction before they happen.

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True False

Q 83Q 83

The intrinsic value of a zero- growth share is simply the capitalised value of its annual dividends.

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True False

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True False

Q 85Q 85

The rate of growth can exceed the required return during the variable- growth period without invalidating the variable growth dividend valuation model.

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True False

Q 86Q 86

The intrinsic value of an asset equals the present value of all future cash flows at a given discount rate.

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True False

Q 87Q 87

Neither the P/E approach nor the dividends- and- earnings approach rely on dividends as the key input into the valuation of a share.

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True False

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True False

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Essay

Q 90Q 90

List the key variables that affect the P/E ratio and explain the relationship between each variable and the P/E ratio.

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Essay

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Essay

Q 92Q 92

1Tureves S.A. is a French biotechnology company that has developed promising therapies for hair loss, obesity, and wrinkled skin. Sales have doubled in each of the last three years, but so far, the company has yet to turn a profit. Which common procedures would be most, and least appropriate to value Tureves' shares.

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Essay

Q 93Q 93

WaterCo is a manufacturer of boat parts and has been in business only a few years. Its board of directors decided to start paying a dividend to help boost the attractiveness of its share. The dividend will be $0.50 per share next year. After that dividends will increase by 4 percent per year. The company has a beta of 1.6. The market rate of return is 8% and the T- bill rate is 3%. Should you purchase shares in this firm at the current market price of $6.98 per share?

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Essay

Q 94Q 94

The ordinary share of Peachtree Paper, Inc., is currently selling for $40 a share. A dividend of $2.00 per share was just paid. You are estimating that this dividend will grow at a constant rate of 10%.
a() Using the constant-growth DVM model, what is your required rate of return if $40 is a reasonable trading price? (Show all work.)
b() If Peachtree Paper is a new company that produces a relatively unknown product, is the constant-growth model a good valuation method for a potential investor to use? Justify your answer.

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Essay