Question 1

One rationale for using expected dividends in valuation is
A) Dividends are a necessary payment in order for a firm to have value.
B) Dividends are paid in cash, and cash serves as a measurable common denominator for comparing the future benefits of alternative investment opportunities.
C) Dividends are the most reliable measure of value because most companies payout dividends to shareholders.
D) Dividend payout ratios are set based on profitability.

Accepted Answer

Expected dividends are used in valuation because they are paid in cash, which serves as a measurable common denominator for comparing the future benefits of alternative investment opportunities. This allows for more accurate comparisons and an understanding of the true value of a company.

Question 2

If a firm has a market beta of 0.9,is subject to an income tax rate of 35 percent,has a risk-free rate of 6 percent,a market risk premium of 7 percent,and has a market value of debt to market value of equity ratio of 60 percent,what does the market expect the firm to generate in terms of equity returns using CAPM?
A) 6%
B) 7%
C) 12.3%
D) 13%

Accepted Answer

The equation for the CAPM is: 
Expected equity return = Risk-free rate + (Beta x Market risk premium) 
= 6% + (0.9 x 7%) 
= 12.3%

Since the firm has a market value of debt to market value of equity ratio of 60%, only the equity portion is being analyzed in the CAPM equation. The income tax rate does not affect the calculation of the expected equity return using CAPM.

Question 3

Which of the following is not a problem with using a dividend-based valuation formula
A) dividends are arbitrarily established
B) dividends represent a transfer of wealth to shareholders
C) some firms do not pay a regular periodic dividend
D) it is a challenge to forecast the final liquidating dividend

Accepted Answer

B

Question 4

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions):
 Determine the weight on equity capital that should be used to calculate Zonk's weighted-average cost of capital:
A) 21.7%
B) 78.3%
C) 41.8%
D) 50%

Accepted Answer

The answer of Zonk Corp. The following data pertains to...

Question 5

Equity valuation models based on dividends,cash flows,and earnings have been the topic of many theoretical and empirical research studies in recent years.All of the following are true regarding these studies except:
A) share prices in the capital markets generally correlate closely with share value
B) share prices do not always equal share values
C) temporary deviations of price from value occur
D) unexpected changes in earnings, dividends, and cash flows do not correlate closely with changes in stock prices

Accepted Answer

This statement is not true. Unexpected changes in earnings, dividends, and cash flows have a significant impact on stock prices, as seen in the reactions of the stock market to quarterly earnings reports or dividend changes.

Question 6

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions):
 Assume that Zonk is a potential leveraged buyout candidate.Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity.Compute the revised equity beta for Zonk based on the new capital structure.
A) 1.24
B) 4.77
C) 4.34
D) 3.91

Accepted Answer

The answer of Zonk Corp. The following data pertains to...

Question 7

When deriving the equity value of a firm,an analyst forecasts the real dividends expected to be paid in the future.In this case,which discount rate should be used?
A) The nominal rate of return
B) The real rate of return
C) The risk free rate of return
D) The risk adjusted rate of return

Accepted Answer

When forecasting real dividends, it is appropriate to use the real rate of return as the discount rate since it takes into account the inflation rate and provides a more accurate value of the future purchasing power of those dividends. The nominal rate of return includes an inflation premium, which would be double-counting the inflation effect on dividends. The risk-free rate or risk-adjusted rate may be relevant in other valuation methods, but not in this specific case where real dividends are being forecasted.

Question 8

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions):
 Assume that Zonk is a potential leveraged buyout candidate.Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pre tax borrowing cost of 14 percent and 30 percent common equity.Compute the weighted average cost of capital for Zonk based on the new capital structure.
A) 20.63%
B) 12.56%
C) 13.01%
D) 9.94%

Accepted Answer

The answer of Zonk Corp. The following data pertains to...

Question 9

Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because
A) debt is typically less risky because fixed claims bear less residual risk than equity claims.
B) equity bears less residual risk than debt.
C) equity capital costs are tax deductible.
D) the yield to maturity on equity is inversely related to its market value

Accepted Answer

Debt is typically less risky than equity because bondholders have a fixed claim on the company's assets and earnings, so they bear less residual risk than equity holders. As a result, investors accept a lower risk-adjusted rate of return on debt capital.

Question 10

In theory,the value of a share of common equity is the present value of ____________________________________________________________.
the expected future dividends

Accepted Answer

The answer of In theory,the value of a share of...

Question 11

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions):
 Assuming that riskless rate is 4.2% and the market premium is 6.2% calculate Zonk's cost of equity capital:
A) 10.4%
B) 7.69%
C) 11.89%
D) 2.0%

Accepted Answer

Zonk's cost of equity capital can be calculated using the CAPM formula:
Cost of equity = Risk-free rate + (Market premium * Beta)
First, we need to calculate Zonk's Beta using the given information. We can use the formula:
Beta = (Stock return - Risk-free rate) / Market return - Risk-free rate)
Beta = (14% - 4.2%) / 12.5% = 0.88
Now we can use the CAPM formula:
Cost of equity = 4.2% + (6.2% * 0.88) = 11.89%
Therefore, the best choice is C, 11.89%.

Question 12

Equity-based valuation models are based on all metrics except
A) dividends
B) cash flow
C) working capital
D) earnings

Accepted Answer

Equity-based valuation models are based on dividends, cash flow, and earnings, but not on working capital. Working capital is more relevant to assessing a company's liquidity and short-term financial health rather than its overall value.

Question 13

With respect to dividends and priority in liquidation,what has priority over common stock?
A) treasury stock
B) debt capital
C) preferred stock
D) nonconvertible common equity

Accepted Answer

Preferred stock has priority over common stock in both dividends and liquidation.

Question 14

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions):
 Determine the weight on debt capital that should be used to calculate Zonk's weighted-average cost of capital:
A) 21.7%
B) 78.3%
C) 50%
D) 58.2%

Accepted Answer

The answer of Zonk Corp. The following data pertains to...

Question 15

Returns on systematic risk-free securities (like U.S.Treasury securities)should exhibit what type of correlation with returns on a diversified marketwide portfolio of stocks?
A) nearly perfect correlation.
B) perfect correlation.
C) no correlation.
D) Unable to tell without specifics about the portfolio.

Accepted Answer

Returns on systematic risk-free securities are not affected by market fluctuations, so there should be no correlation with returns on a diversified marketwide portfolio of stocks.

Question 16

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions):
 Using the above information,calculate Zonk's weighted-average cost of capital:
A) 11.5%
B) 11.89%
C) 7.48%
D) 10.90%

Accepted Answer

The answer of Zonk Corp. The following data pertains to...

Question 17

Under the cash-flow-based valuation approach,free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model because:
A) this approach focuses on earnings as a measure of the capital that a firm creates.
B) over the life of the firm, the free cash flows into the firm and cash flows paid out of the firm in dividends to shareholders will be equivalent.
C) over the life of the firm, the free cash flows out of the firm for investments and cash flows paid into the firm in dividends from these investments will be equivalent.
D) this approach focuses on wealth distribution to shareholders.

Accepted Answer

Free cash flows represent the cash a company generates after accounting for capital expenditures necessary to maintain or expand its current operations. Since these cash flows are available to both debt and equity holders, they represent the future payoffs to all investors, not just shareholders. Additionally, over the life of the firm, the total amount of free cash flows generated and the cash flows paid out in dividends should be equivalent. Therefore, free cash flows can be used instead of dividends in the cash-flow-based valuation approach.

Question 18

Firm-specific factors that increase the firm's nondiversifiable risk include all of the following except:
A) exposure to interest rate changes
B) exposure to inflation
C) exposure to management competence
D) exposure to cyclicality

Accepted Answer

Exposure to management competence is a firm-specific factor that increases the firm's diversifiable risk, as it depends on the abilities and decisions of specific individuals within the company, rather than external market forces such as interest rates, inflation, and cyclicality.

Question 19

The historical discount rate of the firm may be a good indicator of the appropriate discount rate to apply to the firm in the future,when all of the following conditions hold true except:
A) The current risk of the firm is the same as the expected future risk of the firm.
B) Expected future interest rates are likely to equal current interest rates.
C) The existing capital structure of the firm is the same as the expected future capital structure of the firm.
D) The current mix of debt and equity financing is equal.

Accepted Answer

The answer of The historical discount rate of the firm...

Question 20

All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except:
A) Analyze the firm's strategy in terms of the competition.
B) Assess the quality of the firm's accounting and financial reporting.
C) Derive forecasts of future earnings from the firm's projected financial statements.
D) Obtain the national ranking of the firm's external auditors.

Accepted Answer

Obtaining the national ranking of the firm's external auditors is not a step in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value. The other three choices (analyzing the firm's strategy, assessing the quality of accounting, and deriving forecasts of future earnings) are all important steps in this framework.

Quiz 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach

One rationale for using expected dividends in valuation is

Which of the following is not a problem with using a dividend-based valuation formula

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions) : Determine the weight on equity capital that should be used to calculate Zonk's weighted-average cost of capital:

Equity valuation models based on dividends,cash flows,and earnings have been the topic of many theoretical and empirical research studies in recent years.All of the following are true regarding these studies except:

When deriving the equity value of a firm,an analyst forecasts the real dividends expected to be paid in the future.In this case,which discount rate should be used?

Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because

In theory,the value of a share of common equity is the present value of ____________________________________________________________. the expected future dividends

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions) : Assuming that riskless rate is 4.2% and the market premium is 6.2% calculate Zonk's cost of equity capital:

Equity-based valuation models are based on all metrics except

With respect to dividends and priority in liquidation,what has priority over common stock?

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions) : Determine the weight on debt capital that should be used to calculate Zonk's weighted-average cost of capital:

Returns on systematic risk-free securities (like U.S.Treasury securities) should exhibit what type of correlation with returns on a diversified marketwide portfolio of stocks?

Zonk Corp. The following data pertains to Zonk Corp.,a manufacturer of ball bearings (dollar amounts in millions) : Using the above information,calculate Zonk's weighted-average cost of capital:

Under the cash-flow-based valuation approach,free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model because:

Firm-specific factors that increase the firm's nondiversifiable risk include all of the following except:

The historical discount rate of the firm may be a good indicator of the appropriate discount rate to apply to the firm in the future,when all of the following conditions hold true except:

All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except: