Question 1

Which of the following will most directly influence a company's market value?

Accepted Answer

A company's market value is primarily determined by its future cash flows. Investors are interested in a company's ability to generate earnings and cash flow in the future, so a stronger outlook for future cash flows will drive up market value. The state of the economy, book value of assets, and use of financial leverage may all have an indirect impact on a company's future cash flows, but they are not the direct determinants of market value.

Question 2

A decline in earnings that investors expect to be temporary may actually increase a firm's P/E ratio.

Accepted Answer

If investors believe the decline in earnings is temporary, they may still value the company based on the expectation of future earnings growth. This can lead to an increase in the P/E ratio, as the stock price may not decline as much as the earnings drop.

Question 3

The single most important issue in the stock valuation process is a company's

Accepted Answer

The most important issue in stock valuation is a company's expected future returns. This is because the value of a stock is based on the present value of its expected future cash flows. Past earnings record and historic dividend growth rate can provide insights into a company's performance, but they do not necessarily reflect the company's future prospects. Capital structure is also important, but it is only one factor among many that affect a company's future returns.

Question 4

Which of the following might cause a firm's P/E ratio to fall?
I. Earnings increases in line with past expectations.
II. The industry faces increased competition.
III. Inflation and interest rates rise.
IV. The overall market multiple rises.

Accepted Answer

An increase in competition (II) can reduce future growth prospects, leading to a lower P/E ratio. Rising inflation and interest rates (III) can decrease the present value of future earnings, also reducing the P/E ratio. Earnings increasing in line with expectations (I) typically wouldn't affect the P/E ratio significantly, but if expectations were high, it might still cause a decrease. An overall market multiple rise (IV) would generally increase P/E ratios, not decrease them.

Question 5

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

Accepted Answer

The answer of List the key variables that affect the...

Question 6

The value of a stock is a function of

Accepted Answer

The value of a stock is based on the future returns it is expected to generate, so A is the best choice. Historic dividend growth rate and most recent earnings per share can provide some indication of future returns, but they are not the only factors to consider. Past returns may indicate the stock's performance in the past, but it does not necessarily predict future returns.

Question 7

High P/E ratios can be expected when investors expect

Accepted Answer

High P/E ratios indicate that investors are willing to pay a premium price for each dollar of earnings because they expect the company to have significant growth potential in the future.

Question 8

Which of the following variables affect the P/E ratio?
I. capital structure of a firm
II. amount of dividends paid
III. inflation rate
IV. earnings rate of growth

Accepted Answer

The answer of Which of the following variables affect the...

Question 9

Companies with high P/E ratios tend to also have high dividend payout ratios.

Accepted Answer

There is no necessary relationship between P/E ratios and dividend payout ratios. Companies may choose to reinvest earnings rather than pay them out as dividends, leading to a lower dividend payout ratio despite a high P/E ratio. Similarly, a company with a low P/E ratio may have a high dividend payout ratio if it chooses to distribute a large portion of its earnings to shareholders.

Question 10

Most analysts would not feel comfortable forecasting a firm's future earnings for more than

Accepted Answer

Analysts typically use a time horizon of 1 to 3 years when forecasting a firm's earnings. Beyond that, there is too much uncertainty and too many variables that can impact a company's performance, making it difficult to accurately predict future earnings.

Question 11

A relative P/E ratio greater than 1 indicates that a company may be undervalued.

Accepted Answer

A relative P/E ratio greater than 1 indicates that a company may be overvalued, not undervalued. A relative P/E ratio of 1 indicates that a company is fairly valued.

Question 12

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

Accepted Answer

Dividends are often set by the company's board of directors and can be maintained even if earnings per share decline temporarily, as companies may prefer to keep dividends stable to signal confidence to investors.

Question 13

If net income rises, but the number of shares outstanding remains the same, EPS will rise.

Accepted Answer

EPS, or earnings per share, is calculated as net income divided by the number of shares outstanding. Therefore, if net income rises and the number of shares outstanding remains the same, EPS will increase.

Question 14

A company's estimated future earnings and its P/E ratio can be used to estimate the stock's future price.

Accepted Answer

The estimated future earnings and P/E ratio are both factors that can contribute to estimating a stock's future price.

Question 15

The most important factors influencing a stock's current price are its past earnings and dividends.

Accepted Answer

While past earnings and dividends can be important factors, other factors such as current market conditions, industry trends, and company announcements can also heavily impact a stock's current price.

Question 16

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

Accepted Answer

Sales growth represents the increase in revenue over time, while net profit margin measures the profitability of the company. By analyzing these two metrics, investors can evaluate how well a company is performing and predict its future behavior.

Question 17

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

Accepted Answer

The estimated price of a stock in the future includes not only the current price but also any projected capital gains, i.e. the increase in value of the stock over time. So, it is important for investors to have a sense of what the future price of a stock may be in order to make informed decisions about whether to buy, hold, or sell.

Question 18

Which of the following contributes to high P/E ratios?

Accepted Answer

A high rate of earnings growth would increase a company's earnings, which would result in a higher P/E ratio. High dividend payout ratios would decrease earnings and, therefore, lower the P/E ratio. Periods of high inflation and high debt ratios can affect many aspects of a company's financials and may be factors in the calculation of the P/E ratio, but they do not directly contribute to a high P/E ratio.

Question 19

Higher rates of growth and lower debt levels contribute to higher P/E ratios.

Accepted Answer

Higher rates of growth and lower debt levels are seen as positive indicators for a company's future earnings potential, leading to investors being willing to pay a higher price for the stock, thus resulting in a higher P/E ratio.

Question 20

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

Accepted Answer

The common-size income statement is a financial statement that expresses each item on the income statement as a percentage of sales. This helps in analyzing the proportionate contribution of each item towards the overall revenue generated by the company.

Quiz 8: Stock Valuation