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Chapter 07Valuing StocksTrue / False Questions The term "irrational exuberance" was coined by former Fed Chairman Alan Greenspan to describe the dot-com boom. True False The dividend discount model indicates that the value of a stock is the present value of the dividends it will pa...

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Chapter 07 - Valuing Stocks

Chapter 07 Valuing Stocks True / False Questions

1. The term "irrational exuberance" was coined by former Fed Chairman Alan Greenspan to describe the dot-com boom. True False

2. The dividend discount model indicates that the value of a stock is the present value of the dividends it will pay over the investor's horizon plus the present value of the expected stock price at the end of that horizon. True False

3. If investors believe a company will have the opportunity to make very profitable investments in the future, they will pay more for the company's stock today. True False

4. The dividend discount model should not be used to value stocks in which the dividend does not grow. True False

5. Google's stock price tripling after the IPO suggests that valuing growth stocks is an exact science. True False

6. Sustainable growth rates can be estimated by multiplying a firm's ROE by its dividend payout ratio. True False

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Chapter 07 - Valuing Stocks

7. According to the dividend discount model, a stock's price today depends on the investor's horizon for holding the stock. True False

8. The dividend yield of a stock is much like the current yield of a bond. Both ignore prospective capital gains or losses. True False

9. The dividend discount model states that today's stock price equals the present value of all expected future dividends. True False

10. An excess of market value over the book value of equity can be attributed to going concern value. True False

11. Securities with the same expected risk should offer the same expected rate of return. True False

12. The liquidation value of a firm is equal to the book value of the firm. True False

13. Market price is not the same as book value or liquidation value. True False

14. Market value, unlike book value and liquidation value, treats the firm as a going concern. True False

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Chapter 07 - Valuing Stocks

15. At each point in time all securities of the same risk are priced to offer the same expected rate of return. True False

16. If the stock prices follow a random walk, successive stock prices are not related. True False

17. If the stock prices follow a random walk, successive stock price changes are not related. True False

18. If the market is efficient, stock prices should be expected to react only to new information that is released. True False

19. The intent of technical analysis is to discover patterns in past stock prices. True False

20. Technical analysts have no effect on the efficiency of the stock market. True False

21. Technical analysts would be more likely than other investors to index their portfolios. True False

22. Market efficiency implies that security prices impound new information quickly. True False

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23. If the stock prices follow a random walk, successive stock prices fluctuate above and below a normal long-run price. True False

24. If security prices follow a random walk, then on any particular day the odds are that an increase or decrease in price is equally likely. True False

25. Fundamental analysts attempt to get rich by identifying patterns in stock prices. True False

26. Strong-form market efficiency implies that one could earn above-average returns by examining the history of a firm's stock price. True False

Multiple Choice Questions

27. The rise of the dot-coms in the late 1990s is probably due to: A. investors reducing their expectations from common stocks. B. investors being reluctant to incur losses and being overconfident. C. a sharp improvement in the prospects for dividend growth. D. the efficiency of the markets.

28. What dividend yield would be reported in the financial press for a stock that currently pays a $1 dividend per quarter and the most recent stock price was $40? A. 2.5% B. 4.0% C. 10.0% D. 15.0%

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29. Which of the following describes a seasoned offering? A. An IPO of common stock for a well-known firm. B. An IPO that is offered during the best buying season. C. An additional equity issue from a publicly traded firm. D. Any shares traded in the secondary market are seasoned offerings.

30. Which of the following best characterizes the difference between growth stocks and income stocks? A. Growth stocks do not pay dividends. B. Income stocks offer higher rates of return. C. Income stocks are seasoned issues. D. Growth stocks have greater PVGO.

31. If The Wall Street Journal lists a stock's dividend as $1, then it is most likely the case that the stock: A. pays $1 quarterly, or an estimated $4 annually. B. pays $0.25 quarterly, or an estimated $1 annually. C. paid $1 during the past quarter, with no future dividends forecast. D. paid $1 during the past year, with no future dividends forecast.

32. How much should you pay for a share of stock that offers a constant-growth rate of 10%, requires a 16% rate of return, and is expected to sell for $50 one year from now? A. $42.00 B. $45.00 C. $45.45 D. $47.00

33. How is it possible to ignore cash dividends that occur far into the future when using a dividend discount model? Those dividends: A. will be paid to a different investor. B. will not be paid by the firm. C. have an insignificant present value. D. ignore the tax consequences of future dividends.

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34. If the dividend yield for year 1 is expected to be 5% based on the current price of $25, what will the year 4 dividend be if dividends grow at a constant 6%? A. $1.33 B. $1.49 C. $1.58 D. $1.67

35. The value of common stock will likely decrease if: A. the investment horizon decreases. B. the growth rate of dividends increases. C. the discount rate increases. D. dividends are discounted back to the present.

36. When valuing stock with the dividend discount model, the present value of future dividends will: A. change depending on the time horizon selected. B. remain constant regardless of the time horizon selected. C. remain constant regardless of growth rate. D. always equal the present value of the terminal price.

37. Common stock can be valued using the perpetuity valuation formula if the: A. discount rate is expected to remain constant. B. dividends are not expected to grow. C. growth rate in dividends is not constant. D. investor does not intend to sell the stock.

38. What should be the price for a common stock paying $3.50 annually in dividends if the growth rate is zero and the discount rate is 8%? A. $22.86 B. $28.00 C. $42.00 D. $43.75

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39. If next year's dividend is forecast to be $5.00, the constant-growth rate is 4%, and the discount rate is 16%, then the current stock price should be: A. $31.25 B. $40.00 C. $41.67 D. $43.33

40. What price would you expect to pay for a stock with 13% required rate of return, 4% rate of dividend growth, and an annual dividend of $2.50 which will be paid tomorrow? A. $27.78 B. $30.28 C. $31.10 D. $31.39

41. What constant-growth rate in dividends is expected for a stock valued at $32.00 if next year's dividend is forecast at $2.00 and the appropriate discount rate is 13%? A. 5.00% B. 6.25% C. 6.75% D. 15.38%

42. ABC common stock is expected to have extraordinary growth of 20% per year for 2 years, at which time the growth rate will settle into a constant 6%. If the discount rate is 15% and the most recent dividend was $2.50, what should be the approximate current share price? A. $31.16 B. $33.23 C. $37.42 D. $47.77

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43. A payout ratio of 35% for a company indicates that: A. 35% of dividends are plowed back for growth. B. 65% of dividends are plowed back for growth. C. 65% of earnings are paid out as dividends. D. 35% of earnings are paid out as dividends.

44. What would be the approximate expected price of a stock when dividends are expected to grow at a 25% rate for 3 years, then grow at a constant rate of 5%, if the stock's required return is 13% and next year's dividend will be $4.00? A. $61.60 B. $62.08 C. $68.62 D. $79.44

45. What is the plowback ratio for a firm that has earnings per share of $12.00 and pays out $4.00 per share as dividends? A. 25.00% B. 33.33% C. 66.67% D. 75.00%

46. What happens to a firm that reinvests its earnings at a rate equal to the firm's required return? A. Its stock price will remain constant. B. Its stock price will increase by the sustainable growth rate. C. Its stock price will decline unless dividend payout ratio is zero. D. Its stock price will decline unless plowback rate exceeds required return.

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47. What can be expected to happen when stocks having the same expected risk do not have the same expected return? A. At least one of the stocks becomes temporarily mispriced. B. This is a common occurrence indicating that one stock has more PVGO. C. This cannot happen if the shares are traded in an auction market. D. The expected risk levels will change until the expected returns are equal.

48. Dividends that are expected to be paid far into the future have: A. great impact on current stock price due to their expected size. B. equal impact on current stock price as near-term dividends. C. lesser impact on current stock price due to discounting. D. no impact on current stock price because they are uncertain.

49. Which of the following is more likely to be responsible for a firm having low PVGO? A. ROE exceeds required return. B. Plowback is very high. C. Payout is very high. D. Book value of equity is low.

50. What is the most likely value of the PVGO for a stock with current price of $50, expected earnings of $6 per share, and a required return of 20%? A. $10 B. $20 C. $25 D. $30

51. What is the expected constant-growth rate of dividends for a stock with current price of $100, expected dividend payment of $10 per share, and a required return of 16%? A. 6.00% B. 6.25% C. 8.00% D. 10.00%

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52. Which of the following is least assured for firms that plowback a portion of earnings into the firm? A. Growth in earnings per share B. Growth in dividends per share C. Growth in book value of equity D. Growth in stock price

53. What should be the price of a stock that offers a $4 annual dividend with no prospects of growth, and has a required return of 12.5%? A. $8.50 B. $25.00 C. $32.00 D. $50.00

54. What should be the stock value one year from today for a stock that currently sells for $35, has a required return of 15%, an expected dividend of $2.80, and a constant dividend growth rate of 7%? A. $37.45 B. $37.80 C. $40.25 D. $43.05

55. What should be the current price of a share of stock if a $5 dividend was just paid, the stock has a required return of 20%, and a constant dividend growth rate of 6%? A. $19.23 B. $25.00 C. $35.71 D. $37.86

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56. What should be the current price of a stock if the expected dividend is $5, the stock has a required return of 20%, and a constant dividend growth rate of 6%? A. $19.23 B. $25.00 C. $35.71 D. $37.86

57. Reinvesting earnings into a firm will not increase the stock price unless: A. the new paradigm of stock pricing is maintained. B. true depreciation is less than reported depreciation. C. the firm's dividends are growing also. D. the ROE of new investments exceeds the firm's required return.

58. How much of a stock's $30 price is reflected in PVGO if it expects to earn $4 per share, has an expected dividend of $2.50, and a required return of 20%? A. $0 B. $6.00 C. $8.00 D. $10.00

59. In a valuation of a nonconstant dividend growth stock, the terminal value represents the: A. point at which the present value of future dividends equals zero. B. maturity date of the stock. C. present value of future dividends from that point on. D. highest value that the stock will attain.

60. What stock price reaction would you expect from a firm that unexpectedly raises its dividend permanently and by a substantial amount? A. Price should rise, given dividend discount models. B. Price should decline, given discounted cash flow analysis. C. Price will remain constant, due to market efficiency. D. Price will remain constant, due to random-walk behavior.

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61. In the calculation of rates of return on common stock, dividends are _______ and capital gains are _____. A. guaranteed; not guaranteed B. guaranteed; guaranteed C. not guaranteed; not guaranteed D. not guaranteed; guaranteed

62. Which of the following values treats the firm as a going concern? A. Market value B. Book value C. Liquidation value D. None of these

63. The book value of a firm's equity is determined by: A. multiplying share price by shares outstanding. B. multiplying share price at issue by shares outstanding. C. the difference between book values of assets and liabilities. D. the difference between market values of assets and liabilities.

64. If the liquidation value of a firm is negative, then: A. the firm's debt exceeds the market value of assets. B. the firm's debt exceeds the book value of equity. C. the book value of assets exceeds the firm's debt. D. the market value of assets exceeds the firm's debt.

65. A firm's liquidation value is the amount: A. necessary to repurchase all shares of common stock. B. realized from selling all assets and paying off its creditors. C. a purchaser would pay for the firm in bankruptcy. D. equal to the book value of equity.

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66. Which of the following is least likely to account for an excess of market value over book value of equity? A. Inaccurate depreciation methods B. High rate of return on assets C. The presence of growth opportunities D. Valuable off-balance sheet assets

67. Firms with valuable intangible assets are more likely to show a(n): A. excess of book value over market value of equity. B. high going-concern value. C. low liquidation value. D. low P/E ratio.

68. Which of the following is inconsistent with a firm that sells for very near book value? A. Low current earning power B. No intangible assets C. High future earning power D. Low, unstable dividend payment

69. The main purpose of a market-value balance sheet is to: A. show an inflated value of the firm. B. avoid the recording of certain liabilities. C. value assets and liabilities without GAAP restrictions. D. improve the credit rating of the firm.

70. A stock paying $5 in annual dividends sells now for $80 and has an expected return of 14%. What might investors expect to pay for the stock 1 year from now? A. $82.20 B. $86.20 C. $87.20 D. $91.20

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71. Which of the following statements is correct about a stock currently selling for $50 per share that has a 16% expected return and a 10% expected capital appreciation? A. Its expected dividend exceeds the actual dividend. B. Its expected return will exceed the actual return. C. It is expected to pay $3 in annual dividends. D. It is expected to pay $8 in annual dividends.

72. The expected return on a common stock is composed of: A. dividend yield. B. capital appreciation. C. both dividend yield and capital appreciation. D. capital appreciation minus the dividend yield.

73. Firms having a higher expected return have a higher: A. level of expected risk. B. dividend yield. C. market value of equity. D. degree of certainty concerning their returns.

74. What is the expected dividend to be paid in 3 years if yesterday's dividend was $6.00, dividends are expected to grow at a constant 6% annual rate, and the firm has a 10% expected return? A. $6.75 B. $7.15 C. $7.80 D. $9.37

75. Dividing a stock's earnings per share by the expected rate of return will value the share correctly if no new shares are issued and the dividend yield: A. exceeds the required return. B. equals the required return. C. is zero. D. is constant.

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76. What rate of return is expected from a stock that sells for $30 per share, pays $1.50 annually in dividends, and is expected to sell for $33 per share in one year? A. 5.00% B. 10.00% C. 14.09% D. 15.00%

77. A company with a return on equity of 15% and a plowback ratio of 60% would expect a constant-growth rate of: A. 4%. B. 9%. C. 21%. D. 25%.

78. What is the return on equity for a firm that has a constant dividend growth rate of 7% and a dividend payout ratio of 60%? A. 2.80% B. 4.20% C. 11.67% D. 17.50%

79. A positive value for PVGO suggests that the firm has: A. a positive return on equity. B. a positive plowback ratio. C. investment opportunities with superior returns. D. a high rate of constant growth.

80. Which of the following situations accurately describes a growth stock, assuming that each firm has a required return of 12%? A. A firm with PVGO = $0. B. A firm with investment opportunities yielding 10%. C. A firm with investment opportunities yielding 15%. D. All of these firms represent growth stocks.

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81. Other things equal, a firm's sustainable growth rate could increase as a result of: A. increasing the plowback ratio. B. increasing the payout ratio. C. decreasing the return on equity. D. increasing total assets.

82. Which of the following is least likely to contribute to going concern value? A. High liquidation value B. Extra earning power C. Future investment opportunities D. Intangible assets

83. The terminal value of a share of stock: A. is similar to the maturity value of a bond. B. refers to the share value at the end of the investor's holding period. C. is the value received by investors upon liquidation of the firm. D. is the price for shares traded through a dealers' market.

84. Which of the following is true for a firm having a stock price of $42, an expected dividend of $3, and a sustainable growth rate of 8%? A. It has a required return of 15.14%. B. It has a dividend payout ratio of 37.5%. C. It has an ROE of 7.14%. D. It has a plowback rate of 7.14%.

85. What is the value of the expected dividend per share for a stock that has a required return of 16%, a price of $45, and a constant-growth rate of 12%? A. $1.80 B. $3.60 C. $4.50 D. $7.20

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86. What is the required return for a stock that has a 6% constant-growth rate, a price of $25, an expected dividend of $2, and a P/E ratio of 10? A. 5% B. 10% C. 14% D. 22%

87. What is the minimum amount that shareholders should expect to receive in the event of a complete corporate liquidation? A. Market value of equity. B. Book value of equity. C. Zero. D. Shareholders may be required to pay to be liquidated.

88. The required return on an equity security is comprised of a: A. dividend yield and ROE. B. current yield and a terminal value. C. sustainable growth rate and a plowback yield. D. dividend yield and a capital gains yield.

89. What proportion of earnings is being plowed back into the firm if the sustainable growth rate is 8% and the firm's ROE is 20%? A. 8% B. 12% C. 20% D. 40%<...