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Fundamentals of Investing, 13e (Smart)
Chapter 8 Stock Valuation
8.1 Learning Goal 1
1) The most important factors influencing a stock's current price are its past earnings and
dividends.
AACSB: 3 Analytical thinking
Question Status: Previous Edition
Learning Goal: Learning Goal 1
2) The key to the future financial success of a company lies in the sales growth and the net
profit margin.
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Learning Goal: Learning Goal 1
3) Companies with high P/E ratios tend to also have high dividend payout ratios.
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Learning Goal: Learning Goal 1
4) A stock's value depends on future cash flows.
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Question Status: New Question
Learning Goal: Learning Goal 1
5) A company's estimated future earnings and its P/E ratio can be used to estimate the stock's
future price.
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Learning Goal: Learning Goal 1
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6) The estimated price of a stock in the future is important because it includes the projected
capital gain on the stock.
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Learning Goal: Learning Goal 1
7) The single most important issue in the stock valuation process is a company's
A) past earnings record.
B) historic dividend growth rate.
C) expected future returns.
D) capital structure.
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Learning Goal: Learning Goal 1
8) Most analysts would not feel comfortable forecasting a firm's future earnings for more than
A) the next quarter.
B) 1 to 3 years.
C) 4 or 5 years.
D) the next business cycle.
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Learning Goal: Learning Goal 1
9) The value of a stock is a function of
A) future returns.
B) historic dividend growth rate.
C) most recent earnings per share.
D) past returns.
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Learning Goal: Learning Goal 1
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10) Which of the following variables affect the P/E ratio?
I. capital structure of a firm
II. amount of dividends to be paid
III. inflation rate
IV. earnings rate of growth
A) I, II and III only
B) I, II and IV only
C) I, III and IV only
D) I, II, III and IV
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Learning Goal: Learning Goal 1
11) Which of the following will affect the firm's future cash flows?
I. state of the economy
II. state of the industry
III. the firm's recent and current earnings
IV. new products in the firm's pipeline
A) I, II and III only
B) I, II and IV only
C) I, III and IV only
D) I, II, III and IV
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Question Status: New Question
Learning Goal: Learning Goal 1
12) Which of the following contributes to high P/E ratios?
A) high dividend payout ratios
B) high rate of earnings growth
C) periods of high inflation
D) high debt ratios
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Learning Goal: Learning Goal 1
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13) High P/E ratios can be expected when investors expect
A) a high rate of growth in earnings.
B) low earnings. relative to market prices.
C) high interest rates.
D) a bear market.
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Learning Goal: Learning Goal 1
14) Which of the following will most directly influence a company's market value?
A) the state of the economy
B) the book value of its assets
C) the use of financial leverage
D) its future cash flows
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Learning Goal: Learning Goal 1
15) 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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Learning Goal: Learning Goal 1
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Copyright © 2017 Pearson Education, Inc.
8.2 Learning Goal 2
1) The first step in predicting a stock's future price is to forecast profits.
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Learning Goal: Learning Goal 2
2) If net income rises, but the number of shares outstanding remains the same, EPS will rise.
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Learning Goal: Learning Goal 2
3) The common-size income statement expresses every item on the income statement as a
percentage of sales.
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Learning Goal: Learning Goal 2
4) A temporary decline in earnings per share usually results in a temporary reduction of
dividends.
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Learning Goal: Learning Goal 2
5) A decline in earnings that investors expect to be temporary may actually increase a firm's
P/E ratio.
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Learning Goal: Learning Goal 2
6) The sales forecast depends on factors both internal and external to the firm.
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Learning Goal: Learning Goal 2
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7) 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) $19,294
B) $22,050
C) $23,100
D) $23,153
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Learning Goal: Learning Goal 2
8) P/E ratios could rise even as earnings fall if
A) earnings fall at a faster rate than stock prices.
B) earnings fall at a slower rate than stock prices.
C) investors expect lower stock prices to be permanent.
D) investors expect lower earnings to be permanent.
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Learning Goal: Learning Goal 2
9) Even if a company does not officially follow a fixed-dividend policy, dividend payments are
A) extremely difficult to predict.
B) very volatile and subject to economic conditions.
C) fairly stable from one time period to another.
D) directly tied to a company's P/E ratio.
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Learning Goal: Learning Goal 2
10) Columbus Co.'s sales revenue for the most recent quarter was $2.5 million and cost of
goods sold was $1.5 million. If sales grow by 15% in the next quarter and all ratios remain the
same, gross profit will be
A) $2.25 million.
B) $1.725 million.
C) $1.15 million.
D) $1.375 million.
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Learning Goal: Learning Goal 2
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11) If the market multiple is 20.24 and the P/E ratio of a company is 24.5, then the stock's
relative P/E is
A) 0.83.
B) 1.19.
C) 1.21.
D) 4.26.
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Learning Goal: Learning Goal 2
12) 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 of common stock 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 of common stock for next year?
A) $15.18
B) $17.66
C) $18.37
D) $19.29
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Learning Goal: Learning Goal 2
13) The major forces behind earnings per share are
A) return on assets and total asset value.
B) gross revenue and the stock price.
C) growth and the number of shares outstanding.
D) net income and the number of shares outstanding.
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Learning Goal: Learning Goal 2
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14) GLOO stock's P/E ratio is 45 at a time when the market's P/E ratio is 15. GLOO's relative
P/E ratio is
A) 30.
B) -30.
C) 3.
D) .33.
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15) Which one of the following is a correct equation to calculate earnings per share?
A) (ROA)(book value per share)
B) (profit margin)(total asset turnover)(equity multiplier)(book value per share)
C) (profit margin)(equity multiplier)(book value per share)
D) (profit margin)(book value per share)
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16) Which one of the following is is most likely to increase the price of a stock?
A) rapid growth in sales
B) rapid decrease in the company's debt levels
C) rapid growth in earnings
D) rapid increases in bond interest rates
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17) Global Warning's EPS for the current year is $2.75 and its current P/E ratio is 50. You
have forecasted that EPS will grow by 10% but the P/E ratio will fall to 40. What do you
expect the price of a share of GW's stock to be at the end of next year?
A) $110
B) $121
C) $137.50
D) $151.25
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Learning Goal: Learning Goal 2
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18) 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) stock experienced an increase in its P/E ratio.
B) company had a decrease in its dividend payout ratio.
C) current P/E of the overall market is 26.4.
D) overall market P/E is declining.
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Learning Goal: Learning Goal 2
19) Which of the following will lead to an increase in earnings per share?
A) an increase in the P/E ratio.
B) an increase in the dividend payout ratio.
C) an increase in return on equity if book value per share stays the same.
D) a decrease in the number of shares if return on equity stays the same.
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20) 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 one share of common stock in
Markhem Enterprises be selling for in the market?
A) $9.65
B) $14.47
C) $24.12
D) $33.77
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21) The common stock of Rob's Discount Furniture is currently selling at $65.20 a share. The
company adheres to a 60% dividend payout ratio and has a P/E ratio of 19. There are 42,000
shares of stock outstanding. What is the amount of the annual net income for the firm?
A) $42,338
B) $36,032
C) $144,126
D) $72,064
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Learning Goal: Learning Goal 2
8.3 Learning Goal 3
1) The efficient market hypothesis holds that a stock's intrinsic value and market value are
essentially the same.
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Learning Goal: Learning Goal 3
2) A stock will be an attractive investment if the required rate of return exceeds the expected
rate of return.
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Learning Goal: Learning Goal 3
3) 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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Learning Goal: Learning Goal 3
4) The greater the perceived risk of an asset, the lower the expected rate of return.
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Learning Goal: Learning Goal 3
