Essentials of Investments, 11e (Bodie)
Chapter 13 Equity Valuation
1) The accounting measure of a firm’s equity value generated by applying accounting principles
to asset and liability acquisitions is called ________.
A) book value
B) market value
C) liquidation value
D) Tobin’s q
2) The price-to-sales ratio is probably most useful for firms in which phase of the industry life
cycle?
A) start-up phase
B) consolidation
C) maturity
D) relative decline
3) If a firm increases its plowback ratio, this will probably result in ________ P/E ratio.
A) a higher
B) a lower
C) an unchanged
D) The answer cannot be determined from the information given.
4) The value of Internet companies is based primarily on ________.
A) current profits
B) Tobin’s q
C) growth opportunities
D) replacement cost
5) New-economy companies generally have higher ________ than old-economy companies.
A) book value per share
B) P/E multiples
C) profits
D) asset values
6) P/E ratios tend to be ________ when inflation is ________.
A) higher; higher
B) lower; lower
C) higher; lower
D) they are unrelated
7) Which one of the following statements about market and book value is correct?
A) All firms sell at a market-to-book ratio above 1.
B) All firms sell at a market-to-book ratio greater than or equal to 1.
C) All firms sell at a market-to-book ratio below 1.
D) Most firms have a market-to-book ratio above 1, but not all.
8) Earnings yields tend to ________ when Treasury yields fall.
A) fall
B) rise
C) remain unchanged
D) fluctuate wildly
9) Which one of the following is a common term for the market consensus value of the required
return on a stock?
A) dividend payout ratio
B) intrinsic value
C) market capitalization rate
D) plowback ratio
10) Which one of the following is equal to the ratio of common shareholders’ equity to common
shares outstanding?
A) book value per share
B) liquidation value per share
C) market value per share
D) Tobin’s q
11) A firm has current assets that could be sold for their book value of $10 million. The book
value of its fixed assets is $60 million, but they could be sold for $95 million today. The firm has
total debt at a book value of $40 million, but interest rate changes have increased the value of the
debt to a current market value of $50 million. This firm’s market-to-book ratio is ________.
A) 1.83
B) 1.5
C) 1.35
D) 1.46
12) If a stock is correctly priced, then you know that ________.
A) the dividend payout ratio is optimal
B) the stock’s required return is equal to the growth rate in earnings and dividends
C) the sum of the stock’s expected capital gain and dividend yield is equal to the stock’s required
rate of return
D) the present value of growth opportunities is equal to the value of assets in place
13) A stock has an intrinsic value of $15 and an actual stock price of $13.50. You know that this
stock ________.
A) has a Tobin’s q value < 1
B) will generate a positive alpha
C) has an expected return less than its required return
D) has a beta > 1
14) Bill, Jim, and Shelly are all interested in buying the same stock that pays dividends. Bill
plans on holding the stock for 1 year. Jim plans on holding the stock for 3 years. Shelly plans on
holding the stock until she retires in 10 years. Which one of the following statements is correct?
A) Bill will be willing to pay the most for the stock because he will get his money back in 1 year
when he sells.
B) Jim should be willing to pay three times as much for the stock as Bill will pay because his
expected holding period is three times as long as Bill’s.
C) Shelly should be willing to pay the most for the stock because she will hold it the longest and
hence will get the most dividends.
D) All three should be willing to pay the same amount for the stock regardless of their holding
period.
15) A firm that has an ROE of 12% is considering cutting its dividend payout. The stockholders
of the firm desire a dividend yield of 4% and a capital gain yield of 9%. Given this information,
which of the following statements is (are) correct?
I. All else equal, the firm’s growth rate will accelerate after the payout change.
II. All else equal, the firm’s stock price will go up after the payout change.
III. All else equal, the firm’s P/E ratio will increase after the payout change.
A) I only
B) I and II only
C) II and III only
D) I, II, and III
16) A firm cuts its dividend payout ratio. As a result, you know that the firm’s ________.
A) return on assets will increase
B) earnings retention ratio will increase
C) earnings growth rate will fall
D) stock price will fall
17) ________ is the amount of money per common share that could be realized by breaking up
the firm, selling its assets, repaying its debt, and distributing the remainder to shareholders.
A) Book value per share
B) Liquidation value per share
C) Market value per share
D) Tobin’s q
18) An underpriced stock provides an expected return that is ________ the required return based
on the capital asset pricing model (CAPM).
A) less than
B) equal to
C) greater than
D) greater than or equal to
19) Stockholders of Dogs R Us Pet Supply expect a 12% rate of return on their stock.
Management has consistently been generating an ROE of 15% over the last 5 years but now
believes that ROE will be 12% for the next 5 years. Given this, the firm’s optimal dividend
payout ratio is now ________.
A) 0%
B) 100%
C) between 0% and 50%
D) between 50% and 100%
20) The constant-growth dividend discount model (DDM) can be used only when the ________.
A) growth rate is less than or equal to the required return
B) growth rate is greater than or equal to the required return
C) growth rate is less than the required return
D) growth rate is greater than the required return
21) Suppose that in 2018 the expected dividends of the stocks in a broad market index equaled
$240 million when the discount rate was 8% and the expected growth rate of the dividends
equaled 6%. Using the constant-growth formula for valuation, if interest rates increase to 9%, the
value of the market will change by ________.
A) -10%
B) -20%
C) -25%
D) -33%
22) You want to earn a return of 10% on each of two stocks, A and B. Each of the stocks is
expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends is
6% for stock A and 5% for stock B. Using the constant-growth DDM, the intrinsic value of stock
A ________.
A) will be higher than the intrinsic value of stock B
B) will be the same as the intrinsic value of stock B
C) will be less than the intrinsic value of stock B
D) The answer cannot be determined from the information given.
23) Each of two stocks, A and B, is expected to pay a dividend of $7 in the upcoming year. The
expected growth rate of dividends is 6% for both stocks. You require a return of 10% on stock A
and a return of 12% on stock B. Using the constant-growth DDM, the intrinsic value of stock A
________.
A) will be higher than the intrinsic value of stock B
B) will be the same as the intrinsic value of stock B
C) will be less than the intrinsic value of stock B
D) The answer cannot be determined from the information given.
24) You want to earn a return of 11% on each of two stocks, A and B. Stock A is expected to pay
a dividend of $3 in the upcoming year, while stock B is expected to pay a dividend of $2 in the
upcoming year. The expected growth rate of dividends for both stocks is 4%. Using the constant-
growth DDM, the intrinsic value of stock A ________.
A) will be higher than the intrinsic value of stock B
B) will be the same as the intrinsic value of stock B
C) will be less than the intrinsic value of stock B
D) The answer cannot be determined from the information given.
25) You are considering acquiring a common share of Sahali Shopping Center Corporation that
you would like to hold for 1 year. You expect to receive both $1.25 in dividends and $35 from
the sale of the share at the end of the year. The maximum price you would pay for a share today
is ________ if you wanted to earn a 12% return.
A) $31.25
B) $32.37
C) $38.47
D) $41.32
26) The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its
expected ROE is 12%, and its expected EPS is $5. If the firm’s plowback ratio is 50%, its P/E
ratio will be ________.
A) 8.33
B) 12.5
C) 19.23
D) 24.15
27) The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its
expected ROE is 12%, and its expected EPS is $5. If the firm’s plowback ratio is 60%, its P/E
ratio will be ________.
A) 7.14
B) 14.29
C) 16.67
D) 22.22
28) Weyerhaeuser Incorporated has a balance sheet that lists $70 million in assets, $45 million in
liabilities, and $25 million in common shareholders’ equity. It has 1 million common shares
outstanding. The replacement cost of its assets is $85 million. Its share price in the market is $49.
Its book value per share is ________.
A) $16.67
B) $25
C) $37.50
D) $40.83
29) Eagle Brand Arrowheads has expected earnings of $1.25 per share and a market
capitalization rate of 12%. Earnings are expected to grow at 5% per year indefinitely. The firm
has a 40% plowback ratio. By how much does the firm’s ROE exceed the market capitalization
rate?
A) .5%
B) 1%
C) 1.5%
D) 2%
30) Gagliardi Way Corporation has an expected ROE of 15%. If it pays out 30% of its earnings
as dividends, its dividend growth rate will be ________.
A) 4.5%
B) 10.5%
C) 15%
D) 30%
31) A preferred share of Coquihalla Corporation will pay a dividend of $8 in the upcoming year
and every year thereafter; that is, dividends are not expected to grow. You require a return of 7%
on this stock. Using the constant-growth DDM to calculate the intrinsic value, a preferred share
of Coquihalla Corporation is worth ________.
A) $13.50
B) $45.50
C) $91
D) $114.29
32) Brevik Builders has an expected ROE of 25%. Its dividend growth rate will be ________ if it
follows a policy of paying 30% of earnings in the form of dividends.
A) 5%
B) 15%
C) 17.5%
D) 45%
33) A firm is planning on paying its first dividend of $2 three years from today. After that,
dividends are expected to grow at 6% per year indefinitely. The stock’s required return is 14%.
What is the intrinsic value of a share today?
A) $25
B) $16.87
C) $19.24
D) $20.99
34) Rose Hill Trading Company is expected to have EPS in the upcoming year of $8. The
expected ROE is 18%. An appropriate required return on the stock is 14%. If the firm has a
plowback ratio of 70%, its dividend in the upcoming year should be ________.
A) $1.12
B) $1.44
C) $2.40
D) $5.60
35) Rose Hill Trading Company is expected to have EPS in the upcoming year of $6. The
expected ROE is 18%. An appropriate required return on the stock is 14%. If the firm has a
plowback ratio of 70%, its intrinsic value should be ________.
A) $20.93
B) $69.77
C) $128.57
D) $150
36) Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the
upcoming year. Dividends are expected to grow at 8% per year. The risk-free rate of return is
4%, and the expected return on the market portfolio is 14%. Investors use the CAPM to compute
the market capitalization rate and use the constant-growth DDM to determine the value of the
stock. The stock’s current price is $84. Using the constant-growth DDM, the market
capitalization rate is ________.
A) 9%
B) 12%
C) 14%
D) 18%
37) Grott and Perrin, Inc., has expected earnings of $3 per share for next year. The firm’s ROE is
20%, and its earnings retention ratio is 70%. If the firm’s market capitalization rate is 15%, what
is the present value of its growth opportunities?
A) $20
B) $70
C) $90
D) $115
38) Ace Ventura, Inc., has expected earnings of $5 per share for next year. The firm’s ROE is
15%, and its earnings retention ratio is 40%. If the firm’s market capitalization rate is 10%, what
is the present value of its growth opportunities?
A) $25
B) $50
C) $75
D) $100
39) Annie’s Donut Shops, Inc., has expected earnings of $3 per share for next year. The firm’s
ROE is 18%, and its earnings retention ratio is 60%. If the firm’s market capitalization rate is
12%, what is the value of the firm excluding any growth opportunities?
A) $25
B) $50
C) $83.33
D) $208
40) Flanders, Inc., has expected earnings of $4 per share for next year. The firm’s ROE is 8%,
and its earnings retention ratio is 40%. If the firm’s market capitalization rate is 15%, what is the
present value of its growth opportunities?
A) −$6.33
B) $0
C) $20.34
D) $26.67
41) Firm A is high-risk, and Firm B is low-risk. Everything else equal, which firm would you
expect to have a higher P/E ratio?
A) Firm A
B) Firm B
C) Both would have the same P/E if they were in the same industry.
D) There is not necessarily any linkage between risk and P/E ratios.
42) Firms with higher expected growth rates tend to have P/E ratios that are ________ the P/E
ratios of firms with lower expected growth rates.
A) higher than
B) equal to
C) lower than
D) There is not necessarily any linkage between risk and P/E ratios.
43) Value stocks are more likely to have a PEG ratio ________.
A) less than 1
B) equal to 1
C) greater than 1
D) less than zero