5) The common stock book value model ignores a firm’s expected earnings potential and
generally lacks any true relationship to the firm’s value in the marketplace.
6) The liquidation value per share of common stock is the amount per share of common stock
that would be received if all of a firm’s assets were sold for their accounting value and the
proceeds remaining were divided among common stockholders.
7) The book value per share of common stock is the amount per share of common stock that
would be received if all of a firm’s assets were sold for their accounting value and the proceeds
remaining were divided among common stockholders.
8) Ted Corporation expects to generate free-cash flows of $200,000 per year for the next five
years. Beyond that time, free cash flows are expected to grow at a constant rate of 5 percent per
year forever. If the firm’s average cost of capital is 15 percent, the market value of the firm’s debt
is $500,000, and Ted has a half million shares of stock outstanding, what is the value of Ted
stock?
A) $2.43
B) $3.43
C) $1.43
D) $0.00
9) Patrick Company expects to generate free-cash of $120,000 per year forever. If the firm’s
required return is 12 percent, the market value of debt is $300,000, the market value of preferred
stock is $70,000, and the company has 100,000 shares of stock outstanding. What is the value of
Patrick’s stock?
A) $6.30
B) $10.00
C) $7.00
D) $9.70
10) Tangshan China’s stock is currently selling for $160.00 per share and the firm’s dividends are
expected to grow at 5 percent indefinitely. In addition, Tangshan China’s most recent dividend
was $5.50. If the expected risk free rate of return is 3 percent, the expected market premium is 4
percent, and Tangshan has a beta of 1.2, Tangshan’s stock would be ________.
A) overvalued because the market price is higher than the resulting share value
B) undervalued because the market price is less than the resulting share value
C) overvalued because the resulting share value is higher than the market value
D) undervalued because the resulting share value is less than the market value
11) Tangshan China’s stock is currently selling for $160.00 per share and the firm’s dividends are
expected to grow at 5 percent indefinitely. In addition, Tangshan China’s most recent dividend
was $5.50. If the expected risk free rate of return is 3 percent, the expected market return is 8
percent, and Tangshan has a beta of 1.2, Tangshan’s stock would be ________.
A) overvalued because the market price is higher than the resulting share value
B) undervalued because the market price is less than the resulting share value
C) overvalued because the resulting share value is higher than the market value
D) undervalued because the resulting share value is less than the market value
12) ________ is the value of a firm’s ownership in the event that all assets are sold for their exact
accounting value and the proceeds remaining after paying all liabilities (including preferred
stock) are divided among common stockholders.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the common stock
13) ________ is the actual amount each common stockholder would expect to receive if a firm’s
assets are sold for their market value, creditors and preferred stockholders are repaid, and any
remaining money is divided among the common stockholders.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the dividends
14) ________ is a guide to a firm’s value if it is assumed that investors value the earnings of a
given firm in the same way they do the average firm in the industry.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the dividends
15) Which of the following valuation methods is superior to others in the list since it considers
expected earnings?
A) liquidation value
B) book value
C) P/E multiple
D) present value of the interest
16) The use of the ________ is especially helpful in valuing firms that are not publicly traded.
A) liquidation value
B) book value
C) P/E multiple
D) present value of the dividends
17) The current price of DEF Corporation stock is $26.50 per share. Earnings next year should
be $2 per share and it should pay a $1 dividend. The P/E multiple is 15 times on average. What
price would you expect for DEF’s stock in the future?
A) $13.50
B) $15.00
C) $26.50
D) $30.00
18) At year end, Tangshan China Company balance sheet showed total assets of $60 million,
total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock
outstanding. Based on this information, Tangshan’s book value per share of common stock is
________.
A) $105
B) $10.50
C) $15
D) $150
19) At year end, Tangshan China Company balance sheet showed total assets of $60 million,
total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock
outstanding. If Tangshan could sell its assets for $52.5 million, Tangshan’s liquidation value per
share of common stock is ________.
A) $15
B) $7.50
C) $52.50
D) $75
20) At year end, Tangshan China Company balance sheet showed total assets of $60 million,
total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock
outstanding. Next year, Tangshan is projecting that it will have net income of $1.5 million. If the
average P/E multiple in Tangshan’s industry is 15, what should be the price of Tangshan’s stock?
A) $15.00
B) $22.50
C) $52.50
D) $75.00
21) China Imports currently has 2,000 shares of common stock outstanding. The firm has assets
of $200,000 and total liabilities including preferred stock of $75,000. Calculate the book value
per share of China Imports common stock.
22) Based on analysis of the company and expected industry and economic conditions, China
Imports is expected to earn $4.60 per share of common stock next year. The average
price/earnings ratio for firms in the same industry is 8. Calculate the estimated value of a share of
China Imports common stock.
23) Due to growing demand for computer software, the Shine Company has had a very
successful year and expects its earnings per share to grow by 25 percent to reach $5.50 for this
year. Estimate the price of the company’s common stock assuming the industry’s price/earning
ratio is 12.
24) Karina’s Caribbean Foods had total assets as recorded on its balance sheet are $1,500,000.
What is the value of the Karina’s common stock if it has $950,000 in liabilities, and 7,500 shares
of common stock outstanding?
25) Ride World has estimated the market value of its assets to be $1,250,000. What is the value
of Ride World’s common stock if it has $900,000 in liabilities, $50,000 in preferred stock, and
7,500 shares of common stock outstanding?
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26) Smith, Inc. stock currently sells for $75 per share. The firm has total assets of $1,000,000
and total liabilities, including preferred stock, of $350,000. If the firm has 10,000 shares of
common stock outstanding,
(a) what is the book value of each share of common stock?
(b) is the stock overvalued or undervalued in the marketplace?
(c) what is the reason(s) for your answer in (b)?
27) Smith has current assets of $800,000, which can be liquidated at 90 percent of book value.
Total liabilities, including preferred stock, equal $270,000. The firm has 15,000 shares of
common stock outstanding. What is the liquidation value per share of common stock?
7.6 Explain the relationships among financial decisions, return, risk, and the firm’s value.
1) Any action taken by a financial manager that increases risk will also increase the required
return.
2) An action on the part of a firm that increases the level of expected cash flows without a
corresponding increase in risk should reduce share value; an action that reduces the level of
expected cash flows without a corresponding decline in risk should increase share value.
3) Assuming that economic conditions remain stable, any management action that would cause
current and prospective stockholders to raise their dividend expectations should decrease a firm’s
value.
4) The required return can be affected by changes in the risk free rate, even if the risk premium
remains constant.
5) If the risk-free rate decreases due to a shift in government policy, the required return goes up.
6) Milton Glasses recently paid a dividend of $1.70 per share, is currently expected to grow at a
constant rate of 5%, and has a required return of 11%. Milton Glasses has been approached to
buy a new company. Milton estimates if it buys the company, its constant growth rate would
increase to 6.5%, but the firm would also be riskier, therefore increasing the required return of
the company to 12%. Should Milton go ahead with the purchase of the new company?
A) Yes, because the value of the Milton Co. will increase by $3.17 per share.
B) Yes, because the value of the Milton Co. will increase by $2.56 per share.
C) Yes, because the value of the Milton Co. will increase by $4..59 per share.
D) No, because the value of the Milton Co. will decrease by $3.17 per share.