Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Use the information for the question(s) below.
Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of
the second year. You expect Von Bora’s stock price to be $25.00 at the end of two years. Von Bora’s equity cost of capital is
10%
1)
Suppose you plan to hold Von Bora stock for only one year. Your capital gain rate from holding
Von Bora stock for the first year is closest to:
1)
A)
6.0%
B)
4.5%
C)
4.0%
D)
3.5%
2)
If you want to value a firm that has consistent earnings grow, but varies how it pays out these
earnings to shareholders between dividends and repurchases, the simplest model for you to use is:
2)
A)
Discounted free cash flow model
B)
Dividend discount model
C)
Total payout model
D)
Enterprise value model
Use the information for the question(s) below.
Suppose that Texas Trucking (TT) has earnings per share of $3.45 and EBITDA of $45 million. TT also has 5 million shares
outstanding and debt o $150 million (net of cash). You believe that Oklahoma Logistics and Transport (OLT) is comparable
to TT in terms of its underlying business, but OLT has no debt. OLT has a P/E of 12.5 and an enterprise value to EBITDA
multiple of 7.
3)
Based upon the price earnings multiple, the value of a share of Texas Trucking is closest to:
3)
A)
$27.60
B)
$24.15
C)
$43.10
D)
$49.30
4)
Which of the following statements is false?
4)
A)
The more cash the firm uses to repurchase shares, the less it has available to pay dividends.
B)
We estimate a firm’s current enterprise value by computing the present value of the firm’s
free cash flow.
C)
Free cash flow measures the cash generated by the firm after payments to debt or equity
holders are considered.
D)
We can interpret the enterprise value as the net cost of acquiring the firm’s equity, taking its
cash and paying off all debts.
5)
Which of the following formulas is incorrect?
5)
A)
Forward P
E=Dividend Payout Rate
rE– g
B)
Forward P
E=
P0
EPS1
C)
Forward P
E=
EPS1
Div1
rE– g
D)
V0
EBITDA1
=
FCF1
EBITDA1
rwacc –g
rE– g
Use the information for the question(s) below.
Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of
the second year. You expect Von Bora’s stock price to be $25.00 at the end of two years. Von Bora’s equity cost of capital is
10%
6)
Suppose you plan to hold Von Bora stock for only one year. Your dividend yield from holding Von
Bora stock for the first year is closest to:
6)
A)
6.5%
B)
6.0%
C)
4.0%
D)
5.5%
Use the information for the question(s) below.
You expect CCM Corporation to generate the following free cash flows over the next five years:
Year 1 2 3 4 5
FCF ($ millions) 25 28 32 37 40
Following year five, you estimate that CCM’s free cash flows will grow at 5% per year and that CCM’s weighted average cost
of capital is 13%.
7)
The enterprise value of CCM corporation is closest to:
7)
A)
$396 million
B)
$350 million
C)
$290 million
D)
$382 million
Use the information for the question(s) below.
Suppose that Texas Trucking (TT) has earnings per share of $3.45 and EBITDA of $45 million. TT also has 5 million shares
outstanding and debt o $150 million (net of cash). You believe that Oklahoma Logistics and Transport (OLT) is comparable
to TT in terms of its underlying business, but OLT has no debt. OLT has a P/E of 12.5 and an enterprise value to EBITDA
multiple of 7.
8)
Based upon the enterprise value to EBITDA ratio, the value of a share of Texas Trucking is closest
to:
8)
A)
$43.10
B)
$82.50
C)
$21.25
D)
$33.00
9)
Which of the following statements is false?
9)
A)
For valuation purposes, the trailing P/E ratio is generally preferred, since it is based on actual
not expected earnings.
B)
We can estimate the value of a firm’s shares by multiplying its current earnings per share by
the average P/E ratio of comparable firms.
C)
Forward earnings are the expected earnings over the coming 12 months.
D)
Trailing earnings are the earnings over the previous 12 months.
10)
Which of the following statements is false?
10)
A)
An investor will be willing to pay a price today for a share of stock up to the point that this
transaction has a zero NPV.
B)
Because the cash flows from stock are known with certainty, we can discount them using the
risk–free interest rate.
C)
There are two potential sources of cash flows from owning a stock.
D)
An investor might generate cash by choosing to sell the shares at some future date.
11)
Which of the following statements is false?
11)
A)
Looking at enterprise value as a multiple of sales can be useful if it is reasonable to assume
that the firms will maintain similar margins in the future.
B)
Common multiples to consider are enterprise value to EBIT, EBITDA, and free cash flow.
C)
If two stocks have the same payout and EPS growth rates as well as equivalent risk, then they
should have the same P/E ratio.
D)
Because capital expenditures can vary substantially from period to period, most practitioners
rely on enterprise value to free cash flow multiples.
12)
JRN enterprises just announced that it plans to cut its dividend from $2.50 to $1.50 per share and
use the extra funds to expand its operations. Prior to this announcement, JRN’s dividends were
expected to grow at 4% per year and JRN‘s stock was trading at $25.00 per share. With the new
expansion, JRN’s dividends are expected to grow at 8% per year indefinitely. Assuming that JRN’s
risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest
to:
12)
A)
$27.50
B)
$15.00
C)
$31.25
D)
$25.00
13)
Which of the following formulas is incorrect?
13)
A)
Capital Gains Rate =
P0– P1
P0
B)
P0=
Div1
1 + rE
+
Div2 +P2
(1 +rE)2
C)
Dividend Yield =
Div1
P0
D)
rE= Capital Gains Rate + Dividend Yield
Capital Gains Rate =
P1– P0
14)
Which of the following statements is false?
14)
A)
The discounted free cash flow model focuses on the cash flows to all of the firm’s investors,
both debt and equity holders, and allows us to avoid estimating the impact of the firm’s
borrowing decisions on earnings.
B)
The discounted free cash flow model begins by determining the value of the firm’s equity.
C)
In recent years an increasing number of firms have replaced dividend payouts with share
repurchases.
D)
In a share repurchase, the firm uses excess cash to buy back its own stock.
15)
NoGrowth industries presently pays an annual dividend of $1.50 per share and it is expected that
these dividend payments will continue indefinitely. If NoGrowth’s equity cost of capital is 12%,
then the value of a share of NoGrowth’s stock is closest to:
15)
A)
$12.50
B)
$15.00
C)
$10.00
D)
$14.00
Use the information for the question(s) below.
Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of
the second year. You expect Von Bora’s stock price to be $25.00 at the end of two years. Von Bora’s equity cost of capital is
10%
16)
Suppose you plan to hold Von Bora stock for one year. The price would would expect to be able to
sell a share of Von Bora stock in one year is closest to:
16)
A)
$26.50
B)
$23.15
C)
$22.70
D)
$24.10
17)
Which of the following statements is false?
17)
A)
In the dividend discount model we implicitly assume that any cash paid out to the
shareholders takes the form of a dividend.
B)
The total payout model allows us to ignore the firm’s choice between dividends and share
repurchases.
C)
By repurchasing shares, the firm increases its share count, which decreases its earning and
dividends on a per–share basis.
D)
The total payout model discounts the total payouts that the firm makes to shareholders,
which is the total amount spent on both dividends and share repurchases.
18)
Which of the following statements is false?
18)
A)
The long–run growth rate gFCF is typically based on the expected long–run growth rate of
the firm’s revenues.
B)
If the firm has no debt then rwacc = the risk–free rate of return.
C)
Because the firm’s free cash flow is equal to the sum of the free cash flows from the firm’s
current and future investments, we can interpret the firm‘s enterprise value as the total NPV
that the firm will earn from continuing its existing projects and initiating new ones.
D)
When using the discounted free cash flow model, we forecast the firm’s free cash flow up to
some horizon, together with some terminal (continuation) value of the enterprise.
If the firm has no debt then rwacc = the cost of equity.
19)
The Rufus Corporation has 125 million shares outstanding and analysts expect Rufus to have
earnings of $500 million this year. Rufus plans to pay out 40% of its earnings in dividends and
they expect to use another 20% of their earnings to repurchase shares. If Rufus’ equity cost of
capital is 15% and Rufus’ earnings are expected to grow at a rate of 3% per year, then the value of a
share of Rufus stock is closest to:
19)
A)
$33.50
B)
$13.35
C)
$16.00
D)
$20.00
20)
Which of the following statements is false?
20)
A)
The divided yield is the percentage return the investor expects to earn from the dividend paid
by the stock.
B)
The firm might pay out cash to its shareholders in the form of a dividend.
C)
We must discount the cash flows from stock based on the equity cost of capital for the stock.
D)
The dividend yield is the expected annual dividend of a stock, divided by its expected future
sale price.
21)
Which of the following formulas is incorrect?
21)
A)
rE=
Div1
P0
+g
B)
P0=
Div1
rE–g
C)
g= retention rate × return on new investment
D)
Divt=EPSt× Dividend Payout Rate
rE=
Div1
P0
22)
Which of the following statements is false?
22)
A)
The efficient market hypothesis implies that securities will be fairly priced, based on their
future cash flows, given all information that is available to investors.
B)
In most situations, a valuation model is best applied to tell us something about the value of
the firm’s stock.
C)
Only in the relatively rare case in which we have some superior information that other
investors lack regarding the firm‘s cash flows and cost of capital would it make sense to
second–guess the market stock price.
D)
Stock markets aggregate the information and view of many different investors.
23)
You expect KT industries (KTI) will have earnings per share of $3 this year and expect that they
will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI’s return on new
investments is 15% and their equity cost of capital is 12%. The value of a share of KTI’s stock is
closest to:
23)
A)
$33.35
B)
$39.25
C)
$20.00
D)
$12.50
24)
Because of a catastrophic plane crash, the FAA announced that it is withdrawing its air worthiness
certification for Fly by Night Aviation’s (FBNA) new four seat private plane. As a result FBNA’s
future expected free cash flows will decline by $40 million a year for the next eight years. FBNA
has 20 million shares outstanding, no debt, and an equity cost of capital of 12% If this news is a
complete surprise to investors, then the amount that FBNA’s stock price should fall upon the
announcement is closest to:
24)
A)
$9.90
B)
$16.70
C)
$16.00
D)
$2.00
25)
Which of the following statements is false?
25)
A)
Consider the case of a new firm that is identical to an existing publicly traded company. If
these firms will generate identical cash flows, the Law of One Price implies that we can use
the value of the existing company to determine the value of the new firm.
B)
A valuation multiple is a ratio of some measure of the firm’s scale to the value of the firm.
C)
In the method of comparables we estimate the value of the firm based on the value of other,
comparable firms or investments that we expect will generate very similar cash flows in the
future.
D)
Even two firms in the same industry selling the same types of products, while similar in many
respects, are likely to be of different size or scale.
26)
Which of the following statements is false?
26)
A)
We interpret rwacc as the expected return the firm must pay to investors to compensate them
for the risk of holding the firm’s debt and equity together.
B)
The firm’s weighted average cost of capital (WACC) denoted rwacc is the cost of capital that
reflects the risk of the overall business, which is the combined risk of the firm’s equity and
debt.
C)
Intuitively, the difference between the discounted free cash flow model and the
dividend–discount model is that in the divided–discount model the firm’s cash and debt are
included indirectly through the effect of interest income and expenses on earnings in the
dividend–discount model.
D)
When using the discounted free cash flow model we should use the firm’s equity cost of
capital.
27)
Which of the following statements is false?
27)
A)
According to the constant dividend growth model, the value of the firm depends on the
current dividend level, divided by the equity cost of capital plus the grow rate.
B)
A firm can only pay out its earnings to investors or reinvest their earnings.
C)
Successful young firms often have high initial earnings growth rates.
D)
Estimating dividends, especially for the distant future, is difficult.
28)
If you want to value a firm but don’t want to explicitly forecast its dividends, share repurchases , or
its use of debt, what is the simplest model for you to use?
28)
A)
Enterprise value model
B)
Dividend discount model
C)
Total payout model
D)
Discounted free cash flow model
29)
Which of the following formulas is incorrect?
29)
A)
P0=
Div1
1 +rE
+
Div2
(1 +rE)2+ … +
DivN
(1 +rE)N+1
(1 +rE)N×
DivN+ 1
rE–g
B)
Divt=
earningst
shares outstandingt
× Dividend Payout Rate
C)
PN=
DivN
rE– g
D)
earnings growth rate = retention rate x return on new investment
30)
Which of the following statements is false?
30)
A)
For firms with substantial tangible assets, the ratio of price to book value of equity per share
is sometimes used.
B)
The fact that a firm has an exceptional management team, has developed an efficient
manufacturing process, or has just secured a patient on a new technology is ignored when we
apply a valuation multiple.
C)
Valuation multiples have the advantage that they allow us to incorporate specific information
about the firm’s cost of capital or future growth.
D)
Using multiples will not help us determine if an entire industry is overvalued.
31)
Luther Industries has a dividend yield of 4.5% and and a cost of equity capital of 12%. Luther
Industries dividends are expected to grow at a constant rate indefinitely. The grow rate of Luther’s
dividends are closest to:
31)
A)
5.5%
B)
16.5%
C)
12%
D)
7.5%
PN=
32)
Which of the following statements is false?
32)
A)
Total return equals earnings multiplied by the dividend payout rate.
B)
Cutting the firm’s dividend to increase investment will raise the stock price if, and only if, the
new investments have a positive NPV.
C)
As firms mature, their earnings exceed their investment needs and they begin to pay
dividends.
D)
We cannot use the constant dividend growth model to value the stock of a firm with rapid or
changing growth.
Use the information for the question(s) below.
Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of
the second year. You expect Von Bora’s stock price to be $25.00 at the end of two years. Von Bora’s equity cost of capital is
10%
33)
Suppose you plan on purchasing Von Bora stock in one year, right after the $1.40 dividend is paid.
You then plan on selling your stock at the end of year two, right after the $1.50 dividend is paid.
The total return that you will receive on your investment is closest to:
33)
A)
10.75%
B)
10.00%
C)
9.50%
D)
10.25%
34)
If you want to value a firm that consistently pays out its earnings as dividends, the simplest model
for you to use is:
34)
A)
Total payout model
B)
Dividend discount model
C)
Enterprise value model
D)
Discounted free cash flow model
Use the information for the question(s) below.
Defenestration industries plans to pay a $4.00 dividend this year and you expect that the firm’s earnings are on track to grow
at 5% per year for the foreseeable future. Defenestration’s equity cost of capital is 13%.
35)
Suppose that Defenestration decides to pay a dividend of only $2 per share this year and use the
remaining $2 per share to repurchase stock. If Defenestration maintains this dividend and total
payout rate, then the rate at which Defenestration’s dividends and earnings per share are expected
to grow is closest to:
35)
A)
9%
B)
7%
C)
5%
D)
13%
36)
You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean
plans to retain all of its earnings for the next three years. For the subsequent two years, the firm
plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point
forward. Retained earnings will be invested in projects with an expected return of 20% per year. If
Bean’s equity cost of capital is 12%, then the price of a share of Bean’s stock is closest to:
36)
A)
$27.75
B)
$17.00
C)
$10.75
D)
$43.50
Use the information for the question(s) below.
Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of
the second year. You expect Von Bora’s stock price to be $25.00 at the end of two years. Von Bora’s equity cost of capital is
10%
37)
Suppose you plan to hold Von Bora stock for only one year. Your capital gain from holding Von
Bora stock for the first year is closest to:
37)
A)
$1.85
B)
$1.25
C)
$0.95
D)
$1.40
38)
You expect Whirlpool Corporation (WHR)to have earnings per share of $6.10 over the coming year.
If the average P/E ratio for the appliance industry sector is 17.0, the the value of a share of
Whirlpool stock based upon the comparables approach is closest to:
38)
A)
$27.90
B)
$103.75
C)
$23.10
D)
$35.90
39)
Which of the following statements is false?
39)
A)
A valuation model will tell us the most about the variable for which our prior information is
the least reliable.
B)
The idea that investors are able to identify positive NPV trading opportunities is referred to as
the efficient markets hypothesis.
C)
Many managers make the mistake of focusing on accounting earnings as opposed to free cash
flows.
D)
Given accurate information about any two of these variables (a firm’s future cash flows, its
cost of capital, and its share price) a valuation model allows use to make inferences about the
third variable.
40)
Which of the following statements is false?
40)
A)
When using the total payout model, we discount total dividends and share repurchases, and
use the growth rate in earnings when forecasting the growth of the firm’s payout.
B)
To estimate a firm’s enterprise value, we compute the present value of the free cash flows
(FCF) that the firm has available to pay equity holders.
C)
In the total payout model, we first value the firm’s equity, rather than just a single share.
D)
The NPV of any individual project represents its contribution to the firm’s enterprise value.
Use the information for the question(s) below.
Defenestration industries plans to pay a $4.00 dividend this year and you expect that the firm’s earnings are on track to grow
at 5% per year for the foreseeable future. Defenestration’s equity cost of capital is 13%.
41)
Assuming that Defenestration’s dividend payout rate and expected growth rate remain constant,
and Defenestration does not issue or repurchase shares, then Defenestration’s stock price is closest
to:
41)
A)
$50.00
B)
$30.75
C)
$22.25
D)
$32.30
42)
Which of the following statements is false?
42)
A)
Using a valuation multiple based on comparables is best viewed as a “shortcut” to the
discounted cash flow method of valuation.
B)
Because the enterprise value represents the entire value of the firm before the firm pays its
debt, to form an appropriate multiple, we divide it by a measure of earnings or cash flows
after interest payments are made.
C)
We can compute a firm’s P/E ratio by using either trailing earnings or forward earnings with
the resulting ratio called the trailing P/E or forward P/E.
D)
It is common practice to use valuation multiples based on the firm’s enterprise value.