7 – 33 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
d) 11.40%
84. Polar Express Corporation has just reported a net income of $400,000. It has
250,000 common shares outstanding with a book value of $2 million. The firm always
maintain a retention ratio of 25 percent. What is the firm’s price-earnings ratio if its
required return is 10 percent?
a) 5
b) 10
c) 15
d) 20
85. Union Enterprise has an expected profit margin of 12 percent, turnover ratio of 1.5,
and a leverage ratio of 0.8. Union plans to distribute 45 percent of its expected earnings
of $1 million as a dividend next year. What is the firm’s P/E ratio if the risk-free rate is
4.75 percent and the risk premium associated with the shares is 6.75 percent?
a) 8.96
b) 10.48
c) 12.57
d) 15.23
86. Company XYZ has a P/E ratio of 10 and a stock price of $50 per share. Calculate
earnings per share of the company.
a) $5 per share
b) $10 per share
c) $0.20 per share
d) $6 per share
87. A high proportion of the value for a growth stock comes from:
a) past sales figures.
b) past earnings.
c) future growth opportunities.
d) a and b.
88. Why did the book to market ratio become obsolete during the 1980-1990 period?
a) Change in accounting rules
b) The high performance of the stock market
c) Inflation distorted the equity book value
d) Managers use more sophisticated methods of valuation
7 – 35 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
89. Which one of the following is not a relative value ratio?
a) Sales to price ratio
b) Book to market ratio
c) Price to EBIT ratio
d) Interest expense to assets ratio
90. Evaluate the following statement:
The price-to-cash-flow multiple alleviates some of the accounting concerns regarding
measures of earnings.
a) True
b) False
Equity Valuation 7 – 36
PRACTICE PROBLEMS
91. In what ways are preferred shares different from common shares?
92. What are the two basic types of Dividend Discount Models?
93. Explain how earnings are implicitly considered in the DDM model.
94. What is the sustainable growth rate?
95. Explain the difference between required rate of return and growth rate, and show the
relationship between the two.
96. What factors impact the P/E ratio, and what is the direction of the impact?
97. If you were using a constant-dividend growth model to price a stock, what would
happen if the growth rate was greater than the required rate of return?
98. Explain how an evolution in accounting rules will help in the use of relative pricing
methods.
99. Explain how the retention ratio affects the future dividends, and hence, the price of
the stock.
100. The market value and the book value of White Elephant’s one million preferred
shares are $40,000,000 and $35,000,000, respectively. The preferred shares pay an
annual dividend of 8 percent. What is the risk premium associated with these shares if
the risk-free rate is 3.25 percent?
101. Marvellous Ideas Inc. is selling for $18.33 per share. The required rate of return on
the stock is 10 percent. What is the expected dividend in year five when the earnings
and dividends are expected to decline at an annual rate of 2.5 percent indefinitely?
102. Mountain Co. is currently paying a dividend of $2.20 per share. The dividends are
Equity Valuation 7 – 40
expected to grow at 25% per year for the next four years and then grow 5% per year
thereafter. The required rate of return is 10%. Calculate the expected price in year 5.
a) $118.40
b) $120.56
c) $80.67
d) $89.39
103. Elves Corporation has just paid a dividend of $1.25. Dividends are expected to
grow at 15% for years 1-3, 30% for years 4–6, 10% for years 7-8, and 4% thereafter.
What should the stock sell for today if the required return is 16 percent?
104. Rustic Corporation has earnings per share of $2.50 and paid a dividend of $1.75 per
share. The firm’s ROE and P/E are 15% and 20, respectively. Calculate the following:
a) The current stock price
b) The required rate of return
7 – 41 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
c) The dividend yield
105. Zesty Corporation has a net income of $320,000 on sales of $3,000,000. The firm
has total assets of $2,000,000 and the book value of equity is $1,600,000. It has just
paid a dividend of $1.10 per share to maintain a payout ratio of 55 percent. The 90-day
government T-bill yield is 5.25 percent. Determine the following if the firm’s P/E ratio is
10:
a) The number of shares outstanding
b) Sustainable growth rate
c) Earnings per share: lagging and leading EPS
d) Price of the stock today
e) Required rate of return
f) Risk premium of the stock
106. Suppose a firm has just reported an EPS of $4.55 and expects to maintain a
dividend payout ratio of 48 percent. The firm’s price-earnings ratio is 11 and its return
on equity is 17.36 percent.
a) What is current dividend?
b) What is growth rate?
c) What is current stock price?
d) What is its required rate of return?
7 – 43 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
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