Fundamentals of Investments, 8e (Jordan)
Chapter 6 Common Stock Valuation
1) Which one of the following terms is used to identify the evaluation method that determines the
value of a stock by reviewing a firm’s financial statement in conjunction with other financial and
economic information?
A) technical analysis
B) conceptual analysis
C) prediction valuation
D) fundamental analysis
E) discounted valuation
2) The method of valuing a stock based on the present value of the future income derived from
that stock is called:
A) technical analysis.
B) constant valuation.
C) the basic stock valuation method.
D) compound dividend analysis.
E) the dividend discount model.
3) The model used to value a stock that pays a dividend which increases at a constant rate forever
is referred to as which one of the following? Assume the growth rate is less than the discount
rate.
A) diminishing valuation growth model
B) increasing valuation growth model
C) constant perpetual growth model
D) irregular growth perpetual model
E) two-stage growth model
4) How is a sustainable dividend growth rate defined?
A) a constant rate at which dividends increase
B) a rate of growth that does not exceed two percent of the annual increase in revenue
C) a rate of growth that is set equal to one-half of the average growth rate of a firm’s earnings
D) a rate that can be supported over time by a company’s earnings
E) a rate of dividend growth that is equal to the discount rate used to value the firm’s stock
5) The portion of net income that is held by a firm, for future growth, comprises which one of the
following balance sheet accounts?
A) capital surplus
B) common stock
C) internal earnings
D) retained earnings
E) net earnings
6) What is the percentage of a firm’s earnings that is distributed to shareholders called?
A) payout ratio
B) distribution percentage
C) retention ratio
D) dividend portion
E) outflow ratio
7) What is the percentage of a firm’s net income which is reinvested in the firm to support future
growth called?
A) payout ratio
B) distribution percentage
C) retention ratio
D) equity ratio
E) equity reinvestment
8) The model used to value the stock of a firm which has a short-term growth rate that varies
from its long-term growth rate is called the ________ dividend growth model.
A) flexible
B) increasing
C) two-stage
D) stepped up
E) geometric
9) What is beta?
A) a rate of return measure
B) the return on a stock relative to the overall market
C) the rate of dividend growth
D) the percentage of net income paid out as a dividend
E) measure of a stock’s risk relative to the stock market average
10) What is the accounting relationship in which earnings per share minus dividends equal the
change in book value per share called?
A) clean surplus relationship
B) economic value added relationship
C) accounting earnings identity
D) payout-retention identity
E) dividend valuation equation
11) The Free Cash Flow Model:
I. can be used to value a company with negative earnings.
II. is based on a firm having positive cash flows.
III. requires that a firm pay a dividend.
IV. directly estimates a value for a firm’s equity
A) I only
B) I and II only
C) I and III only
D) I, II, and III only
E) I, II, III, and IV
12) What is the market value of a share of stock divided by the net income per share called?
A) earnings per share
B) price-earnings ratio
C) value-earnings ratio
D) earnings yield
E) market multiple
13) The net income per share divided by the market price per share is called the:
A) profit margin.
B) profit yield.
C) market yield.
D) earnings yield.
E) income ratio.
14) Growth stocks are frequently described as having which one of the following characteristics?
A) high dividends
B) a value orientation
C) high P/E ratios
D) low cash flows per share
E) low retention ratios
15) The price-book ratio is computed as the market value per share divided by the per share book
value of:
A) total assets.
B) long-term debt.
C) equity.
D) long-term debt plus equity.
E) net working capital.
16) A firm’s current stock price divided by the firm’s revenue per share is referred to as which
one of the following ratios?
A) price-earnings
B) price-book
C) price-income
D) price-sales
E) price-cash flow
17) An analysis of which of the following are commonly included as part of fundamental
analysis?
I. sales
II. book value
III. earnings per share
IV. cash flow
A) I and II only
B) I and IV only
C) II, III, and IV only
D) I, II, and IV only
E) I, II, III, and IV
18) Based on the dividend discount model, an increase in which of the following will lower the
current value of a stock?
I. amount of the next dividend
II. dividend growth rate
III. discount rate
A) I only
B) III only
C) I and II only
D) II and III only
E) I, II, and III
19) The dividend discount model assumes that:
A) the dividend payout ratio will remain constant.
B) the dividend growth rate is equal to the discount rate.
C) discount rate increases at a constant rate.
D) at least one dividend will be paid in the future.
E) the dividend payout ratio increases at a constant rate.
20) The constant perpetual growth model assumes the:
A) dividends are paid for a stated number of years only.
B) net income is all paid out in dividends.
C) growth rate is less than the discount rate.
D) dividends are constant in amount.
E) discount rate increases at a constant rate.
21) The constant perpetual growth model is applicable primarily to those firms which:
A) adhere to a residual dividend policy.
B) pay dividends that increase at a steady rate.
C) have irregular dividend growth rates.
D) maintain a constant dividend payout ratio.
E) have multiple rates of dividend growth.
22) Which one of the following is a correct formula for computing a geometric average dividend
growth rate?
A) [(1 + D0) + (1 + D1) × (1 + DN)]N + 1 – 1
B) [(1 + D0) × (1 + D1) × (1 + DN)]N – 1 – 1
C) [DN/D0]1/N – 1
D) [D0/DN]N – 1
E) [DN/D0]N/1 – 1
23) The arithmetic average dividend growth rate is:
A) the compounded rate of growth over a specified time period.
B) easier to compute than the geometric average dividend growth rate.
C) the summation of the annual dividend growth rates.
D) generally preferred over the geometric average growth rate by most financial analysts.
E) generally larger than the geometric average growth rate when the annual growth rates are
positive.
24) The retention ratio is the:
A) net income divided by total equity.
B) percentage of net income paid out to shareholders.
C) net income divided by the number of shares outstanding.
D) percentage of net income held by a firm for future growth.
E) inverse of the dividend payout ratio.
25) An increase in the retention ratio will:
A) increase the dividends per share.
B) decrease a firm’s sustainable rate of growth.
C) decrease the equity of a firm.
D) increase the dividend growth rate.
E) increase the value of a firm’s stock.
26) A decrease in which one of the following will increase a firm’s sustainable rate of growth?
A) net income
B) dividend payout ratio
C) total assets
D) retention ratio
E) earnings per share
27) The sustainable growth rate is equal to:
A) ROE × (1 – Payout ratio).
B) ROA × (1 – Payout ratio).
C) ROE × (1 – Retention ratio).
D) ROA × (1 – Retention ratio).
E) ROE × ROA.
28) Hypo Tech expects its net income to grow at 20 percent a year for the next two years and
then taper off to a constant 5 percent annual rate of growth. The firm maintains a constant
dividend payout ratio. Which one of the following models is best suited for computing the
current value of this firm’s stock?
A) irregular dividend
B) constant perpetual growth
C) constant dividend
D) two-stage dividend growth
E) perpetuity formula
29) Which one of the following is a requirement of the two-stage dividend growth model?
A) both growth rates must be less than the discount rate
B) one of the two growth rates must exceed the discount rate
C) the first growth rate must exceed the second growth rate
D) the first growth rate must equal the discount rate
E) the second growth rate must be less than the discount rate
30) Which one of the following statements concerning beta is correct?
A) The beta assigned to the overall market is zero.
B) A stock with a beta of 1.2 earns a higher risk premium than a stock with a beta of 1.3.
C) A stock with a beta of 0.5 has 50 percent more risk than the overall market.
D) Beta is applied to the T-bill rate when computing the discount rate used for the dividend
discount models.
E) The higher the beta, the higher the discount rate used for the dividend discount models.
31) Which one of the following is correct concerning the two-stage dividend growth model?
A) The discount rate is based on the coupon rate a firm pays on its outstanding bonds.
B) The first growth rate must be higher than the second growth rate.
C) The time value of money is ignored.
D) The discount rate ignores the risks associated with an individual firm.
E) The discount rate considers the risk-free rate of return.
32) How will the price of a stock be affected if the dividend growth rate is decreased?
A) increase
B) either increase or no change
C) no change
D) either decrease or no change
E) decrease
33) Which one of the following will increase the current residual income of a firm?
A) an increase in required earnings
B) a decrease in the current earnings per share
C) a decrease in future earnings per share
D) a decrease in the required return on the firm’s equity
E) an increase in the firm’s beginning book equity per share
34) Which one of the following models can be used to value the stock of a firm that maintains a
one hundred percent retention ratio?
A) two-stage growth
B) residual income
C) perpetual dividend growth
D) supernormal growth
E) perpetual cash flow
35) Which of the following have the same meaning as the term “economic value added”?
I. abnormal earnings
II. residual income
III. value created by a firm in period t
IV. EPSt – Bt-1× k
A) I and II only
B) III and IV only
C) I, II, and III only
D) II, III, and IV only
E) I, II, III, and IV
36) Which one of the following correctly expresses the clean surplus relationship?
A) The change in book value per share is equal to earnings per share minus dividends.
B) The change in retained earnings is equal to net income.
C) The change in market value per share is equal to the change in book value per share.
D) The change in market value per share is equal to earnings per share minus dividends.
E) The rate of change in book value per share is equal to the firm’s discount rate.
37) Which one of the following statements related to the price-earnings (P/E) ratio is correct?
A) The earnings yield is the inverse of the P/E ratio.
B) The P/E ratio is equal to the market price per share divided by total net income.
C) The P/E ratio shown in The Wall Street Journal is based on next year’s estimated earnings per
share.
D) The P/E ratio varies directly with earnings per share.
E) The earnings for the past twelve months is the method analysts prefer for computing earnings
for the P/E ratio.
38) Which one of the following is used as an indicator that a firm has good-quality earnings?
A) declining price-earnings ratios
B) constant price-earnings ratios
C) cash flow per share that exceeds earnings per share
D) earnings per share that exceed cash flow per share
E) positive earnings per share
39) Which one of the following is the most common definition of cash flow as used in the price-
cash flow ratio?
A) net income minus dividends
B) net income plus depreciation
C) net income minus depreciation plus taxes
D) earnings before interest and taxes plus depreciation
E) earnings before interest and taxes
40) The price-sales ratio helps measure the ability of a firm to generate:
A) net profits.
B) quality cash flows.
C) higher earnings per share.
D) higher cash flow per share.
E) revenue growth.
41) You would like to know the value of a firm’s equity today in relation to the cost of that
equity. Which one of the following ratios will provide you with this information?
A) price-earnings
B) price-book
C) price-sales
D) price-cash flow
E) price-assets
42) America Boats plans to pay a $2.10 a share dividend at the end of each of the next 2 years.
At the end of year 3, it will pay a final liquidating dividend of $13 a share. After that, the
company plans to close its doors permanently. What is the current value of this stock at a
discount rate of 12 percent?
A) $9.89
B) $10.26
C) $11.54
D) $12.80
E) $13.50
43) Upwind Tours just announced that it will pay an annual dividend of $3.60 a share one year
from now. Two years from now, the company expects to pay a $28 a share liquidating dividend.
After that, the company will cease operations. What is the current value per share at a discount
rate of 12.5 percent?
A) $23.88
B) $24.97
C) $25.32
D) $28.09
E) $29.16