Chapter 18 – Equity Valuation Models
18–21
50. High Tech Chip Company is expected to have EPS in the coming year of $2.50. The
expected ROE is 12.5%. An appropriate required return on the stock is 11%. If the firm has a
plowback ratio of 70%, the growth rate of dividends should be
A. 5.00%
B. 6.25%
Difficulty: Easy
51. A company paid a dividend last year of $1.75. The expected ROE for next year is 14.5%.
An appropriate required return on the stock is 10%. If the firm has a plowback ratio of 75%,
the dividend in the coming year should be
A. $1.80
B. $2.12
Difficulty: Moderate
52. High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next
year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback
ratio of 60%, the dividend in the coming year should be
A. $1.00
B. $2.50
Difficulty: Moderate
Chapter 18 – Equity Valuation Models
18–22
53. Suppose that the average P/E multiple in the oil industry is 20. Dominion Oil is expected
to have an EPS of $3.00 in the coming year. The intrinsic value of Dominion Oil stock should
be _____.
A. $28.12
B. $35.55
Difficulty: Easy
54. Suppose that the average P/E multiple in the oil industry is 22. Exxon Oil is expected to
have an EPS of $1.50 in the coming year. The intrinsic value of Exxon Oil stock should be
_____.
D. $72.00
E. none of the above
Difficulty: Easy
55. Suppose that the average P/E multiple in the oil industry is 16. Mobil Oil is expected to
have an EPS of $4.50 in the coming year. The intrinsic value of Mobil Oil stock should be
_____.
A. $28.12
B. $35.55
Difficulty: Easy
Chapter 18 – Equity Valuation Models
18–23
56. Suppose that the average P/E multiple in the gas industry is 17. KMP is expected to have
an EPS of $5.50 in the coming year. The intrinsic value of KMP stock should be _____.
A. $28.12
Difficulty: Easy
57. An analyst has determined that the intrinsic value of HPQ stock is $20 per share using the
capitalized earnings model. If the typical P/E ratio in the computer industry is 25, then it
would be reasonable to assume the expected EPS of HPQ in the coming year is ______.
A. $3.63
B. $4.44
Difficulty: Easy
58. An analyst has determined that the intrinsic value of Dell stock is $34 per share using the
capitalized earnings model. If the typical P/E ratio in the computer industry is 27, then it
would be reasonable to assume the expected EPS of Dell in the coming year is ______.
A. $3.63
B. $4.44
Difficulty: Easy
Chapter 18 – Equity Valuation Models
18–24
59. An analyst has determined that the intrinsic value of IBM stock is $80 per share using the
capitalized earnings model. If the typical P/E ratio in the computer industry is 22, then it
would be reasonable to assume the expected EPS of IBM in the coming year is ______.
D. $22.50
E. none of the above
Difficulty: Easy
60. Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the coming year.
Dividends are expected to decline at the rate of 2% per year. The risk-free rate of return is 6%
and the expected return on the market portfolio is 14%. The stock of Old Quartz Gold Mining
Company has a beta of -0.25. The intrinsic value of the stock is ______.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–25
61. Low Fly Airline is expected to pay a dividend of $7 in the coming year. Dividends are
expected to grow at the rate of 15% per year. The risk-free rate of return is 6% and the
expected return on the market portfolio is 14%. The stock of low Fly Airline has a beta of
3.00. The intrinsic value of the stock is ______.
D. $62.50
E. none of the above
Difficulty: Moderate
62. Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year.
Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 6%
and the expected return on the market portfolio is 14%. The stock of Sunshine Corporation
has a beta of 0.75. The intrinsic value of the stock is _______.
A. $10.71
B. $15.00
Difficulty: Moderate
Chapter 18 – Equity Valuation Models
18–26
63. Low Tech Chip Company is expected to have EPS in the coming year of $2.50. The
expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a
dividend payout ratio of 40%, the intrinsic value of the stock should be
A. $22.73
B. $27.50
Difficulty: Difficult
Risk Metrics Company is expected to pay a dividend of $3.50 in the coming year. Dividends
are expected to grow at a rate of 10% per year. The risk-free rate of return is 5% and the
expected return on the market portfolio is 13%. The stock is trading in the market today at a
price of $90.00.
64. What is the market capitalization rate for Risk Metrics?
A. 13.6%
Difficulty: Moderate
Chapter 18 – Equity Valuation Models
18–27
65. What is the approximate beta of Risk Metrics’s stock?
A. 0.8
B. 1.0
Difficulty: Difficult
66. The market capitalization rate on the stock of Flexsteel Company is 12%. The expected
ROE is 13% and the expected EPS are $3.60. If the firm’s plowback ratio is 50%, the P/E
ratio will be _________.
A. 7.69
B. 8.33
Difficulty: Difficult
67. The market capitalization rate on the stock of Flexsteel Company is 12%. The expected
ROE is 13% and the expected EPS are $3.60. If the firm’s plowback ratio is 75%, the P/E
ratio will be ________.
A. 7.69
B. 8.33
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–28
68. The market capitalization rate on the stock of Fast Growing Company is 20%. The
expected ROE is 22% and the expected EPS are $6.10. If the firm’s plowback ratio is 90%,
the P/E ratio will be ________.
A. 7.69
B. 8.33
Difficulty: Difficult
69. J.C. Penney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year
2 of $1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at
the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should
be worth _______ today.
A. $33.00
B. $40.67
Calculations are shown in the table below.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–29
70. Exercise Bicycle Company is expected to pay a dividend in year 1 of $1.20, a dividend in
year 2 of $1.50, and a dividend in year 3 of $2.00. After year 3, dividends are expected to
grow at the rate of 10% per year. An appropriate required return for the stock is 14%. The
stock should be worth _______ today.
A. $33.00
B. $39.86
Calculations are shown in the table below.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–30
71. Antiquated Products Corporation produces goods that are very mature in their product life
cycles. Antiquated Products Corporation is expected to pay a dividend in year 1 of $1.00, a
dividend of $0.90 in year 2, and a dividend of $0.85 in year 3. After year 3, dividends are
expected to decline at a rate of 2% per year. An appropriate required rate of return for the
stock is 8%. The stock should be worth ______.
D. $22.22
E. none of the above
Calculations are shown below.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–31
72. Mature Products Corporation produces goods that are very mature in their product life
cycles. Mature Products Corporation is expected to pay a dividend in year 1 of $2.00, a
dividend of $1.50 in year 2, and a dividend of $1.00 in year 3. After year 3, dividends are
expected to decline at a rate of 1% per year. An appropriate required rate of return for the
stock is 10%. The stock should be worth ______.
A. $9.00
Calculations are shown below.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–32
73. Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is
expected to have before-tax cash flow from operations of $500,000 in the coming year. The
firm’s corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be
invested in new fixed assets. Depreciation for the year will be $100,000. After the coming
year, cash flows are expected to grow at 6% per year. The appropriate market capitalization
rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The
projected free cash flow of Utica Manufacturing Company for the coming year is _______.
A. $150,000
Calculations are shown below.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–33
74. Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is
expected to have before-tax cash flow from operations of $500,000 in the coming year. The
firm’s corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be
invested in new fixed assets. Depreciation for the year will be $100,000. After the coming
year, cash flows are expected to grow at 6% per year. The appropriate market capitalization
rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The total
value of the equity of Utica Manufacturing Company should be
A. $1,000,000
Difficulty: Difficult
75. A firm’s earnings per share increased from $10 to $12, dividends increased from $4.00 to
$4.80, and the share price increased from $80 to $90. Given this information, it follows that
________.
D. the required rate of return decreased
E. none of the above
Difficulty: Moderate
Chapter 18 – Equity Valuation Models
18–34
76. In the dividend discount model, _______ which of the following are not incorporated into
the discount rate?
A. real risk-free rate
B. risk premium for stocks
Difficulty: Moderate
77. A company whose stock is selling at a P/E ratio greater than the P/E ratio of a market
index most likely has _________.
A. an anticipated earnings growth rate which is less than that of the average firm
Difficulty: Moderate
78. Which of the following would tend to reduce a firm’s P/E ratio?
A. The firm significantly decreases financial leverage
B. The firm increases return on equity for the long term
Difficulty: Moderate
Chapter 18 – Equity Valuation Models
18–35
79. Other things being equal, a low ________ would be most consistent with a relatively high
growth rate of firm earnings and dividends.
D. inflation rate
E. none of the above
Difficulty: Moderate
80. A firm has a return on equity of 14% and a dividend payout ratio of 60%. The firm’s
anticipated growth rate is _________.
D. 20%
E. none of the above
Difficulty: Easy
81. A firm has a return on equity of 20% and a dividend payout ratio of 30%. The firm’s
anticipated growth rate is _________.
A. 6%
B. 10%
Difficulty: Easy
Chapter 18 – Equity Valuation Models
18–36
82. Sales Company paid a $1.00 dividend per share last year and is expected to continue to
pay out 40% of earnings as dividends for the foreseeable future. If the firm is expected to
generate a 10% return on equity in the future, and if you require a 12% return on the stock, the
value of the stock is ________.
D. $18.67
E. none of the above
Difficulty: Moderate
83. Assume that at the end of the next year, Bolton Company will pay a $2.00 dividend per
share, an increase from the current dividend of $1.50 per share. After that, the dividend is
expected to increase at a constant rate of 5%. If you require a 12% return on the stock, the
value of the stock is ________.
D. $31.78
E. none of the above
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–37
84. The growth in dividends of Music Doctors, Inc. is expected to be 8%/year for the next two
years, followed by a growth rate of 4%/year for three years; after this five year period, the
growth in dividends is expected to be 3%/year, indefinitely. The required rate of return on
Music Doctors, Inc. is 11%. Last year’s dividends per share were $2.75. What should the
stock sell for today?
A. $8.99
B. $25.21
Calculations are shown below.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–38
85. The growth in dividends of ABC, Inc. is expected to be 15%/year for the next three years,
followed by a growth rate of 8%/year for two years; after this five year period, the growth in
dividends is expected to be 3%/year, indefinitely. The required rate of return on ABC, Inc. is
13%. Last year’s dividends per share were $1.85. What should the stock sell for today?
A. $8.99
B. $25.21
Calculations are shown below.
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–39
86. The growth in dividends of XYZ, Inc. is expected to be 10%/year for the next two years,
followed by a growth rate of 5%/year for three years; after this five year period, the growth in
dividends is expected to be 2%/year, indefinitely. The required rate of return on XYZ, Inc. is
12%. Last year’s dividends per share were $2.00. What should the stock sell for today?
A. $8.99
Calculations are shown below.
Difficulty: Difficult
87. If a firm’s required rate of return equals the firm’s return on equity, there is no advantage
to increasing the firm’s growth. Suppose a no-growth firm had a required rate of return and a
ROE of 12% and a stock price of $40. However, if the firm is able to increase the ROE to
15% with a plowback ratio of 50%, what is the present value of growth opportunities now?
(Last year’s dividends were $2.00/share).
A. $9.78
Difficulty: Difficult
Chapter 18 – Equity Valuation Models
18–40
88. If a firm has a required rate of return equal to the ROE
A. the firm can increase market price and P/E by retaining more earnings.
B. the firm can increase market price and P/E by increasing the growth rate.
Difficulty: Easy
89. According to James Tobin, the long run value of Tobin’s Q should tend toward
A. 0.
Difficulty: Easy
90. The goal of fundamental analysts is to find securities
D. all of the above.
E. none of the above.
Difficulty: Easy