-
Chapter 18 Equity Valuation Models
Multiple Choice
Questions
1.
________ is equal to the
total market value of the firm's common stock
divided by (the
replacement cost of the
firm's assets less liabilities).
A)
Book value
per share
B)
Liquidation value per share
C)
Market value
per share
D)
Tobin's Q
E)
None of the above.
Answer: D
Difficulty: Easy
Rationale:
Book value per
share is assets minus liabilities divided by
number of shares.
Liquidation value
per share is the amount a shareholder would
receive in the event of
bankruptcy.
Market value per share is the market price of the
stock.
2.
High P/E ratios tend to
indicate that a company will _______, ceteris
paribus.
A)
grow quickly
B)
grow at the same speed as
the average company
C)
grow slowly
D)
not grow
E)
none of the above
Answer: A Difficulty:
Easy
Rationale:
Investors pay for growth; hence the high P/E ratio
for growth firms; however,
the investor
should be sure that he or she is paying for
expected, not historic, growth.
3.
_________ is equal to (common
shareholders' equity/common shares outstanding).
A)
Book value per share
B)
Liquidation
value per share
C)
Market value per share
D)
Tobin's Q
E)
none of the above
Answer: A
Difficulty: Easy
Rationale:
See rationale for
test bank question 18.1
Bodie, Investments, Sixth Edition
399
Chapter 18 Equity
Valuation Models
4.
________ are analysts who use
information concerning current and prospective
profitability of a firms to assess the
firm's fair market value.
A)
Credit analysts
B)
Fundamental
analysts
C)
Systems analysts
D)
Technical analysts
E)
Specialists
Answer: B Difficulty:
Easy
Rationale:
Fundamentalists
use all public information in an attempt to value
stock
(while hoping to identify
undervalued securities).
5.
The _______ is defined as the present
value of all cash proceeds to the investor in the
stock.
A)
dividend payout ratio
B)
intrinsic value
C)
market
capitalization rate
D)
plowback ratio
E)
none of the above
Answer: B Difficulty:
Easy
Rationale:
The cash flows
from the stock discounted at the appropriate rate,
based on
the perceived riskiness of the
stock, the market risk premium and the risk free
rate,
determine the intrinsic value of
the stock.
6.
_______ is the amount of money per
common share that could be realized by breaking
up the firm, selling the assets,
repaying the debt, and distributing the remainder
to
shareholders.
A)
Book value per share
B)
Liquidation
value per share
C)
Market value per share
D)
Tobin's Q
E)
None of the above
Answer: B Difficulty:
Easy
Rationale:
See explanation
for test bank question 18.1.
400
Bodie, Investments,
Sixth Edition
Chapter 18
Equity Valuation Models
7.
Since 1955, Treasury bond yields and
earnings yields on stocks were_______.
A)
identical
B)
negatively correlated
C)
positively
correlated
D)
uncorrelated
Answer: C Difficulty: Easy
Rationale:
The earnings
yield on stocks equals the expected real rate of
return on the
stock market, which
should be equal to the yield to maturity on
Treasury bonds plus a
risk premium,
which may change slowly over time. The yields are
plotted in Figure
18.8 on page
640.
8.
Historically, P/E ratios have tended to
be _________.
A)
higher when inflation has been high
B)
lower when
inflation has been high
C)
uncorrelated with inflation rates but
correlated with other macroeconomic variables
D)
uncorrelated
with any macroeconomic variables including
inflation rates
E)
none of the above
Answer: B Difficulty: Easy
Rationale:
P/E ratios have
tended to be lower when inflation has been high,
reflecting
the market's assessment that
earnings in these periods are of
artificially distorted by inflation,
and warranting lower P/E ratios.
9.
The ______ is a common
term for the market consensus value of the
required return on
a stock.
A)
dividend payout ratio
B)
intrinsic
value
C)
market
capitalization rate
D)
plowback rate
E)
none of the above
Answer: C Difficulty: Easy
Rationale:
The market
capitalization rate, which consists of the risk-
free rate, the
systematic risk of the
stock and the market risk premium, is the rate at
which a stock's
cash flows are
discounted in order to determine intrinsic
value.
Bodie, Investments, Sixth Edition
401
Chapter 18 Equity
Valuation Models
10.
The
_________ is the fraction of earnings reinvested
in the firm.
A)
dividend payout ratio
B)
retention
rate
C)
plowback ratio
D)
A and C
E)
B and C
Answer: E
Difficulty: Easy
Rationale:
Retention rate,
or plowback ratio, represents the earnings
reinvested in the
firm. The retention
rate, or (1 - plowback) = dividend
payout.
11.
The Gordon model
A)
is a generalization of the perpetuity
formula to cover the case of a growing
perpetuity.
B)
is valid only when
g
is less than
k
.
C)
is valid only when
k
is less than
g
.
D)
A and B.
E)
A and C.
Answer: D
Difficulty: Easy
Rationale:
The Gordon model
assumes constant growth indefinitely.
Mathematically, g
must be less than k;
otherwise, the intrinsic value is
undefined.
12.
You wish to earn a
return of 13% on each of two stocks, A and B.
Stock A is expected
to pay a dividend
of $$3 in the upcoming year while Stock B is
expected to pay a
dividend of $$4 in the
upcoming year. The expected growth rate of
dividends for both
stocks is 7%. The
intrinsic value of stock A ______.
A)
will be
greater than the intrinsic value of stock B
B)
will be the same as the intrinsic value
of stock B
C)
will be less than the intrinsic value
of stock B
D)
cannot be calculated without knowing
the market rate of return
E)
none of the above is a
correct answer.
Answer: C Difficulty: Easy
Rationale:
PV0 = D1/(k-g);
given k and g are equal, the stock with the larger
dividend
will have the higher
value.
402
Bodie,
Investments, Sixth Edition
Chapter 18 Equity Valuation Models
13.
You wish to earn a return of 12% on
each of two stocks, A and B. Each of the stocks
is
expected to pay a dividend of $$2 in
the upcoming year. The expected growth rate of
dividends is 9% for stock A and 10% for
stock B. The intrinsic value of stock A _____.
A)
will be greater than the intrinsic
value of stock B
B)
will be the same as the
intrinsic value of stock B
C)
will be less than the
intrinsic value of stock B
D)
cannot be calculated
without knowing the rate of return on the market
portfolio.
E)
none of the above is a correct
statement.
Answer: C Difficulty: Easy
Rationale:
PV0 = D1/(k-g);
given that dividends are equal, the stock with the
higher
growth rate will have the higher
value.
14.
Each of two stocks, A
and B, are expected to pay a dividend of $$5 in the
upcoming year.
The expected growth
rate of dividends is 10% for both stocks. You
require a rate of
return of 11% on
stock A and a return of 20% on stock B. The
intrinsic value of stock A
_____.
A)
will be greater than the intrinsic
value of stock B
B)
will be the same as the
intrinsic value of stock B
C)
will be less than the
intrinsic value of stock B
D)
cannot be calculated
without knowing the market rate of return.
E)
none of the above is true.
Answer: A Difficulty:
Easy
Rationale:
PV0 =
D1/(k-g); given that dividends are equal, the
stock with the larger
required return
will have the lower value.
15.
Recent
empirical research indicates _______.
A)
that real
rates of return on stocks are positively
correlated with inflation
B)
that real rates of return
on stocks are uncorrelated with inflation
C)
that real rates of return on stocks are
negatively correlated with inflation
D)
the ratio of
the real rate of return on stocks to inflation is
1.0
E)
nothing about real rates of return on
stocks
Answer:
C Difficulty: Moderate
Rationale:
Although stocks
have been considered to be a hedge against
inflation, recent
research indicates
that real rates of return are negatively
correlated with inflation.
Bodie, Investments, Sixth Edition
403
Chapter 18 Equity
Valuation Models
16.
If the
expected ROE on reinvested earnings is equal to k,
the multistage DDM reduces
to
A)
V
0
= (Expected
Dividend Per Share in Year 1)/k
B)
V
0
= (Expected
EPS in Year 1)/k
C)
V
0
= (Treasury Bond Yield in Year 1)/k
D)
V
0
= (Market
return in Year 1)/k
E)
none of the above
Answer: B
Difficulty: Moderate
Rationale:
If ROE = k, no
growth is occurring; b = 0; EPS = DPS
17.
Agricultural Equipment Company has an
expected ROE of 10%. The dividend growth
rate will be ________ if the firm
follows a policy of paying 40% of earnings in the
form
of dividends.
A)
3.0%
B)
4.8%
C)
7.2%
D)
6.0%
E)
none of the above
Answer: D Difficulty:
Easy
Rationale:
10% X
0.60 = 6.0%.
18.
Music Doctors Company
has an expected ROE of 14%. The dividend growth
rate will
be ________ if the firm
follows a policy of paying 60% of earnings in the
form of
dividends.
A)
5.6%
B)
4.8%
C)
7.2%
D)
6.0%
E)
none of the above
Answer: A Difficulty:
Easy
Rationale:
14% X
0.40 = 5.6%.
404
Bodie, Investments, Sixth
Edition
Chapter 18 Equity
Valuation Models
19.
QQAG Company
has an expected ROE of 16%. The dividend growth
rate will be
________ if the firm
follows a policy of paying 70% of earnings in the
form of
dividends.
A)
3.0%
B)
4.8%
C)
7.2%
D)
6.0%
E)
none of the above
Answer: B Difficulty:
Easy
Rationale:
16% X
0.30 = 4.8%.
20.
LJP Company has an
expected ROE of 15%. The dividend growth rate
will be
________ if the firm follows a
policy of paying 50% of earnings in the form of
dividends.
A)
3.0%
B)
4.8%
C)
7.5%
D)
6.0%
E)
none of the
above
Answer: C
Difficulty: Easy
Rationale:
15% X 0.50 =
7.5%.
21.
Construction Machinery
Company has an expected ROE of 11%. The dividend
growth
rate will be _______ if the firm
follows a policy of paying 25% of earnings in the
form
of dividends.
A)
3.0%
B)
4.8%
C)
8.25%
D)
9.0%
E)
none of the above
Answer: C Difficulty:
Easy
Rationale:
11% X
0.75 = 8.25%.
Bodie,
Investments, Sixth Edition
405
Chapter 18 Equity Valuation Models
22.
A preferred stock will pay a dividend
of $$2.75 in the upcoming year, and every year
thereafter, i.e., dividends are not
expected to grow. You require a return of 10% on
this
stock. Use the constant growth
DDM to calculate the intrinsic value of this
preferred
stock.
A)
$$0.39
B)
$$27.50
C)
$$31.82
D)
$$56.25
E)
none of the above
Answer: B Difficulty:
Moderate
Rationale:
2.75
/ .10 = 27.50
23.
A preferred stock will
pay a dividend of $$3.00in the upcoming year, and
every year
thereafter, i.e., dividends
are not expected to grow. You require a return of
9% on this
stock. Use the constant
growth DDM to calculate the intrinsic value of
this preferred
stock.
A)
$$33.33
B)
$$0.56
C)
$$31.82
D)
$$56.25
E)
none of the above
Answer: A Difficulty:
Moderate
Rationale:
3.00
/ .09 = 33.33
24.
A preferred stock will
pay a dividend of $$1.25 in the upcoming year, and
every year
thereafter, i.e., dividends
are not expected to grow. You require a return of
12% on this
stock. Use the constant
growth DDM to calculate the intrinsic value of
this preferred
stock.
A)
$$11.56
B)
$$9.65
C)
$$11.82
D)
$$10.42
E)
none of the above
Answer: D Difficulty:
Moderate
Rationale:
1.25
/ .12 = 10.42
406
Bodie, Investments, Sixth
Edition
Chapter 18 Equity
Valuation Models
25.
A preferred
stock will pay a dividend of $$3.50 in the upcoming
year, and every year
thereafter, i.e.,
dividends are not expected to grow. You require a
return of 11% on this
stock. Use the
constant growth DDM to calculate the intrinsic
value of this preferred
stock.
A)
$$0.39
B)
$$0.56
C)
$$31.82
D)
$$56.25
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale:
3.50 / .11 =
31.82
26.
You are considering
acquiring a common stock that you would like to
hold for one year.
You expect to
receive both $$1.25 in dividends and $$32 from the
sale of the stock at the
end of the
year. The maximum price you would pay for the
stock today is _____ if you
wanted to
earn a 10% return.
A)
$$30.23
B)
$$24.11
C)
$$26.52
D)
$$27.50
E)
none of the
above
Answer: A
Difficulty: Moderate
Rationale:
.10 = (32 - P +
1.25) / P; .10P = 32 - P + 1.25; 1.10P = 33.25; P
= 30.23.
27.
You are considering
acquiring a common stock that you would like to
hold for one year.
You expect to
receive both $$0.75 in dividends and $$16 from the
sale of the stock at the
end of the
year. The maximum price you would pay for the
stock today is _____ if you
wanted to
earn a 12% return.
A)
$$23.91
B)
$$14.96
C)
$$26.52
D)
$$27.50
E)
none of the
above
Answer: B
Difficulty: Moderate
Rationale:
.12 = (16 - P +
0.75) / P; .12P = 16 - P + 0.75; 1.12P = 16.75; P
= 14.96.
Bodie, Investments,
Sixth Edition
407
Chapter 18
Equity Valuation Models
28.
You are
considering acquiring a common stock that you
would like to hold for one year.
You
expect to receive both $$2.50 in dividends and $$28
from the sale of the stock at the
end
of the year. The maximum price you would pay for
the stock today is _____ if you
wanted
to earn a 15% return.
A)
$$23.91
B)
$$24.11
C)
$$26.52
D)
$$27.50
E)
none of the
above
Answer: C
Difficulty: Moderate
Rationale:
.15 = (28 - P +
2.50) / P; .15P = 28 - P + 2.50; 1.15P = 30.50; P
= 26.52.
29.
Bonded Paper Company has
a balance sheet which lists $$85 million in assets,
$$40
million in liabilities and $$45
million in common shareholders' equity. It has
1,400,000
common shares outstanding.
The replacement cost of the assets is $$115
million. The
market share price is
$$90.
What is Bonded Paper's book value per
share?
A)
$$1.68
B)
$$2.60
C)
$$32.14
D)
$$60.71
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale:
$$45M/1.4M =
$$32.14.
30.
One of the problems with
attempting to forecast stock market values is that
A)
there are no variables that seem to
predict market return.
B)
the earnings multiplier
approach can only be used at the firm level.
C)
the level of uncertainty surrounding
the forecast will always be quite high.
D)
dividend payout ratios are highly
variable.
E)
none of the above.
Answer: C Difficulty:
Easy
Rationale:
Although some variables such as market dividend
yield appear to be strongly
related to
market return, the market has great variability
and so the level of uncertainty
in any
forecast will be high.
408
Bodie, Investments, Sixth
Edition
Chapter 18 Equity
Valuation Models
31.
The most
popular approach to forecasting the overall stock
market is to use
A)
the dividend multiplier.
B)
the aggregate return on assets.
C)
the historical ratio of book value to
market value.
D)
the aggregate earnings
multiplier.
E)
Tobin's Q.
Answer: D Difficulty: Easy
Rationale:
The earnings
multiplier approach is the most popular approach
to forecasting
the overall stock
market.
Use the
following to answer questions 32-34:
Dominion Tool Company is
expected to pay a dividend of $$2 in the upcoming
year. The
risk-free rate of return is
4% and the expected return on the market portfolio
is 14%. Analysts
expect the price of
Dominion Tool Company shares to be $$22 a year from
now. The beta of
Dominion Tool
Company's stock is 1.25.
32.
The market's
required rate of return on Dominion's stock is
_____.
A)
14.0%
B)
17.5%
C)
16.5%
D)
15.25%
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale:
4% + 1.25(14% -
4%) = 16.5%.
33.
What is the intrinsic
value of Dominion's stock today?
A)
$$20.60
B)
$$20.00
C)
$$12.12
D)
$$22.00
E)
none of the above
Answer: A Difficulty:
Difficult
Rationale:
k =
.04 + 1.25 (.14 - .04); k = .165; .165 = (22 - P +
2) / P; .165P = 24 - P;
1.165P = 24; P
= 20.60.
Bodie, Investments,
Sixth Edition
409
Chapter 18
Equity Valuation Models
34.
If
Dominion's intrinsic value is $$21.00 today, what
must be its growth rate?
A)
0.0%
B)
10%
C)
4%
D)
6%
E)
7%
Answer: E
Difficulty: Difficult
Rationale:
k = .04 + 1.25
(.14 - .04); k = .165; .165 = 2/21 + g; g =
.07
Use the
following to answer questions 35-36:
Civil Engineering
Corporation is expected to pay a dividend of $$1.00
in the upcoming year.
Dividends are
expected to grow at the rate of 6% per year. The
risk-free rate of return is 5% and
the
expected return on the market portfolio is 13%.
The stock of Civil Engineering Corporation
has a beta of 1.2.
35.
What is the return you should require
on Civil Engineering's stock?
A)
12.0%
B)
14.6%
C)
15.6%
D)
20%
E)
none of the above
Answer: B Difficulty:
Moderate
Rationale:
5% +
1.2(13% - 5%) = 14.6%.
36.
What is the
intrinsic value of Civil Engineering's stock?
A)
$$14.29
B)
$$14.60
C)
$$12.33
D)
$$11.62
E)
none of the above
Answer: D
Difficulty: Difficult
Rationale:
k = 5% + 1.2(13%
- 5%) = 14.6%; P = 1 / (.146 - .06) =
$$11.62.
410
Bodie, Investments, Sixth
Edition
Chapter 18 Equity
Valuation Models
37.
High Fly
Airline is expected to pay a dividend of $$7 in the
coming year. Dividends are
expected to
grow at the rate of 15% per year. The risk-free
rate of return is 6% and the
expected
return on the market portfolio is 14%. The stock
of High Fly Airline has a beta
of 3.00.
The return you should require on the stock is
________.
A)
10%
B)
18%
C)
30%
D)
42%
E)
none of the above
Answer: C
Difficulty: Moderate
Rationale:
6% + 3(14% - 6%)
= 30%.
38.
Old Quartz Gold Mining
Company is expected to pay a dividend of $$8 in the
upcoming
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 return you
should require on the
stock is
________.
A)
2%
B)
4%
C)
6%
D)
8%
E)
none of the above
Answer: B
Difficulty: Moderate
Rationale:
6% + [-0.25(14% -
6%)] = 4%.
39.
High Tech Chip Company
is expected to have EPS in the coming year of
$$2.50. The
expected ROE is 12.5%. An
appropriate required return on the stock is 11%.
If the firm
has a plowback ratio of
70%, the growth rate of dividends should be
A)
5.00%
B)
6.25%
C)
6.60%
D)
7.50%
E)
8.75%
Answer: E Difficulty:
Easy
Rationale:
12.5%
X 0.7 = 8.75%.
Bodie,
Investments, Sixth Edition
411
Chapter 18 Equity Valuation Models
40.
A company paid a dividend last year of
$$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
C)
$$1.77
D)
$$1.94
E)
none of the
above
Answer: D
Difficulty: Moderate
Rationale:
g = .155 X .75 =
10.875%; $$2.50(1.10875) = $$1.94
41.
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)
$$2.50
C)
$$2.69
D)
$$2.81
E)
none of the above
Answer: C Difficulty:
Moderate
Rationale:
g =
.125 X .6 = 7.5%; $$2.50(1.075) = $$2.69
42.
Suppose that the average P/E multiple
in the oil industry is 20. Dominion Oil is
expected to have an EPS of $$3.00 in the
coming year. The intrinsic value of Dominion
Oil stock should be _____.
A)
$$28.12
B)
$$35.55
C)
$$60.00
D)
$$72.00
E)
none of the above
Answer: C Difficulty:
Easy
Rationale:
20 X
$$3.00 = $$60.00.
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Bodie, Investments, Sixth
Edition
Chapter 18 Equity
Valuation Models
43.
Suppose that
the average P/E multiple in the oil industry is
22. Exxon Oil is expected to
have an
EPS of $$1.50 in the coming year. The intrinsic
value of Exxon Oil stock should
be
_____.
A)
$$33.00
B)
$$35.55
C)
$$63.00
D)
$$72.00
E)
none of the above
Answer: A
Difficulty: Easy
Rationale:
22 X $$1.50 =
$$33.00.
44.
Suppose that the average
P/E multiple in the oil industry is 16. Mobil Oil
is expected to
have an EPS of $$4.50 in
the coming year. The intrinsic value of Mobil Oil
stock should
be _____.
A)
$$28.12
B)
$$35.55
C)
$$63.00
D)
$$72.00
E)
none of the above
Answer: D Difficulty:
Easy
Rationale:
16 X
$$4.50 = $$72.00.
45.
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
B)
$$93.50
C)
$$63.00
D)
$$72.00
E)
none of the
above
Answer: B
Difficulty: Easy
Rationale:
17 X $$5.50 =
$$93.50.
Bodie, Investments,
Sixth Edition
413
Chapter 18
Equity Valuation Models
46.
An analyst
has determined that the intrinsic value of Compaq
stock is $$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 Compaq in the coming
year is
______.
A)
$$3.63
B)
$$4.44
C)
$$0.80
D)
$$22.50
E)
none of the above
Answer: C
Difficulty: Easy
Rationale:
$$20(1/25) =
$$0.80.
47.
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)
$$4.44
C)
$$14.40
D)
$$1.26
E)
none of the above
Answer: D
Difficulty: Easy
Rationale:
$$34(1/27) =
$$1.26.
48.
An analyst has
determined that the intrinsic value of IBM stock
is $$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
______.
A)
$$3.64
B)
$$4.44
C)
$$14.40
D)
$$22.50
E)
none of the above
Answer: A Difficulty:
Easy
Rationale:
$$80(1/22) = $$3.64.
414
Bodie, Investments, Sixth
Edition
Chapter 18 Equity
Valuation Models
49.
Old Quartz
Gold Mining Company is expected to pay a dividend
of $$8 in the coming
year. Dividends are
expected to decline at the rate of 2% per year.
The risk-free rate of
return is 6% and
the expected return on the market portfolio is
14%. The stock of Old
Quartz Gold
Mining Company has a beta of -0.25. The intrinsic
value of the stock is
______.
A)
$$80.00
B)
133.33
C)
$$200.00
D)
$$400.00
E)
none of the above
Answer: B
Difficulty: Difficult
Rationale:
k = 6% +
[-0.25(14% - 6%)] = 4%; P = 8 / [.04 - (-.02)] =
$$133.33.
50.
High Fly Airline is
expected to pay a dividend of $$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 High
Fly Airline has a beta
of 3.00. The
intrinsic value of the stock is ______.
A)
$$46.67
B)
$$50.00
C)
$$56.00
D)
$$62.50
E)
none of the above
Answer: A
Difficulty: Moderate
Rationale:
6% + 3(14% - 6%)
= 30%; P = 7 / (.30 - .15) = $$46.67.
51.
Sunshine Corporation is expected to pay
a dividend of $$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
C)
$$17.75
D)
$$25.00
E)
none of the above
Answer: D
Difficulty: Moderate
Rationale:
6% + 0.75(14% -
6%) = 12%; P = 1.50 / (.12 - .06) =
$$25.
Bodie, Investments,
Sixth Edition
415
Chapter 18
Equity Valuation Models
52.
High Tech
Chip Company is expected to have EPS in the coming
year of $$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
C)
$$28.57
D)
$$38.46
E)
none of the above
Answer: D
Difficulty: Difficult
Rationale:
g = 14% X 0.6 =
8.4%; Expected DPS = $$2.50(0.4) = $$1.00; P = 1 /
(.11
- .084) = $$38.46.
Use the following to answer
questions 53-54:
Questionable Systematic Risk Company is
expected to pay a dividend of $$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
$$90.00.
53.
What is the market
capitalization rate for Questionable Systematic
Risk?
A)
13.6%
B)
13.9%
C)
15.6%
D)
16.9%
E)
none of the above
Answer: B
Difficulty: Moderate
Rationale:
k = 3.50 / 90 +
.10; k = 13.9%
54.
What is the approximate
beta of Questionable's stock?
A)
0.8
B)
1.0
C)
1.1
D)
1.4
E)
none of the above
Answer: C Difficulty:
Difficult
Rationale:
k =
13.9% from 18.41; 13.9 = 5% + b(13% - 5%) =
1.11.
416
Bodie,
Investments, Sixth Edition
Chapter 18 Equity Valuation Models
55.
The market capitalization rate on the
stock of Flexible Dividend Company is 12%. The
expected ROE is 13% and the expected
EPS are $$3.60. If the firm's plowback ratio is
50%, the P/E ratio will be _________.
A)
7.69
B)
8.33
C)
9.09
D)
11.11
E)
none of the above
Answer: C
Difficulty: Difficult
Rationale:
g = 13% X 0.5 =
6.5%; D1 = 3.60 X 0.5 = $$1.80; P = 1.80 / (.12 -
.065) =
$$65.45; $$65.45/$$3.60 =
18.18.
56.
The market
capitalization rate on the stock of Flexible
Dividend Company is 12%. The
expected
ROE is 13% and the expected EPS are $$3.60. If the
firm's plowback ratio is
75%, the P/E
ratio will be ________.
A)
7.69
B)
8.33
C)
9.09
D)
11.11
E)
none of the
above
Answer: D
Difficulty: Difficult
Rationale:
g = 13% X 0.75 =
9.75%; D1 = 3.60 X 0.25 = $$0.90; P = .90 / (.12 -
.0975) =
$$40.00; $$40.00/$$3.60 =
11.11.
Bodie, Investments,
Sixth Edition
417
Chapter 18
Equity Valuation Models
57.
J.C. Penney
Company is expected to pay a dividend in year 1 of
$$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
C)
$$77.53
D)
$$66.00
E)
none of the above
Answer: C Difficulty:
Difficult
Rationale:
Calculations are shown in the table
below.
Yr
Dividend
PV of Dividend @ 11%
1
$$1.65
$$1.65/(1.11) = $$1.4865
2
$$1.97
$$1.97/(1.11)
2
=
$$1.5989
3
$$2.54
$$2.54/(1.11)
3
=
$$1.8572
Sum
$$4.94
P
3
= $$2.54 (1.08)
/ (.11-.08) = $$91.44; PV of
P
3
=
$$91.44/(1.08)
3
= $$72.5880;
P
O
= $$4.94
+
$$72.59 = $$77.53.
418
Bodie,
Investments, Sixth Edition
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