SET 3 PRACTICE QUESTIONS Chapters 10-15: Common Stocks (Valuation and Management), Efficient Markets, Market/Economy, Industry, Company Analysis

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1. A stock’s intrinsic value isa. The estimated present value of the future stream of cash flows for the stockb. The same as its market pricec. The sum of all dividends expected to be paid from now to infinityd. Based on the accounting value of the assets

2. The basic premise of the DDM is thata. the present value of all future dividends, properly discounted, is the intrinsic value

of the stockb. the present value of all future earnings, properly discounted, is the intrinsic value

of the stockc. the price of a stock is the sum of all dividends to be paid from now to infinityd. investors can accurately access the future levels of dividends, and therefore can

determine what a stock is worth

3. Which of the following statements is CORRECT concerning the DDM?a. earnings are the foundation of valuation for common stocksb. the DDM states that the value of a stock is the discounted value of all future

dividendsc. the DDM is operationalized by estimating the expected future earnings to be paid

by a company, estimating the required rate of return, and discountingd. earnings are the only cash flow stream to be received directly by investors

4. Choose the INCORRECT statement concerning the DDM:a. It is based on the position that the price of a stock is the discounted value of all

future dividendsb. Not all of its three growth rate cases involve a present value processc. The no growth rate case is the least likely case to be encounteredd. The multiple growth rate case involves at least two different growth rates

5. Using the constant growth version of the DDM to determine the intrinsic value of a stocka. the formula calls for the dividend to be paid this periodb. the required rate of return is expected to be larger than the growth rate in

dividendsc. there is no present value process involved in the simple equation used in this cased. the answer obtained from this equation is the definitive value for the stock for all

investors

6. Which of the following statements is INCORRECT about dividends?a. dividends are the foundation of valuation for common stocksb. the DDM states that the value of a stock is the discounted value of all future

earningsc. the DDM is operationalized by estimating the expected future dividends to be

paid by a company and estimating the required rate of returnd. dividends are the only cash flow stream to be received directly by investors

7. Sardi Company currently earns $3.00 per share and currently pays $1.20 per share in dividends. It is expected to have a constant growth rate of 7% per year. The required rate of return is 14%. The stock price isa. $42.86b. $18.34c. $17.14d. $40.05

8. Johnson stock is currently selling for $40. The expected dividend is $2. This is a constant growth firm. If investors require a return of 15% on this stock, what do they think the growth rate will be?a. 6%b. 7%c. 8%d. 11%e. none of the above

9. Calculate the estimated price of the following stock. Required rate of return: 15%; Expected dividend next year: $20Expected constant growth rate of dividends: 10%a. 4b. 400c. 440d. none of the above

10. BLC Industries is expected to pay a dividend of $1.50, and the dividend is expected to grow at a constant rate of 7%. This stock is 15% less risky than the market as a whole. The risk-free rate is 6%, and the equity risk premium for the market is 8%. The estimated price of the stock isa. $18.75b. $21.43c. $27.76d. $25.86

11. Your required rate of return is 15%. Z Corp. is currently selling for $40 and the most recent dividend paid was $2.55. The expected constant growth rate is 8%. What is the maximum you should pay for this stock?a. $39.29b. $40c. $36.43d. none of the above

12. Percy Pondscum & Company currently earns $3.00 per share and currently pays $1.20 per share in dividends. It is expected to have a constant growth rate of 7% per year. The risk free rate of return is 6%, the market risk premium is 8%, and the beta for this company is 1.0. The stock price isa. $42.86b. $18.34c. $17.14d. $40.05e. none of the above

13. Xila expects to earn $4.00 per share next year, with an expected payout of 30%. Investors expect the dividend to grow at a constant rate of 8% for the foreseeable future. The risk-free rate is 5%, and the beta that is 10% more volatile than the market as a whole, and the expected return on the market is 14%. What is the estimated price of the stock?a. $12.12b. $50c. $13.33 d. none of the above

14. Johnsey Industries' current dividend is $2. The average growth rate for the past many years has been steady at 8%, but the consensus of analysts is that the expected growth rate is 6% . k = 16%. The intrinsic value of this stock is:a. $20b. $18.80c. $9.09d. $21.20

15. Jack buys Wealth Enterprises for $40. He expects the firm's earnings and dividends to grow at an annual rate of 7%. The firm expects to pay a dividend of $2.00 next year. The market risk premium is 8%. Jack's expected rate of return is a. 10%b. 12%c. 12.35%d. 15%

16. Walter Company currently earns $3.00 per share and pays $1.00 in dividends. The dividend is expected to double in 9 years and also to grow at that rate beyond that time. The required rate of return is 15%. The estimated stock price isa. $15.42b. $6.66c. $14.29d. none of the above

17. Your required rate of return is 15.1%. Davis Drives is currently selling for $38 per share and is expected to pay a dividend of $3 next period. The expected constant growth rate is 7%. Which of the following statements is true in making a stock decision?a. you can justify buying this stock because: expected return > the required returnb. you cannot justify buying this stock because: the required return > the expected

returnc. you cannot justify buying this stock because: the required return < the expected

returnd. you can justify buying this stock because: the required return > than the expected

return

18. Investor A and investor B both have required rates of return of 12%. They are considering the purchase of XTRA stock, which each views as a constant growth case. Both have estimated the dividend for the next period at $1.00, and both agree that the expected growth rate in dividends will be 6% a year. However, investor A plans to buy the stock and hold it for 10 years, while investor B plans to buy the stock and hold it for ONLY 1 year. Which of the following statements is CORRECT about stock valuation?a. Investor A should be willing to pay more for this stock than B.b. Investor B should be willing to pay more for this stock than A.c. Both investors should be willing to pay the same price for the stock.d. None of these.

19. Using the constant growth model, an increase in the required rate of return from 15 to 16%, combined with an increase in the growth rate from 7 to 8%, would cause the price of a constant growth stock, to: (assume the next dividend is $2.00)a. increase in priceb. decrease in pricec. stay the samed. not enough information to answer the question

20. Low Labs. last dividend was $1.50. Its current equilibrium stock price is $15.75, and its expected growth rate is a constant 5 percent. If the stockholders' required rate of return is 15 percent, what is the expected dividend yield and expected capital gains yield for the coming year?a. 0%; 15%b. 5%; 10%c. 10%; 5%d. 15%; 0%

21. The Smith Reclamation Company has been hit hard due to increased competition. The company’s analysts predict that earnings (and dividends) will decline at a rate of 5 percent annually from now on. k = 14% and D0 = $2.00. What will be the estimated price of the company’s stock four years from now (this will be the price at the beginning of year 5)? Round all calculations to two places.a. $27.17b. $11.11c. $28.50d. $10.18e. $8.16

22. A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.00, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, what is the estimated price of this stock? Round calculations to two places.a. $67.81b. $22.49c. $58.15d. $31.00e. none of the above

23. Find the estimated price of Robot Communications if the expected growth rate in dividends is 14% for the next three years, after which the dividend is expected to slow down and grow at a rate of 6%. The current dividend is $2.00 per share, and the required rate of return is 18%. Round calculations to two decimal places.a. $31.77 b. $26.17c. $21.52d. $15.94

24. ABC Company has been growing at a 10% rate, and it just paid a dividend of D0 = $3.00. Due to a new product, ABC expects to achieve a dramatic increase in its short-run growth rate, to 20% annually for the next 2 years, after which growth is expected to return to the long-run constant rate of 10 percent. The company’s beta is 2.0, the required return on an average stock is 11 percent, and the risk-free rate is 7 percent. Calculate the expected dividend yield, D1/P0. Round calculations to two places.a. 3.93%b. 4.58%c. 10.00%d. 7.54%

25. Which of the following statements about stock valuation is INCORRECT?a. dividends are the foundation of valuation for common stocksb. the DDM states that the value of a stock is the discounted value of all future

earningsc. the DDM is based on a present value processd. dividends are the only cash flow stream to be received directly by investors

26. Common stocks are difficult to value becausea. The price change component of total return, unlike the income component,

cannot be known with certaintyb. The DDM equation involves an infinity signc. Inflation affects stock returns more than bond returnsd. Both the cash flows and the required rate of return must be estimated

27. ABC corp. expects to earn $4.00 per share next year, and pay $3.00 per share in dividends.  Expected growth rate in dividends is 6%, required rate of return is 16%. The P/E ratio isa. 6b. 10c. 7.5d. 5

28. X Corp. retains 70% of its earnings in the business. The long-run earnings growth is expected to be 10%. The risk-free rate is 8%, the expected return on the market is 12%, the beta is 2.0, and the most recent dividend was $1.50. What are the most likely market price and P/E for this stock today?a. $27.50, 5xb. $33, 6xc. $25, 5xd. $22.50, 4.5xe. $45, 4.5x

29. Price to book value isa. the ratio of book value to stockholder's equityb. most useful when book value and market value differs sharplyc. sometimes used to value companiesd. useful because it avoids any accounting problems

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30. Which statement about the required rate of return is INCORRECT?a. There are many required rates of return.b. The average required rate of return on bonds is different from that generally

required in common stocks.c. Investor optimism leads to an increase in the required return for a particular stock.d. The level of the required rates of return changes over time.

31. The INCORRECT statement involving the required rate of return for a stock is:a. it equals the risk-free rate plus the market risk premiumb. ex ante, it must slope upwardc. the overall level of required rates of return changes as the risk premiums change d. it is the minimum expected rate of return needed to induce an investor to purchase

a security

32. Select the INCORRECT statement concerning a buy-and-hold strategya. it is applicable to the investor's portfolio, whatever its composition b. it emphasizes the avoidance of transaction costsc. investors must still perform several functions while the strategy is in existenced. it avoids the decision of having to make an initial selection

33. Sector rotation isa. one form of passive investingb. an active strategy similar to stock selectionc. an attempt to earn excess returns by varying the percentage of portfolio assets in

equity securities d. not dependent on an accurate assessment of current economic conditions

34. With regard to security analysts,a. there are more sell side analysts than buy side analystsb. security analyst have become more and more respected over the yearsc. analysts’ estimates have become more and more accurated. investors can use analysts reports and information intelligently

35. Fundamental analysts assume that the market price and intrinsic value of a stock a. are always identicalb. can differ from time to timec. bear no relationship to each otherd. none of these

36. Which of the following statements about valuation is CORRECT?a. valuation is an art and not a scienceb. required rates of return for an asset remain unchanged over timec. earnings per share for next year can be estimated with little errord. an investor’s holding period is relevant for valuation

37. With regard to active and passive strategies for stocks,a. market timing is to be preferred over stock selectionb. sector rotation is a passive strategyc. 3 possible active strategies were discussed in the textd. indexing is a passive strategy while buy-and-hold is an active strategy

38. The recommended framework for fundamental analysis a. puts heavy emphasis on value versus growth stocksb. concerns the relationship between active and passive strategiesc. is, in order, economy/market, industry and then companyd. uses the concept of efficient markets to make decisions

39. Which of the following statements concerning stock investing is INCORRECT?a. Technical analysis refers to the methodology of forecasting fluctuations in

securities pricesb. momentum investing involves buying companies whose earnings or stock prices

are falling, with heavy emphasis on price momentumc. fundamental analysis is based on the premise that any security has an intrinsic

valued. behavioral finance recognized that investors can, and do, behave irrationally

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40. An efficient market does not require thata. stock prices incorporate all informationb. all known information be reflected in pricesc. the adjustments occur very quicklyd. each adjustment be perfect

41. A "Random Walk" occurs when:a. stock price changes are random but predictable.b. stock prices respond slowly to both new and old information.c. future price changes are uncorrelated with past price changes.d. past information is useful in predicting future prices.

42. The semi-strong form of the efficient market hypothesis asserts that stock prices:a. fully reflect all historical price information.b. fully reflect all publicly available information.c. fully reflect all relevant information including insider information.d. may be predictable.

43. Testing investor reactions to announcements and news is a. a weak-form statistical testb. a weak-form test of technical trading rulesc. a semi-strong form testd. a strong-form test

44. An efficient market can be shown to exist ifa. a large number of profit-seeking participants are presentb. information is widely available and is generated in a random fashionc. both a and b occurd. an efficient market cannot be shown to exist with any conditions present

45. Weak form market efficiencya. is identical to the random walk hypothesisb. involves only price and volume informationc. incorporates semi-strong form efficiencyd. is compatible with technical analysis

46. Statistically testing the independence of stock price changes is a test ofa. weak form efficiencyb. semi-strong form efficiencyc. strong form efficiencyd. the seasonal effect

47. Which of the following is not a test of semi-strong form efficiency?a. insider transactionsb. stock splitsc. accounting changesd. dividend announcements

48. With regard to the efficient market hypothesis, choose the INCORRECT statement.a. The strong form of the EMH incorporates the other two formsb. Technical analysis and the weak form of the EMH are direct oppositesc. The anomalies were apparent exceptions to market efficiency, and all have now

been refutedd. Stock prices can have some degree of statistical dependence while being

economically independent

49. Which of the following portfolio management tasks do not have to be performed if the market is efficient?a. minimization of transaction costsb. ensuring the proper amount of diversificationc. adjusting the asset allocation percentages based on perceived changes in

economic conditionsd. achieving a level of risk appropriate for the portfolio

50. If the anomalies work, investors should prefera. low SUE, high P/E, small cap stocksb. low SUE, low P/E, large cap stocksc. high SUE, low P/E, small cap stocksd. high SUE, high P/E, small cap stocks

51. Which of the following is not a market anomaly?a. higher risk-adjusted returns for small firms than for large firmsb. high returns for stocks in Januaryc. lag in adjustment of stock prices to earnings announcementsd. the relationship between accounting changes and stock prices

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52. Relative to the business cycle, stock prices tend toa. move up following a spurt in economic growth.b. move in tandem with economic growth.c. turn down a few months prior to a general down turn in the economy.d. move in a random fashion.

53. Which of the following relationships are INVERSE, other things equal?a. interest rates and stock pricesb. GDP and corporate profitsc. interest rates and P/E ratiosd. both a and ce. none of the above

54. Based on the last 10 economic slumps, the market P/E ratioa. usually falls just before the end of a slumpb. usually falls just before the end of a slump and then rises stronglyc. usually rises just before the end of a slump and then falls sharplyd. usually rises just before the end of a slump and then remains roughly unchanged

over the next year

55. The dividend payout ratio on the S&P 100 is 40% when RF = 9%. Investors demand an equity risk premium of 8 percent. If the growth rate of dividends is expected to be 10 percent, what is the estimated price of the market index if the earnings expectation is $30?a. $384.00b. $213.44c. $266.56d. $171.43

56. Stock prices have almost always risen as the business cyclea. approaches a peakb. approaches a troughc. coincides with a peakd. hits a peak

57. With regard to market P/E ratios, choose the INCORRECT statementa. the multiplier is more volatile than the earnings component in determining the

market’s levelb. P/E ratios tend to be high when inflation and interest rates are lowc. when analyzing the market, P/E ratios are always calculated using historical datad. by historical standards, P/E ratios were unusually high in the late 1990s

58. In using the business cycle to make market forecasts, which of the following statements is INCORRECT?a. it is particularly important to switch into stocks before business cycle troughsb. as the economy recovers, stock prices may level off or even declinec. based on the last 10 economic slumps, the market P/E usually falls just before the

end of the slumpd. if the investor can recognize the bottoming out of the economy before it occurs, a

market rise can be predicted, at least based on past experience, before the bottom is hit

59. With regard to yield curves and the economy,a. every recession since WW II has been preceded by a downward sloping yield

curveb. a flat yield curve suggests that the economy is accelerating in terms of activityc. several studies suggest that the yield curve is not useful in making economic

forecastsd. a steepening yield curve suggests the economy is slowing down because interest

rates are increasing.

60. Which of the following statements is INCORRECT about the market and the economy?a. Stock prices generally lead the economyb. The market has given false signals, particularly with regard to recessions.c. The market almost always rises before a recession’s troughd. Typically, as investors recognize what the economy is doing, the stock market

also recognizes the event and reacts to it

61. Which of the following statements about market/economy analysis is INCORRECT?a. it is the first step in top-down fundamental security analysisb. it is not the first step in bottom-up fundamental security analysisc. what happened in the markets in 2000-2003 indicate that market analysis is less

important than it used to bed. market timing is very difficult to do, if indeed it can be done successfully at all

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62. In which stage of the industry life cycle do firms often offer stability in earnings anddividend growth?a. pioneering stageb. expansion stagec. stabilization staged. in all three stages equally

63. What stage of the industry life cycle is likely to be of most interest to the majority of investors?a. pioneering stageb. expansion stagec. maturity staged. declining stage

64. During the maturity stage of the industry life cycle, companies often tend to pay high dividends because ofa. high capital gainsb. small riskc. few growth opportunitiesd. good stability

65. Based on the industry life cycle, investor risk is the highest during thea. pioneering stage.b. expansion stage.c. stabilization stage.d. declining stage.

66. Which of the following statements about the industry life cycle is INCORRECT?a. All industries can be classified very accurately into a specific phase of the life

cycle.b. Companies may not always fit into a particular stage of the life cycle.c. Even the general framework may not apply to some industries.d. It does not explicitly lead to stock price determination.

67. According to Michael Porter,a. the issue of competitive strategy involves the search for a competitive position in

an industryb. industry profitability determines the five competitive forcesc. industry structure is a function of industry profitabilityd. investors must analyze industry profitability to assess the strength of the five

competitive forces

68. Which of the following in not one of the five competitive forces of Porter?a. structural changes in the economyb. bargaining power of buyersc. threat of substitute products or servicesd. threat of new entrants

69. The most important point of Michael Porter’s analysis is that industry profitability is a function of the a. economy.b. interest-rate level.c. industry structure.d. industry beta.

70. With regard to the consistency of industry performance, choose the INCORRECT statement.a. industry analysis is clearly valuable over timeb. even over very short periods, such as one month, industries can perform very

differently.c. industry rankings on a periodic basis such as yearly or quarterly are consistentd. investors cannot choose those industries that have performed well recently and

reliably expect them to continue to do so for the next several periods

71. An industry which is least affected by recessions and economic adversity is a(n)a. growth industry.b. defensive industry.c. cyclical industry.d. aggressive industry.

72. In which source of industry information can you find a ranking of industries in terms of timeliness?a. Forbesb. Value Line Investment Surveyc. Standard and Poor’s Industry Surveyd. Robert Morris Associates’ Annual Studies

73. Investors who are interested primarily in capital gains should avoid industries that are in the __stage because they have ______.a. stabilization stage; low dividend payoutsb. stabilization stage; high dividend payouts and low growth prospectsc. pioneering; low dividend payoutsd. expansion stage; high risk

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74. Under fundamental analysis, a security is considered attractive for purchase if its computed intrinsic value isa. less than its current price.b. greater than its current price.c. less than its book value.d. greater than its book value.

75. A stock’s intrinsic value isa. The estimated present value of the future stream of cash flows for the stockb. The same as its market pricec. The sum of all dividends expected to be paid from now to infinityd. Based on the accounting value of the assets

76. The cash flow statement is designed to track the flow of cash through the firm and consists of three parts. Which of the following is not one of the designated parts?a. cash from operating activitiesb. cash from spending activitiesc. cash from financing activitiesd. cash from investing activities

77. ROA a. Is usually equal to or greater than ROE.b. Is calculated using book value and turnover.c. Is calculated using leverage and book value.d. Is calculated using net income margin and turnover.

Given the following, answer the next two questions: operating efficiency = 0.1net income = $50,000,000; net income margin = 0.15turnover = 2; leverage = 1.5; retention rate = 0.3

78. Find ROAa. 0.30b. 0.10c. 0.15d. 0.225

79. Find ROE a. .225b. .3375c. .15d. .45

80. If a firm’s ROA and ROE are equal, it can be concluded that the firm isa. losing money.b. liquid enough to pay some extra dividends.c. financed by all equity.d. financed by a high proportion of debt

81. The two components of EPS area. ROA and leverageb. book value and leveragec. ROE and book valued. leverage and profit margin

82. Assume ROA is 18.45%, the leverage factor is 2.278, and the BV ps is $3.41. The EPS will bea. $.63b. $1.43c. $.42d. none of the above

83. Bilbro Co., has a book value of $10, pays a current dividend of $1, has an ROE of .10, an ROA of .05, a leverage ratio of 2, and a profit margin of 15%. Its EPS area. $3b. $2c. $1.50d. none of the above

84. Calculate the expected growth rate, g, of a firm which has a current dividend of $1.50 and a ROE of 20%.a. 20%b. 10%c. 40%d. answer cannot be calculated from this information.

85. The internal growth rate of a firm, g, can be calculated as the product ofa. the retention rate and ROA.b. the dividend payout ratio and leverage.c. the retention rate and the return on equity.d. the payout ratio and the return on equity.

86. Which of the following statements about company analysis is INCORRECT?a. g = ROE x ( 1 – payout ratio)b. what matters is the future expected growth rate, not the actual historical growth

ratec. leverage = stockholders’ equity / total assetsd. EBIT / Sales is a measure of the pretax, preinterest profit margin

87. When estimating the internal growth rate for a company,a. what matters is the future growth rateb. g = b x ROAc. it is best to estimate the internal growth rate on the basis of one year’s resultsd. empirical evidence clearly indicates that earnings trends persist.

88. Which of the following statements is INCORRECT?a. turnover is a measure of efficiencyb. leverage measures how the firm finances its assetsc. EPS is solely a function of ROEd. ROA is a fundamental measure of firm profitability

89. You are considering a stock with a current market price of $20. The stock's last dividend was $2.00, and earnings and dividends are expected to increase at a constant growth rate of 10 percent. Your required return on this stock is 20 percent. From the standpoint of making a valuation decision, you should:a. Not buy the stock; it is overvalued by $3.00.b. Buy the stock; it is undervalued by $3.00.c. Buy the stock; it is undervalued by $2.00.d. Not buy the stock; it is overvalued by $3.00.

90. With regard to the class discussion about earnings, we can conclude:a. GAAP generally produces the highest EPS figure of the alternatives usedb. Each company can use its own rules in producing Operating Earnings numbersc. Pro forma earnings numbers are typically less favorable to a company than the

earnings number produced under GAAPd. Investors can have confidence in comparing pro forma EPS numbers among

companies

91. Stock prices tend to ___________ earnings surprises.a. leadb. lag behindc. be coincident withd. be independent of

92. Given the SUE's of 4 different stocks, which has the greatest unexpected earnings?a. -3.5b. -2.5c. 2.0d. 3.0

93. Other things equal, concerning k, the discount rate for stocks, we can saya. as k rises, the P/E ratio risesb. if the risk premium rises, k will fallc. if the risk-free rate rises, k will rised. discount rates and P/E ratios move directly with each other

94. Select the INCORRECT statement involving the required rate of returna. it equals the risk-free rate plus the risk premiumb. ex ante, it must slope upwardc. the overall level of required rates of return changes as the risk premiums changed. it is the maximum expected rate of return needed to induce an investor to

purchase a security.

95. Other things equal, concerning the P/E ratio, we can say that ifa. required rate of return increases, the P/E ratio will rise.b. risk premium increases, the P/E ratio will rise.c. risk-free rate rises, the P/E ratio will fall.d. dividend payout increases, the P/E ratio will fall.

96. How would you explain P/E ratio differences among companies? By investora. expectations about the future growth of the market.b. estimates of the recent growth of earnings.c. expectations about the future growth of earnings.d. estimates about the recent growth of dividends.

97. High P/E stocks are generally associated witha. mature companies.b. cyclical companies.c. young fast-growing companies.d. defensive companies.

98. A P/E ratio a. can only be calculated based on the prior 12-month earningsb. can be calculated using prior earnings or estimated earningsc. for the market as a whole is not likely to change much from one year to the nextd. can be calculated for every company every year

99. When considering the determinants of the P/E ratio,

a. the higher the expected payout ratio, the higher the P/E ratio, other things equal.b. P/E and g are inversely related.c. the relationship between k and the P/E ratio is direct.d. as k declines, the P/E ratio declines.

100. Wibex is expected to earn $4.00 next year, and pay $2.00 per share in dividends. The expected growth rate in dividends is 6% and required rate of return is 16%. Calculate the P/E ratio.a. 6b. 10c. 50d. 5