Chapter 11—Stock Valuation and Risk

1.The price-earnings valuation method applies the ____ price-earnings ratio to ____ earnings per share in order to value the firm’s stock.

a. firm’s; industry

b. firm’s; firm’s

c. average industry; industry

d. average industry; firm’s

ANS: D PTS: 1 DIF: Easy OBJ: FMAI.MADU.15.11.01

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Knowledge

2.A firm is expected to generate earnings of $2.22 per share next year. The mean ratio of share price to expected earnings of competitors in the same industry is 15. Based on this information, the valuation of the firm’s shares based on the price-earnings (PE) method is

a. $2.22.

b. $6.76.

c. $33.30.

d. none of the above

ANS: C PTS: 1 DIF: Moderate OBJ: FMAI.MADU.15.11.01

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Application

3.The PE method to stock valuation may result in an inaccurate valuation for a firm if errors are made in forecasting the firm’s future earnings or in choosing the industry composite used to derive the PE ratio.

a. True

b. False

ANS: T PTS: 1 DIF: Easy OBJ: FMAI.MADU.15.11.01

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY: Bloom’s: Comprehension

4.Bolwork Inc. is expected to pay a dividend of $5 per share next year. Bolwork’s dividends are expected to grow by 3 percent annually. The required rate of return for Bolwork stock is 15 percent. Based on the dividend discount model, a fair value for Bolwork stock is $____ per share.

a. 33.33

b. 166.67

c. 41.67

d. 60.00

ANS: C PTS: 1 DIF: Moderate OBJ: FMAI.MADU.15.11.01

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Application

5.Protsky Inc. just paid a dividend of $2.20 per share. The dividend growth rate for Protsky’s dividends is 3 percent per year. If the required rate of return on Protsky stock is 12 percent, the stock should be valued at $____ per share according to the dividend discount model.

a. 24.44

b. 25.18

c. 18.88

d. 75.53

ANS: B PTS: 1 DIF: Moderate OBJ: FMAI.MADU.15.11.01

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Application

6.The limitations of the dividend discount model are more pronounced when valuing stocks

a. that pay most of their earnings as dividends.

b. that retain most of their earnings.

c. that have a long history of dividends.

d. that have constant earnings growth.

ANS: B PTS: 1 DIF: Moderate OBJ: FMAI.MADU.15.11.01

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Knowledge

7.Vansel Inc. retains most of its earnings. The company currently has earnings per share of $11. Vansel expects its earnings to grow at a constant rate of 2 percent per year. Furthermore, the average PE ratio of all other firms in Vansel’s industry is 12. Vansel is expected to pay dividends per share of $3.50 during each of the next three years. If investors require a 10 percent rate of return on Vansel stock, a fair price for Vansel stock today is $____.

a. 113.95

b. 111.32

c. 105.25

d. none of the above

ANS: A PTS: 1 DIF: Challenging OBJ: FMAI.MADU.15.11.01

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Application

8.When evaluating stock performance, ____ measures variability that is systematically related to market returns; ____ measures total variability of a stock’s returns.

a. beta; standard deviation

b. standard deviation; beta

c. intercept; beta

d. beta; error term

ANS: A PTS: 1 DIF: Moderate OBJ: FMAI.MADU.15.11.02

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY: Bloom’s: Comprehension

9.The ____ is commonly used as a proxy for the risk-free rate in the Capital Asset Pricing Model.

a. Treasury bond rate

b. prime rate

c. discount rate

d. federal funds rate

ANS: A PTS: 1 DIF: Easy OBJ: FMAI.MADU.15.11.02

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Knowledge

10.A beta of 1.8 implies that the stock has a risk premium of 1.8%.

a. True

b. False

ANS: F PTS: 1 DIF: Easy OBJ: FMAI.MADU.15.11.02

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY: Bloom’s: Comprehension

11.Stock prices of U.S. firms primarily involved in exporting are likely to be ____ affected by a weak dollar and ____ affected by a strong dollar.

a. favorably; adversely

b. adversely; adversely

c. favorably; favorably

d. adversely; favorably

ANS: A PTS: 1 DIF: Easy OBJ: FMAI.MADU.15.11.03

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Knowledge

12.A weak dollar may enhance the value of a U.S. firm whose sales are dependent on the U.S. economy.

a. True

b. False

ANS: T PTS: 1 DIF: Easy OBJ: FMAI.MADU.15.11.03

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Knowledge

13.The January effect refers to the ____ pressure on ____ stocks in January of every year.

a. downward; large

b. upward; large

c. downward; small

d. upward; small

ANS: D PTS: 1 DIF: Moderate OBJ: FMAI.MADU.15.11.03

NAT: BUSPROG.FMAI.MADU.15.03 STA: DISC.FMAI.MADU.15.02

KEY:Bloom’s: Knowledge