Exam 11: Equity Analysis and Valuation

Which of the following is not a factor in producing earnings forecasts?

Which of the following is not a typical form of earnings management?

The SEC has issued "safe harbor" rules to encourage forecasts by registrants, but it has had limited success.

Which of the following factors is least likely to affect earnings persistence?

Pitfalls when forecasting earnings include failure to consider: I. capital adequacy. II. capacity constraints. III. anticipated return on equity. IV. new management.

If a company has a price-to-book ratio that is less than one, this implies that future expected return on equity is less than required return on equity.

Hupta Corporation Net income \ 6,000 Dividends \ 2,000 Total assets-12/31/05 \ 50,000 Total liabilities-12/31/05 \ 20,000 Number of shares outstanding 1,000 Cost of equity 10\% -Using the dividend discount model, assuming dividends grow at 10% in 2006 and at 5% thereafter, what is the value per share of Hupta at 12/31/05?

Which of the following is not included in the definition of earnings persistence?

Although interim financial reports are normally prepared using the same accounting methods as the annual financial reports they are generally less reliable, in part because of the increased use of estimates in the interim periods.

Management of earnings has been a newsworthy subject, above and beyond the business press. Analysts are forced to devote time and attention to ferreting out the real numbers, when the clues are available. Explain four kinds of earnings management, giving examples.

If a company has a low price-to-book ratio and a high price-to-earnings ratio, this is an indicator that the stock is most likely underpriced.

You are analyzing a stock. You expect that earnings will grow quickly relative to its current level, but the expected return on common stockholders' equity is low. Assuming price to be constant, what levels of the price-to-earnings ratio (PE) and the price-to-book ratio (PB) would you expect to see? PE Ratio PB Ratio A) Low Low B) Low High C) High High D) High Low

Which of the following statements concerning interim financial reports is incorrect?

When considering the determinants of the price-to-book ratio (PB) which of the following is correct? I. All other things being equal, the greater a company's return on common stockholders' equity, the greater the PB ratio. II. All other things being equal, the greater a company's cost of equity, the greater the PB ratio. III. If a company's return on common stockholders' equity equals its cost of equity, the PB ratio should equal 1. IV. The greater a company's current earnings the higher the PB ratio.

When assessing earnings persistence, it is important to analyze discretionary expenditures. Which of the following is correct? I. Research and development is generally considered a discretionary expenditure. II. Decreased discretionary expenditures should always be taken as a positive indicator that the company is getting costs under control. III. Advertising expenditures can be considered discretionary expenditures, which often have implications for future sales. IV. Absolute levels of discretionary expenditures are more important than the level of expenditures relative to sales.

Dominik Corporation is a fast growing company. They were the first to the market with state-of-the-art voice identification software. Earnings per share for 2005 were $2.08, and book value per share at the beginning of 2005 was $9.55. Dominik does not pay dividends nor is it expected to do so in the foreseeable future. Dominik's cost of equity is 12%. Analysts predict that earnings for 2006 and 2007 will be $3.22 and $3.90, respectively, and that earnings will grow at 19% per year for the following three years (2008-2010). The stock is currently trading at $35 per share, and analysts have set a target price of $50 by the end of 2006. Assuming that the analysts' earnings forecasts for the next five years are correct, and assuming that after the end of the next five years the competition will have driven Dominik's abnormal returns down to zero, what would your target price be for the end of 2006? What will the price-to-book and price-to-earnings ratios be at the end of 2006?

If a company has a return on equity that is lower than its cost of equity capital, it could be said to be destroying value.

Which of the following is least likely to affect analysis of earnings persistence?

When assessing earnings persistence, it is important to determine if there has been any earnings management.

The quality of earnings is a measure of the difference between this year's earnings and last year's earnings.