Question 1

Gonzales Corporation generated free cash flow of $86 million this year. For the next two years, the company's free cash flow is expected to grow at a rate of 10%. After that time, the company's free cash flow is expected to level off to the industry long-term growth rate of 4% per year. If the weighted average cost of capital is 11% and Gonzales Corporation has cash of $100 million, debt of $275 million, and 100 million shares outstanding, what is Gonzales Corporation's expected current share price?

Accepted Answer

A)   $14.37
B)   $11.87
C)   $12.49
D)   $16.24 C

Question 2

Which of the following statements is FALSE?

Accepted Answer

A)   Even two firms in the same industry selling the same types of products, while similar in many respects, are likely to be of different size or scale.
B)   In the method of comparables, we estimate the value of a firm based on the value of other, comparable firms or investments that we expect will generate very similar cash flows in the future.
C)   Consider the case of a new firm that is identical to an existing publicly traded company. If these firms will generate identical cash flows, the Law of One Price implies that we can use the value of the existing company to determine the value of the new firm.
D)   A valuation multiple is a ratio of some measure of a firm's scale to the value of the firm. D

Question 3

In the method of comparables, the known values of a firm's cash flows are used to estimate the unknown cash flows of a similar firm.

Accepted Answer

A) True 
 B)False  True

Question 4

Which of the following is NOT an advantage of the valuation multiple method as compared to the discounted cash flow method?

Accepted Answer

A)   calculations based upon widely available information
B)   based upon actual stock prices of real firms
C)   does not rely on estimates of future cash flows
D)   takes into account important differences between different firms

Question 5

If you want to value a firm that consistently pays out its earnings as dividends, the simplest model for you to use is the ________.

Accepted Answer

A)   enterprise value model
B)   method of comparables
C)   dividend-discount model
D)   discounted free cash flow model

Question 6

A study of trading behavior of individual investors at a discount brokerage found that individual investors ________.

Accepted Answer

A)   trade very actively, despite the fact that their performance is actually worse because of trading costs
B)   trade very conservatively, despite the fact that their performance is actually worse because of trading costs
C)   trade very actively, partly because their performance is better than the professionals' due to low trading costs
D)   trade very conservatively, partly because their performance is better than the professionals' due to low trading costs

Question 7

Praetorian Industries will pay a dividend of $2.50 per share this year and has an equity cost of capital of 8%. Praetorian's stock is currently trading at $84 per share. By comparing Praetorian with similar firms, an investor expects that its dividends will grow by up to 5% per year. What is the best next step that the investor should take regarding Praetorian's stock?

Accepted Answer

A)   Sell any Praetorian stock that she owns.
B)   Short Praetorian's stock.
C)   Revise Praetorian's equity cost of capital.
D)   Revise her estimate of Praetorian's dividend growth.

Question 8

Which of the following is the appropriate way to calculate the price of a share of a given company using the free cash flow valuation model?

Accepted Answer

A)   P0 = Div1/(rE - g) 
B)   P0 = PV(Future Free Cash Flow of Firm)  / (Shares Outstanding0) 
C)   P0 = [Div1 / (rE - g) ] / (Shares Outstanding0) 
D)   P0 = (V0 + Cash0 - Debt0)  / (Shares Outstanding0)

Question 9

What are the implications of the efficient markets hypothesis for corporate managers regarding accounting earnings?

Accepted Answer

The answer of What are the implications of the efficient...

Question 10

Gonzales Corporation generated free cash flow of $81 million this year. For the next two years, the company's free cash flow is expected to grow at a rate of 9%. After that time, the company's free cash flow is expected to level off to the industry long-term growth rate of 4% per year. If the weighted average cost of capital is 11% and Gonzales Corporation has cash of $100 million, debt of $300 million, and 100 million shares outstanding, what is Gonzales Corporation's expected free cash flow in year 2?

Accepted Answer

A)   $1429.79 million
B)   $86.61 million
C)   $1572.77 million
D)   $96.24 million

Question 11

In an efficient market, investors will only find positive-NPV trading opportunities if they have some form of competitive advantage over other investors.

Accepted Answer

A) True 
 B)False

Question 12

Carbondale Oil announces that a well that it has sunk in a new oil province has shown the existence of substantial oil reserves. The exploitation of these reserves is expected to increase Carbondale's free cash flow by $100 million per year for eight years. If investors had not been expecting this news, what is the most likely effect on Carbondale's stock price upon the announcement, given that Carbondale has 80 million shares outstanding, no debt, and an equity cost of capital of 11%?

Accepted Answer

A)   no effect
B)   rise by $5.15
C)   rise by $6.43
D)   rise by $7.72

Question 13

On a particular date, FedEx has a stock price of $89.27 and an EPS of $7.11. Its competitor, UPS, had an EPS of $0.38. What would be the expected price of UPS stock on this date, if estimated using the method of comparables?

Accepted Answer

A)   $4.77
B)   $7.16
C)   $9.54
D)   $10.50

Question 14

Use the table for the question(s) below.
 
-The table above shows the stock prices and multiples for a number of firms in the newspaper publishing industry. Another newspaper publishing firm (not shown) had sales of $640 million, EBITDA of $84 million, excess cash of $67 million, $14 million of debt, and 120 million shares outstanding. If the average enterprise value to sales for comparable businesses is used, which of the following is the range of reasonable share price estimates?

Accepted Answer

A)   $6.27 to $8.86
B)   $4.59 to $12.23
C)   $1.15 to $1.53
D)   $6.19 to $9.32

Question 15

Which of the following statements is FALSE?

Accepted Answer

A)   The most common valuation multiple is the price-earnings ratio.
B)   You should be willing to pay proportionally more for a stock with lower current earnings.
C)   A firm's price-earnings ratio is equal to the share price divided by its earnings per share.
D)   The intuition behind the use of the price-earnings ratio is that when you buy a stock, you are in a sense buying the rights to the firm's future earnings, and differences in the scale of firms' earnings are likely to persist.

Question 16

On a particular day, a mining company reveals that, due to new extraction technology, the extractable yield from several of its nickel/lead mines has risen by 15%. Which of the following is the LEAST likely consequence of such an announcement?

Accepted Answer

A)   The price of the stock would rise.
B)   Investors would determine that the estimates of the firm's value on the date prior to the announcement were too high.
C)   Investors would increase their forecast of future cash flows in that firm.
D)   Investors would revise their estimates of the net present value (NPV)  of the firm.

Question 17

Which of the following should be done by a manager wishing to raise his stock's price? I. Focus on maximizing the present value (PV) of the free cash flow.

Accepted Answer

A)   I only
B)   II only
C)   I and II
D)   II and II

Question 18

If you value a stock using a range of stock valuation methods and these valuations indicate a stock price that is greater than its actual market price, it is most likely that the stock is under-valued.

Accepted Answer

A) True 
 B)False

Question 19

Use the table for the question(s) below.
 
-The table above shows the stock prices and multiples for a number of firms in the newspaper publishing industry. Another newspaper publishing firm (not shown) had sales of $620 million, EBITDA of $81 million, excess cash of $62 million, $11 million of debt, and 120 million shares outstanding. If the firm had an EPS of $0.41, what is the difference between the estimated share price of this firm if the average price-earnings ratio is used and the estimated share price if the average enterprise value/EBITDA ratio is used?

Accepted Answer

A)   -$0.08
B)   -$0.13
C)   -$1.27
D)   -$1.39

Question 20

Which of the following statements is FALSE?

Accepted Answer

A)   A firm's weighted average cost of capital, denoted rwacc, is the cost of capital that reflects the risk of the overall business, which is the combined risk of the firm's equity and debt.
B)   Intuitively, the difference between the discounted free cash flow model and the dividend-discount model is that in the divided-discount model, a firm's cash and debt are included indirectly through the effect of interest income and expenses on earnings in the dividend-discount model.
C)   We interpret rwacc as the expected return a firm must pay to investors to compensate them for the risk of holding the firm's debt and equity together.
D)   When using the discounted free cash flow model, we should use a firm's equity cost of capital.

Exam 10: Stock Valuation: a Second Look

Which of the following statements is FALSE?

In the method of comparables, the known values of a firm's cash flows are used to estimate the unknown cash flows of a similar firm.

Which of the following is NOT an advantage of the valuation multiple method as compared to the discounted cash flow method?

If you want to value a firm that consistently pays out its earnings as dividends, the simplest model for you to use is the ________.

A study of trading behavior of individual investors at a discount brokerage found that individual investors ________.

Which of the following is the appropriate way to calculate the price of a share of a given company using the free cash flow valuation model?

What are the implications of the efficient markets hypothesis for corporate managers regarding accounting earnings?

In an efficient market, investors will only find positive-NPV trading opportunities if they have some form of competitive advantage over other investors.

On a particular date, FedEx has a stock price of $89.27 and an EPS of $7.11. Its competitor, UPS, had an EPS of $0.38. What would be the expected price of UPS stock on this date, if estimated using the method of comparables?

Which of the following statements is FALSE?

On a particular day, a mining company reveals that, due to new extraction technology, the extractable yield from several of its nickel/lead mines has risen by 15%. Which of the following is the LEAST likely consequence of such an announcement?

Which of the following should be done by a manager wishing to raise his stock's price? I. Focus on maximizing the present value (PV) of the free cash flow.

If you value a stock using a range of stock valuation methods and these valuations indicate a stock price that is greater than its actual market price, it is most likely that the stock is under-valued.

Which of the following statements is FALSE?