Exam Questions Valuing Shares Chapter 5 - Corporate Finance Asia Pacific 2e Complete Test Bank by Chris Adam. DOCX document preview.
Chapter 5 – Valuing shares
MULTIPLE CHOICE
1. The first public sale of company shares to outside investors is called a(n):
a. | seasoned equity offering |
b. | shareholders’ meeting |
c. | initial public offering |
d. | proxy fight |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
2. Which statement about ordinary shareholders is incorrect?
a. | Shareholders only have a residual claim. |
b. | Shareholders have precedence over all other claimholders in the case of bankruptcy. |
c. | Shareholders have voting rights. |
d. | Shareholders are the ultimate owners of a corporation. |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
3. What is the market capitalisation of a company?
a. | The market value of all outstanding debt |
b. | The book value of the company’s debt |
c. | The market value of all outstanding shares |
d. | The book value of the company’s total equity |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
4. Which of the following stock exchanges has the strictest listing requirements?
a. | American Stock Exchange |
b. | Australian Stock Exchange |
c. | New York Stock Exchange |
d. | Pacific Stock Exchange |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
5. Bavarian Sausage, Inc. has preferred shares outstanding. These shares pay a semiannual dividend of $2.50. If the next dividend is paid six months from now and the annual required return is 10%, what should be the value of a preferred share?
a. | $6.25 |
b. | $25.00 |
c. | $12.50 |
d. | $50.00 |
2.50/(0.10/2) = 50
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
6. Bavarian Sausage, Inc. just paid a $2.00 dividend, and investors expect that dividend to grow by 6% each year forever. If the required return on the share investment is 14%, what should be the price of the share today?
a. | $11.21 |
b. | $18.32 |
c. | $17.44 |
d. | $26.50 |
2.00(1.06)/(0.14 – 0.06) = 26.50
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
7. Bavarian Sausage, Inc. is expected to pay a $2.00 dividend next year, and investors expect that dividend to grow by 6% each year forever. If the required return on the share investment is 12%, what should be the price of a share in five years?
a. | $18.32 |
b. | $42.28 |
c. | $44.52 |
d. | $17.44 |
D5 = 2.00(1.06)4 = 2.52
P5 = 2.52(1.06)/(0.12 – 0.06) = 44.52
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
8. Smith Construction, Inc. just paid a $3.78 dividend. The dividend is expected to grow by 5% each year for the next three years. After that, the company will never pay another dividend ever again. If your required return on the share investment is 10%, what should the share sell for today?
a. | $7.46 |
b. | $28.91 |
c. | $46.33 |
d. | $10.34 |
D1 = 3.78(1.05) = 3.97
D2 = 3.97(1.05) = 4.17
D3 = 4.17(1.05) = 4.37
P = 3.97/1.1 + 4.17/1.12 + 4.37/1.13 = 10.34
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
9. Miller Juice, Inc. is not paying a dividend right now, but it is expected to pay a $5.46 dividend two years from now. Investors expect that dividend to grow by 2% every year forever. If the required return on the share investment is 12%, what should be the price of a Miller Juice share today?
a. | $53.69 |
b. | $36.49 |
c. | $48.75 |
d. | $43.84 |
P2 = 5.46(1.02)/(0.12 – 0.02) = 55.69
P = (5.46 + 55.69)/1.122 = 48.75
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
10. Miller Juice, Inc. is expected to pay a $2 dividend next year and a $3 dividend in two years. After that, dividends are expected to grow at 4% forever. If investors require a return of 10% on the investment, what should a Miller Juice share sell for today?
a. | $60.00 |
b. | $47.26 |
c. | $49.39 |
d. | $53.70 |
P2 = 3(1.04)/(0.10 – 0.04) = 52
P = 2/1.10 + (52 + 3)/1.102 = 47.26
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
11. Miller Juice, Inc. traditionally pays out 22% of its earnings as dividends. Last year, Miller’s available earnings for ordinary shareholders were $186 million and the book value of its equity was $544 million. What is Miller’s growth rate?
a. | 24.54% |
b. | 35.00% |
c. | 26.67% |
d. | 13.22% |
(256/678)(1 – 0.35) = 0.2667
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
12. Miller Juice, Inc. traditionally retains 42% of its earnings for future investments. Last year Miller’s return on equity was 12%. What is Miller’s growth rate?
a. | 15.00% |
b. | 9.75% |
c. | 5.04% |
d. | 18.38% |
0.12(0.42) = 0.0504
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
13. Bavarian Sausage’s free cash flow for the current year is $4 580 000, and investors believe that the company’s free cash flow will grow by 4% annually forever. If Bavarian Sausage’s weighted average cost of capital is 12%, what is its enterprise value?
a. | $67 500 000 |
b. | $85 350 000 |
c. | $56 780 000 |
d. | $59 540 000 |
4 580 000(1.04)/(0.12 – 0.04) = 59 540 000
PTS: 1 DIF: E
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
14. Bavarian Sausage, Inc.’s enterprise value is $64 000 000, the market value of its debt is $18 000 000 and the company does not have any preferred shares outstanding. If the company has3 000 000 shares outstanding, what should be Bavarian Sausage’s share price?
a. | $21.43 |
b. | $15.34 |
c. | $28.00 |
d. | $6.57 |
(64 000 000 – 18 000 000)/3 000 0000 = 15.34
PTS: 1 DIF: E
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
15. Bavarian Sausage, Inc. is expected to pay a $1.38 dividend next year. If the required return on the share investment is 12% and a share currently sells for $25.44, what is the implied dividend growth rate for this company?
a. | 6.37% |
b. | 9.43% |
c. | 6.57% |
d. | 15.76% |
25.44 = 1.38/(0.12 – g)
g = 0.0657
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
Use the following information to answer questions 16 to 18.
Miller Juice is a young company that currently does not pay a dividend. The company retains all its earnings to finance its growth. However, 10 years from now the company is expected to start paying a $1.50 dividend. According to research reports, the dividend should then grow by 5% annually forever.
16. If the required return on the share investment is 15%, what should be Miller’s share price today?
a. | $19.69 |
b. | $6.24 |
c. | $3.89 |
d. | $10.37 |
P10 = 1.5(1.05)/(0.15 – 0.05) = 15.75P = (1.5 + 15.75)/(1.15)10 = 3.89
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
17. If the required return on the share investment is 15%, what should be Miller’s share price five years from today?
a. | $11.50 |
b. | $6.24 |
c. | $8.57 |
d. | $16.28 |
P10 = 1.50(1.05)/(0.15 – 0.05) = 15.75
P5 = (1.5 + 15.75)/(1.15)5 = 8.57
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
18. If the required return on the share investment is 15%, what should be Miller’s share price immediately after the first dividend is paid?
a. | $6.24 |
b. | $19.69 |
c. | $16.28 |
d. | $15.75 |
P10 = 1.50(1.05)/(0.15 – 0.05) = 15.75
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
19. Which of the following investors can force a company into bankruptcy court if the company does not pay the expected cash flow to investors?
a. | Ordinary equity investor |
b. | Preferred equity investor |
c. | Debt investor |
d. | Venture capital investor |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
20. Which of the following securities poses the greatest financial risk for the investor?
a. | Ordinary equity |
b. | Preferred equity |
c. | Debt |
d. | Convertible debt |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: acquire an understanding of risk and return
21. MeFirst Corporation has a cumulative preferred share issue that is supposed to pay a quarterly dividend of $2. MeFirst failed to pay three consecutive dividends to investors and then managed to pay an ordinary share dividend the very next quarter. How much cash must MeFirst pay to each preferred shareholder?
a. | $2 per share |
b. | $6 per share |
c. | $8 per share |
d. | $10 per share |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
22. Retained earnings represent:
a. | a pool of cash that a company can use should a need for cash arise |
b. | the increased market value, due to management’s efforts, of all of a company’s equity securities issued |
c. | earnings that a company reinvested during the company’s history |
d. | the cumulative amount of cash that a company has paid out in dividends |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
23. Which of the following is not the responsibility of the lead underwriter for an equity issuance?
a. | To stabilise the price of the issue |
b. | To exercise discretion over the distribution of shares for sale among the syndicate and the selling group |
c. | To buy shares in the green-shoe option |
d. | Often, to serve as the market maker for trading in the issuers securities |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
24. Which of the following is not an important consideration when an underwriter is trying to establish the price for an initial public offering?
a. | The underwriter’s reputation |
b. | The value of the company |
c. | The demand for the securities of the issuer |
d. | Providing the absolute maximum price possible for the issuer of the shares |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
25. The vast majority of initial public offerings have underwriting spreads that cost the company what percentage of the net capital raised?
a. | 0.5% |
b. | 7.0% |
c. | 7.5% |
d. | 8.0% |
The company will net $93 out of each $100 raised. Therefore, the cost to the company is 7/93 = 0.075
PTS: 1 DIF: H
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
26. The largest stock exchange in the world is:
a. | the London Stock Exchange |
b. | the New York Stock Exchange |
c. | the NASDAQ |
d. | the Paris Bourse |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
27. If viewing a share quote from the Wall Street Journal, the columns labelled ‘HI’ and ‘LO’ refer to:
a. | the highest and lowest prices at which the share was sold in the last 52 weeks |
b. | the highest and lowest prices at which the share was sold in the last six months |
c. | the highest and lowest prices at which the share was sold in the last month |
d. | the highest and lowest prices at which the share was purchased in the last month |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
28. When valuing a preferred share, the type of security that we treat the preferred share like, for valuation purposes, is:
a. | a bond |
b. | a perpetuity |
c. | an ordinary share |
d. | an annuity |
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Reflective thinking
LOC: understand shares and bonds
29. AlwaysAround Co. has just issued a preferred share that pays an annual $4 dividend. The first dividend will be received one year from today. If the required rate of return on this share is 5%, then what is the price of the share?
a. | $3.81 |
b. | $4.20 |
c. | $80.00 |
d. | $50.50 |
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
30. The Perp, Inc. has a preferred share that will pay its next annual $6 dividend one year from now. The current price of the share is $120. What is the required rate of return on the share?
a. | 4.55% |
b. | 4.00% |
c. | 5.00% |
d. | 22.00% |
120 = 6/r ===> r = 0.05
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
31. You are approached about purchasing an ordinary share in a company that will definitely go out of business exactly two years from today. The company is anticipated to pay a $810 dividend one year from now and a $105 dividend two years from now (immediately before it goes out of business). What price are you willing to pay for the share if the required rate of return on it is 6%?
a. | $14.35 |
b. | $17.13 |
c. | $16.45 |
d. | $25.00 |
8/1.06 + 10/(1.06)2 = 16.45
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
32. Static Utility Company anticipates its revenues, and consequently its ordinary share dividends, will remain flat forever. It currently pays an annual dividend of $18 per year. If it pays the next dividend exactly one year from today, then what is the price of Static’s ordinary shares if the required rate of return is 11%?
a. | $24.00 |
b. | $40.00 |
c. | $163.64 |
d. | $200.00 |
18/0.11 = 163.64
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
33. ConsGrough, Inc. has increased its annual ordinary dividend by 4% in each of the years that the company has existed. If you believe that the company can continue to do so indefinitely, then what price would you be willing to pay for ConsGrough if the required rate of return is 7% and the dividend that it paid yesterday was $6?
a. | $85.83 |
b. | $166.67 |
c. | $171.67 |
d. | 208.00 |
(6 × 1.04)/(0.07 – 0.04)
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
34. ConsGrough, Inc. has increased its annual ordinary dividend by 4% in each of the years that the company has existed. If you believe that the company can continue to do so indefinitely, then what is the required rate of return if the price of ConsGrough is $208.00 and the dividend that it paid yesterday was $6?
a. | 0.029 |
b. | 0.03 |
c. | 0.06 |
d. | 0.07 |
208 = (6 × 1.04)/(r – 0.04) ===> r = 0.07
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
35. Predictable Corp. has increased its annual dividend each year of its life by 2% and will continue to do so indefinitely. If Predictable paid its annual dividend yesterday of $8 and the cost of capital is currently 4%, then by what amount will the share price decrease if the cost of capital increases to 5%?
a. | $408.00 |
b. | $272.00 |
c. | $136.00 |
d. | $350.00 |
Now: (8 × 1.02)/(0.04 – 0.02) = 408.00
Later: (8 × 1.02)/(0.05 – 0.02) = 272.00
Decrease = 408 – 272 = 136
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
36. You are asked by the chief financial officer of your company to predict what the company’s share price will be exactly four years from today. If your company is expected to grow at 3% indefinitely, the cost of capital is 10% and the expected annual dividend one year from today is $10, then what should be the price of a share four years from today?
a. | $142.86 |
b. | $160.79 |
c. | $112.55 |
d. | $150.67 |
P4 = [D1 × (1 + g)4]/(r – g)
P4 = [10 × (1.03)4]/(0.1 – 0.03) = 160.79
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
37. Last year Sample Corp. had earnings of $3 a share based upon an ordinary share book value of $25 per share. If Sample paid a dividend of $1.50 last year, then estimate Sample’s growth rate.
a. | 6% |
b. | 12% |
c. | 50% |
d. | 21% |
g = rr × ROE = (1.5/3) × (3/25) = 0.06
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
38. Balance Corp. has a weighted average cost of capital equal to 5.5%. If the company is financed with 25% equity and 75% debt and if the after-tax of that debt is 4%, then what is the cost of equity for the company?
a. | 0.025 |
b. | 0.06 |
c. | 0.1 |
d. | 0.01 |
(0.25)(Cost of equity) + (0.75)(0.04) = 0.055 ===> Cost of equity = 0.1
PTS: 1 DIF: M
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
39. Borrower Corp. has the ability to produce $4 000 000 of free cash flow next year and expects that to grow by 2% per year thereafter. If Borrower’s weighted average cost of capital is 13%, then what is the value of Borrower?
a. | $40 000 000.00 |
b. | $30 769 230.77 |
c. | $36 363 636.36 |
d. | $20 000 000.00 |
4 000 000/(0.13 – 0.02) = 36 363 636.36
PTS: 1 DIF: M
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
40. Equal, Inc. is financed with equal portions of debt and equity. The after-tax cost of debt is 6% and the cost of equity is 8%. If Equal expects next year’s free cash flow to be $25 000 000 with growth of 3% thereafter, what is the value of Equal, Inc. to the nearest dollar? Equal’s marginal tax rate is 35%.
a. | $357 142 857 |
b. | $625 000 000 |
c. | $833 333 333 |
d. | $500 000 000 |
WACC = (0.5)(0.08) + (0.5)(0.06) = 0.07
Value = 25 000 000/(0.07 – 0.03) = 625 000 000
PTS: 1 DIF: M
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
41. Undetermined Corporation currently has a 10% weighted average cost of capital. It is concerned that its after-tax cost of debt will increase in the near future by 2%. If Undetermined finances its projects with 30% debt, then what will the new weighted average cost of capital for Undetermined be?
a. | 12.0% |
b. | 13.0% |
c. | 10.6% |
d. | 11.6% |
0.10 + (0.3)(0.02) = 0.106
PTS: 1 DIF: M
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of capital budgeting and the cost of capital
42. Which is true concerning preferred shares?
a. | Preferred shares are considered debt on the company balance sheet. |
b. | Preferred shareholders have voting rights for the company board of directors. |
c. | Preferred share payments are variable like ordinary share payments. |
d. | Preferred shares are viewed as less risky than a company’s ordinary shares. |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
Use the following information to answer questions 43 and 44.
Kramerica, Inc. just paid its investors a dividend of $2. This growing company expects dividends to grow at 20% for the next two years. After year 2, dividends are expected to grow constantly at 5% per year. Investors require a 15% return on Kramerica share.
43. What will be the dividend in two years for Kramerica?
a. | $2.21 |
b. | $2.40 |
c. | $2.52 |
d. | $2.88 |
Dividend in year 2 = 2.00 × 1.20 × 1.20 = 2.88
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
44. What is the equation to price a share of Kramerica?
a. | P0  |
b. | P0  |
c. | P0  |
d. | P0  |
Selling price at year 2 = 2.00 × (1.20)2 × (1.05)/(0.15 – 0.05) = 30.24
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Reflective thinking
LOC: understand shares and bonds
Use the following information to answer questions 45 to 47.
ABC Corporation just paid a dividend of $1.50 a share. The dividend is expected to grow at 10% a year for the next two years and then 5% per year thereafter. The required return to invest in ABC share is 12.50%.
45. What is the expected dividend for ABC in year 2?
a. | $1.65 |
b. | $1.73 |
c. | $1.82 |
d. | $1.91 |
Dividend in year 2 = 1.50 × 1.10 × 1.10 = 1.82
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
46. What is the current price (or intrinsic value) of ABC?
a. | $21.00 |
b. | $22.98 |
c. | $23.41 |
d. | $24.48 |
Dividend in year 2 = 1.50 × 1.10 × 1.10 = 1.82
Selling price at year 2 = 1.82 × 1.05/(0.125 – 0.05) = 25.41
Price = PV of cash flows = 1.65/1.125 + (1.82 + 25.41)/(1.125)2
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
47. Suppose you want to buy ABC and hold it for the next four years. What would the selling price be for ABC in four years, assuming that none of our assumptions change?
a. | $28.01 |
b. | $28.76 |
c. | $29.40 |
d. | $30.80 |
Dividend in year 2 = 1.50 × 1.10 × 1.10 = 1.82
Dividend in year 4 = 1.50 × 1.10 × 1.10 × 1.05 × 1.05 = 2.00
Selling price at year 4 = 2.00 × 1.05/(0.125 – 0.05) = 28.01
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
48. A share just paid a $2 dividend this morning. You believe that dividends will grow constantly starting today at a rate of 5% per year. If you require a 10% return to own this share, what is a fair price to pay for the share?
a. | $40.00 |
b. | $41.00 |
c. | $42.00 |
d. | $43.00 |
2 × 1.05/(0.1 – 0.05) = 42.00
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
49. Suppose that you estimate D1=$0.72, D2=$0.76, D3=$0.84 and D4=$0.88 for a share. You also estimate that, beginning in year 4, dividends will grow continually at a rate of 2% per year. If the required return to hold the share is 14.6%, what is the share’s current price?
a. | $6.20 |
b. | $6.25 |
c. | $6.30 |
d. | $6.40 |
Selling price at year 4 = 0.88 × 1.02/(0.146 – 0.02) = $7.12
Price = 0.72/1.146 + 0.76/(1.146)2 + 0.84/(1.146)3 + 8.00/(1.146)4
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
50. Suppose you plan on buying a share today and holding it for one year. The share will pay you a dividend in exactly one year, on the day you will sell. You believe the selling price in one year will be $27.10. The share will also pay a dividend of $2.40 in one year. If you require 16.60% return to invest in the share, what is a fair price to pay today?
a. | $25.50 |
b. | $25.30 |
c. | $23.24 |
d. | $21.18 |
Price = (27.10 + 2.40)/(1.166) = 25.30
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
Use the following information to answer questions 51 and 52.
An analyst seeks to determine the value of Bulldog Industries. After careful research, the analyst believes that free cash flows for the company will be $80 million in 2017 and will grow at 10% for 2018 and 2019. The free cash flows will grow at a rate of 5% after 2019.
51. If Bulldog Industries has a weighted average cost of capital of 10%, what is the market value of the company? (Assume that it is 1 January 2017.)
a. | $2085.26 |
b. | $1946.52 |
c. | $1745.45 |
d. | $1665.45 |
FCF2013 = 80 × 1.10 = 88
FCF2014 = 88 × 1.10 = 96.80
Total value = 96.80 × 1.05/(0.1 – 0.05) = 2032.80
MV of company = 80/1.10 + 88/(1.10)2 + (96.80 + 2032.80)/(1.10)3 = 1745.45
PTS: 1 DIF: H
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
52. The market value of Bulldog Industries debt and preferred shares is $934 million. If the company has a weighted average cost of capital of 10%, what is the equity value of the company’s shares? The company has 50 million shares outstanding. (Assume that it is 1 January 2017.)
a. | $14.63 |
b. | $16.23 |
c. | $17.03 |
d. | $22.63 |
FCF2013 = 80 × 1.10 = 88
FCF2014 = 88 × 1.10 = 96.80
Total value = 96.80 × 1.05/(0.1 – 0.05) = 2032.80
MV of company = 80/1.10 + 88/(1.10)2 + (96.80 + 2032.80)/(1.10)3 = 1745.45
Equity value = 1745.45 – 934 = 811.45
Per share = 811.45/50 =16.23
PTS: 1 DIF: H
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
53. A company plans on paying a constant dividend of $2 per share into the foreseeable future. If investors seek a 12% return to hold the company’s share, what is fair value for one of the company’s shares?
a. | $13.67 |
b. | $15.67 |
c. | $16.67 |
d. | $18.67 |
2/0.12 = 16.67
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
54. Which of these is not a feature of ordinary shares?
a. | voting rights |
b. | priority over debt holders for liquidation rights |
c. | rights to dividends and other distributions |
d. | majority voting system |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
55. After careful research, you find the present value of the free cash flows of a company to be $100 million. The market value of the company’s preferred shares is $15 million, while the market value of the company’s debt is $40 million. If the company has 2 million shares outstanding, what is the equity value per share?
a. | $20.00 |
b. | $22.50 |
c. | $27.50 |
d. | $30.00 |
Equity value per share = (100 – 15 – 40)/2 = 22.50
PTS: 1 DIF: E
REF: 5.3 The Free Cash Flow Approach to Ordinary Share Valuation
NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
56. You estimate the following cash flows for Nick’s Incorporated: D1 = $0.83, D2 = $0.87, D3 = $0.96 and P3 = $27.40. If the required return to hold Nick’s share is 15.1%, what is the price today for one of Nick’s shares?
a. | $18.31 |
b. | $18.85 |
c. | $19.98 |
d. | $20.35 |
Price = 0.83/1.151 + 0.87/(1.151)2 + (0.96 + 27.40)/(1.151)3
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
57. What term refers to the number of shares issued by a company multiplied by the current price of the shares on the secondary market?
a. | Financial leverage |
b. | Market capitalisation |
c. | Additional paid-in capital |
d. | Liquidation value |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
58. An investor bought a share this morning for $50 and plans to sell the share one year from today. The investor believes the share will pay a $1 dividend during the next year and that the share can be sold for $53 in one year. Given the investor’s beliefs, what is the return from investing in this share for the next year?
a. | 4% |
b. | 6% |
c. | 8% |
d. | 10% |
Return = (53 – 50 + 1)/50
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: acquire an understanding of risk and return
59. A preferred share pays a $2 annual dividend, but it pays the dividend in four equal quarterly instalments. Investors seek a 12% annual percentage return on the investment. For what price should the preferred shares trade?
a. | $4.17 |
b. | $6.67 |
c. | $8.50 |
d. | $16.67 |
0.50/0.03 = 16.67
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
60. Stone Cold, Inc. reported net income of $10 million for 2014. In addition, shareholder equity for the company was $80 million at the end of 2014. The company was able to pay $3 million out as dividends to the shareholders for 2014. After 2014, excess paid-in capital was $60 million. Given this information, what is the growth rate available for Stone Cold?
a. | 3.75% |
b. | 5.00% |
c. | 7.50% |
d. | 8.75% |
ROE = 10/80 = 0.125
rr = 1 – (3/10) = 0.70
Growth = 0.7 × 0.125
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
61. For a share pricing model, an analyst selects 10% as the sustainable growth rate in dividends for a company. Given that the company pays out 40% of net income as dividends each year, what is the return on shareholder equity for this company?
a. | 2.50% |
b. | 4.00% |
c. | 10.00% |
d. | 16.67% |
g = 0.10
rr = 0.60
g = rr × ROE
ROE = 0.1/0.6
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
62. A share is expected to pay a dividend of $3.00 in one year. To purchase the share, investors seek a 15% annual return. If the share is currently trading at $60, what is the implied constant growth rate in dividends for the future?
a. | 5% |
b. | 10% |
c. | 15% |
d. | 20% |
60 = 3/(0.15 – g)
0.15 – g = 3/60
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic skills
LOC: understand shares and bonds
63. Shareholder voting rights include:
a. | voting on the amount of dividends the company will pay to current shareholders |
b. | voting as to whether the company should file for bankruptcy |
c. | voting for members on the board of directors |
d. | voting on whether the company will issue additional debt |
e. | voting on the frequency of dividends the company will pay to current shareholders |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
64. The decision as to whether a company will pay dividends is explicitly made by the:
a. | shareholders |
b. | bondholders |
c. | board of directors |
d. | chief financial officer |
e. | chief executive officer |
REF: 5.1 The Essential Features of Preferred and Ordinary Shares
NAT: Reflective thinking
LOC: understand shares and bonds
65. Which of the following activities is not one of the three principal lines of business for investment banks?
a. | Working capital management |
b. | Corporate finance |
c. | Trading |
d. | Asset management |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: understand the role of the finance function in the enterprise
66. One of the most time-consuming aspects of preparing for an equity offering is:
a. | preparing the necessary documents for filing with regulators |
b. | putting on the road show so that managers can pitch their business plan to prospective investors |
c. | oversubscribing the offering |
d. | paying dividends to shareholders |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
67. When evaluating the secondary market based upon how securities are traded, the market can be divided into two segments:
a. | a bull market and a bear market |
b. | a share market and a bond market |
c. | a primary market and a secondary market |
d. | a broker market and a dealer market |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
68. A dealer market is:
a. | when buyers and sellers contact each other directly to arrange an exchange of securities |
b. | a market in which the buyer and seller are not brought together directly but, rather, have their orders executed by securities dealers |
c. | a market in which buyers and sellers are brought together on a securities exchange to trade securities |
d. | when buyers contact the bank to exchange securities |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
69. A broker market is:
a. | when buyers and sellers contact each other directly to arrange an exchange of securities |
b. | a market in which the buyer and seller are not brought together directly but, rather, have their orders executed by securities dealers |
c. | a market in which buyers and sellers are brought together on a securities exchange to trade securities |
d. | when buyers contact the bank to exchange securities |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
70. The abbreviation used to identify a company when its share price is being quoted is called:
a. | a CUSIP |
b. | a ticker tape |
c. | a ticker symbol |
d. | a ticker type |
REF: 5.5 Primary and Secondary Markets for Equity Securities NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
71. For the zero growth model:
a. | because the valuation formula reduces to the equation for the present value of a perpetuity, the process is essentially the same for valuing preferred shares |
b. | because the valuation formula reduces to the equation for the future value of a perpetuity, the process is essentially the same for valuing preferred shares |
c. | because the valuation formula reduces to the equation for the present value of an ordinary annuity, the process is essentially the same for valuing preferred shares |
d. | because the valuation formula reduces to the equation for the future value of an ordinary annuity, the process is essentially the same for valuing preferred shares |
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Reflective thinking
LOC: understand shares and bonds
72. __________ represents the amount of cash that would remain if a company’s assets were sold and all liabilities were paid.
a. | Book value |
b. | Market value |
c. | Liquidation value |
d. | Present value |
e. | Future value |
REF: 5.4 Other Approaches to Ordinary Share Valuation NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
73. __________ represents the value of a company’s equity shown on its balance sheet.
a. | Book value |
b. | Market value |
c. | Liquidation value |
d. | Present value |
e. | Future value |
REF: 5.4 Other Approaches to Ordinary Share Valuation NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
74. Zeb Corporation just paid a dividend of $3.11 and has an expected growth rate of 12% for the foreseeable future. If the discount rate is 18%, what is the appropriate share price today?
a. | $58.05 |
b. | $51.83 |
c. | $57.87 |
d. | $55.06 |
g = 0.12
D0 = 3.11
D1 = 3.48
r = 0.18
P0= (r – g)
P0 = 58.05
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
75. Ajax Corporation just paid a dividend of $5.23 and has an expected growth rate of 5% for the foreseeable future. If the discount rate is 17%, what is the appropriate share price today?
a. | $49.20 |
b. | $51.34 |
c. | $50.48 |
d. | There is not enough information to answer the question. |
Divide by zero.
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
76. Declining Corporation just paid a dividend of $1.23 and has an expected growth rate of –5% for the foreseeable future. If the discount rate is 7%, what is the appropriate share price today?
a. | $ 9.74 |
b. | $10.25 |
c. | $9.67 |
d. | $11.43 |
g = –0.05
D0 = 1.23
D1 = 1.17
r = 0.07
P0 = D1/(r – g)
P0 = 9.74
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
77. Fading Away Corporation just paid a dividend of $1.23 and has an expected growth rate of –5% for the foreseeable future. If the discount rate is 7%, what is the appropriate share price today?
a. | $58.86 |
b. | $47.72 |
c. | $50.35 |
d. | $47.84 |
g = –0.05
D0 = 8.56
D1 = 8.13
r = 0.12
P0 =D1/(r – g)
P0 = 47.84
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
78. Beta Corp has an ROE of 15%, has just paid a dividend of $1.50 and pays 10% of its earnings out in dividends. The appropriate discount rate is 20%. What is the current share price?
a. | $7.50 |
b. | $26.19 |
c. | $11.35 |
d. | $31.43 |
g = ROE × rr
rr = 0.9
g = 0.135
D1 = 1.703
P0 = D1/(r – g)
P0 = 26.19
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
79. DDP Enterprises currently does not pay a dividend but plans to makes its first dividend payment of $1 in three years. If the expected growth rate is 10% per year once dividends commence and the appropriate is discount rate is 18%, what is the current share price today?
a. | $8.98 |
b. | $8.37 |
c. | $13.75 |
d. | $14.75 |
g = ROE × rr
rr = 1.00
g = 0.1000
D3 = 1.0000
D4 = 1.1000
P3 = 13.7500
P0 = PVP3 + PVD3
P0 = 8.9773
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
80. DDP Enterprises currently does not pay a dividend but plans to makes its first dividend payment of $1 in three years. If the expected growth rate is 10% per year once dividends commence and the appropriate is discount rate is 18%, what is the current share price today?
a. | $8.98 |
b. | $8.37 |
c. | $13.75 |
d. | $14.75 |
g = 0.1000
D3 = 1.0000
D4 = 1.1000
P3 = 13.7500
P0 = PVP3 + PVD3
P0 = 8.9773
PTS: 1 DIF: M
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
81. Roxy Incorporated expects non-normal dividend growth over the next three years – that is a 20% growth rate for three years followed by growth of 10% thereafter. If the last dividend paid was $3 and the appropriate discount rate is 16%, what is the price of the share today?
a. | $73.24 |
b. | $95.04 |
c. | $70.10 |
d. | $60.89 |
D1 = 3.60
D2 = 4.32
D3 = 5.18
D4 = 5.70
P3 = D4/(r – g)
P3 = 95.04
PVD1 = 2.68
PVD2 = 3.21
PVD3 = 3.32
PVP3 = 60.89
P0 = 70.10
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
82. Emma, Inc. expects non-normal dividend growth over the next three years – that is a 0% growth rate in the first year, then 25%, and then 12% followed by growth of 8% thereafter. If the last dividend paid was $2.50 and the appropriate discount rate is 12%, what is the price of the share today?
a. | $67.26 |
b. | $94.50 |
c. | $76.64 |
d. | $74.24 |
D1 = 2.50
D2 = 3.13
D3 = 3.50
D4 = 3.78
P3 = D4/(r – g)
P3 = 94.50
PVD1 = 1.99
PVD2 = 2.49
PVD3 = 2.49
PVP3 = 67.26
P0 = 74.24
PTS: 1 DIF: H
REF: 5.2 Valuing Preferred and Ordinary Shares NAT: Analytic thinking
LOC: understand shares and bonds
SHORT ANSWER
1. Describe the differences between preferred and ordinary shares.
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares
2. What is the difference between a primary market and a secondary market?
PTS: 1 DIF: E
REF: 5.5 Primary and Secondary Markets for Equity Securities
3. What are the approaches used to value ordinary shares?
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares.
4. How can a company be valued if it does not pay dividends?
PTS: 1 DIF: E
REF: 5.2 Valuing Preferred and Ordinary Shares
5. Provide examples of secondary markets in Australia.
PTS: 1 DIF: E
REF: 5.5 Primary and Secondary Markets for Equity Securities
6. What is the main responsibility of a lead underwriter?
PTS: 1 DIF: E
REF: 5.5 Primary and Secondary Markets for Equity Securities