Chapter 7: Valuing Stocks
The dividend discount model implies that investors who agree about the firm’s future dividends
and risk will also agree about its current share price.
Which of the following statements are correct regarding the method of valuation by
comparable?
1.A firm’s market value can be estimated by multiplying its earning per share by the P/E
ration for a similar firm.
2.A firm’s market value can be estimated by multiplying its book value by the market/book
ration for a similar firm
When a firm sells its shares directly to investors and receives the proceeds from the sale, this is
called a primary market transaction.
When investors sell shares of a firm’s stock to each other on an exchange or through an
electronic network, this is called a secondary market transaction.
Which of the following statements are correct about the book value of a firm’s equity?
1.it can be calculated from the balance sheet as assets minus liabilities
2.it includes book value of common stock and retained earnings
3.it is generally less than the market value of the firm’s equity
When an investor purchases a share of a firm’s stock, she receives in return: an ownership
share
in the firm and a share in the company’s future successes and setbacks.
The terminal value is defined as the stock price at the start of the year in which constant
dividend growth begins.
Which of the following statements are true regarding the intrinsic value of a stock? It is the
present value of the cash payoffs anticipated by the investor who buys the stock; it is the price
that should be observed in a well-functioning stock market.
A stock that pays out a perpetual stream of constant dividends can be valued as a perpetuity.
Technically analysis of stock price movements will not lead an investor to superior returns
because: if investors did identify a pricing pattern they could exploit, their trading would
quickly
eliminate it and stock prices move randomly without identifiable patterns that could be
exploited.
The sustainable growth rate “g” is the maximum rate of book equity, earning, and dividends
assuming that the long-term debt ration, the ROE, and the plowback ratio are all held constant.
Researchers in the field of behavioral finance have identified three broad areas of
psychology that may explain investors’ irrational behavior. These three areas are:
1.attitudes toward risk
2.beliefs about probabilities
3. sentiment
The expected return on a stock can be calculated as the sum of the dividend yield and the
capital gains yield.
The principle stock markets in the United States are NYSE and NASDAQ.
The price-earnings multiple, also known as the P/E ratio, is calculated by: price per share /
earnings per share.
The dividend discount model asserts that the value of a share of stock today is determined by
the present value of all forecasted future dividends paid by the stock.
When comparing the book value
and market value balance sheets
for a firm, a market-to-book equity ratio greater than 1 indicates that:
1.the firm has intangible assets not shown on the balance sheet
2.the firm has valuable future investment opportunities
3.the assets on the balance sheet are undervalued
A growth stock can be valued using the following formula: Po=EPS/r + PVGO
The expected rate return for a stock and its current market price (PO) are inversely related.
Which of the factors listed below contribute to the market value of a going concern?
1.value of future investments
2.extra earning power
3.intangible assets
The net proceeds that could be realized by selling the firm’s assets and paying off its creditors is
known as the firm’s liquidation value.
If a firm is experiencing non-constant dividend growth and if the horizon year is “H”, which of
the following are valid expressions for the terminal value?
The expected rate of return for a stock whose next dividend is “DIV1”, that has a required rate
of return “r” and expects to grow its future dividends at a rate of “g” is: r = DIV/PO + g
Fundamental analysis of a firm’s condition and prospects will not lead to superior returns
because: by the time an investor discovers new publicly available info about a firm, the market
already knows it and has responded with a price adjustment.
Which of the following is true regarding the market value of the firm?
It includes investors’ expectations of future earning power
It treats the firm as a going concern
It is affected by the earnings a firm can generate by current tangible and intangible
assets
If the firm uses repurchases instead of dividends to distribute returns to shareholders, how
would the dividend discount model be modified to accommodate this? Discount free cash flows
instead of dividends, then divide by number of shares to get share value.
If a stock has a required return of “r”, its next dividend is expected to be “DIV1”, and its
dividends are expected to grow at a constant rate “g” thereafter, then its current share price
“PO” can be determined by: PO=DIV1/(r-g).
Helena Handbaskets expects to pay a dividend of $0.50 at year-end and expects that dividend to
grow at a rate of 6 percent per year thereafter. If investors require a 15 percent return on
Helena’s stock, what should the current share price be? $5.56
Equation: $0.50/(0.15-0.06)=$5.56
