C11 - Equities (25-30 Qs C11-C14 'Asset Classes') BC

Question 1

If the dividend cover is 10, the PE ratio is 4 and the share price is £4.80, calculate the dividend per share.
A) 5p
B) 8p
C) 12p
D) 15p

Answer 1

C - 12p

Dividend cover = Earnings per share (EPS) / Dividend per share (DPS)
First, need to find the EPS via the PE ratio:
PE: Price/EPS
4 = £4.80/EPS Rearranged: EPS = £4.80/4 = £1.20

Returning to the dividend cover formula: 10 = £1.20/DPS
Rearranged DPS = £1.20/10 = £0.12

Question 2

Dividend cover is calculated by dividing the earnings per share (EPS) by:
A) Gross assets per share
B) Net dividend per share
C) Gross Dividend per share
D) Net assets per share

Answer 2

C - Gross Dividend per share

Question 3

ABC plc has a PE Ratio of 55 and the industry average P/E ratio is only 25
What does this indicate about ABC plc?
A) It is under-performing
B) It is undervalued
C) It could be subject to a possible takeover bid
D) It is a growth company with a low yield

Answer 3

D - It is a growth company with a low yield

A relatively high PE ratio in comparison to the sector indicates a high price in relation to earnings. This could indicate that the company has good future growth prospects. A higher price delivers a lower yield.

Question 4

If dividends are 10p per share, and EPS is 25p, the dividend cover is:
A) 250x
B) 25x
C) 0.25x
D) 2.5x

Answer 4

D - 2.5x

Dividend cover = EPS / DPS = £0.25/£0.10 = 2.5x

Question 5

The price earnings ratio and dividend yield respectively of a company with a high rate of profit growth will normally be:
A) High/High
B) Low/High
C) Low/Low
D) High/Low

Answer 5

D - High/Low

Generally if the P/E is high the share prices has risen which which will depress the dividend yield which is an ex-post measure.

Question 6

Earnings per share is 20p, dividend cover is 1.370
If the market price is £2.50, what is the P/E ratio and the dividend per share?
A) P/E - 12.5, DPS - 6.85p
B) P/E - 0.5, DPS - 14.6p
C) P/E - 12.5, DPS - 14.6p
D) P/E - 0.5, DPS - 6.85p

Answer 6

C - P/E - 12.5, DPS - 14.6p

PE Ratio = Price/EPS = £2.50/£0.20= 12.5
Dividend cover = EPS/DPS
1.37 = £0.20 / DPS
Rearranged: DPS = 1.37 / £0.20 = £0.146

When rearranging an A = B / C equation - to get B (numerator) you you multiple the two given (A & C), to get C (denominator) you swap A and C round

Question 7

A firm has 8 million 10 pence ordinary shares in issue at a market price of 240p

IF the EPS was 12p, what is the PE ratio?
A) 0.05
B) 20
C) 5
D) 28.8

Answer 7

B - 20

The number and nominal value of the issued shares are distractors

PE Ratio = Price / EPS

SO PE = £2.40/£0.12 = 20

The price-to-earnings (P/E) ratio is the proportion of a company’s share price to its earnings per share. A high P/E ratio could mean that a company’s stock is overvalued or that investors expect high growth rates.

Question 8

A firm has 10m ordinary shares in issues te PE ratio is 10, and the share price is 120 pence, what were the total earnings?
A) 12 pence
B) £12m
C) £1.2m
D) £1.20

Answer 8

C - £1.2m

PE Ratio = Price/EPS
10 = £1.20/EPS

Rearranged, EPS = £1.20 / 10 (PE) = £0.12
Total Earnings = £0.12 x 10m = £1.2m

The price-to-earnings (P/E) ratio is the proportion of a company’s share price to its earnings per share. A high P/E ratio could mean that a company’s stock is overvalued or that investors expect high growth rates.

Question 9

Under normal stock market conditions, which of the following statements are NOT true?
1. A high dividend yield implies that a company is highly regarded for its growth prospects
2. Companies with high PE ratios tend to have low dividend yields
3. Dividend yields are normally calculated on the gross dividends of companies rather than on the net dividends
4. Dividend yields are only of interest to non-taxpayers

A) 1 and 2
B) 1 and 4
C) 2, 3 and 4
D) All of the above

Answer 9

B - 1 (High dividend = growth) and 4 (non-taxpayers)

Question 10

If the share price was £3 before a 1 to 2 rights issue, and the issue price is £2.40 what will be the share price after the rights issue?

A) £5.40
B) £2.40
C) £2.80
D) £3.00

Answer 10

C - £2.80

Theoretical ex-rights price = [(2 x £3) + (1 x £2.40)] / 3 = £2.80

As there are more rights being issued and at a discount, there will naturally be reduction in the share price so it cannot be the same or above the existing share price. It will also not be below the discounted rights issue price as the share price will blend the existing shares and new shares together.

A Rights Issue is where existing shareholders are given the opportunity to buy a set number of new shares in the company they own. These new shares are often available at a discount to the existing share price, to encourage investors to take part.

Question 11

A company has an issue 20m ordinary shares of 50p, originally issued at a premium of 25p each. It decides to make a 1 for 4 scrip issue to its existing shareholders

How much cash will the company receive as a result of this issue?

A) £3.75m
B) £2.50m
C) £1.25m
D) Nil

Answer 11

D - Nil

A bonus issue, also known as a scrip issue or a capitalization issue, is an offer of FREE additional shares to existing shareholders. For example, a company may give one bonus share for every five shares held. Companies issue bonus shares to attract further investment and reward shareholders.

Question 12

A company has had a 2 for 5 rights issue at £1.25 per share and the new shares each have a theoretical nil paid price of £0.25

Calculate the previous cum rights place.
A) £1.30
B) £1.50
C) £1.60
D) £1.75

Answer 12

C - £1.60

The new shares have a subscription price of £1.25, this plus the nil paid price = Theoretical ex-rights price (TERP)

Therefore, £1.25 + £0.25 = £1.50

The new holding of 7 shares with a TERP of £1.50 = £10.50

TERP = (5 x Cum-rights price) + (2 x £1.25) / 7

SO REARRANGED Cum Rights Price = [(7 x £1.50) - (2 x £1.25)] / 5 = £1.60

Cum rights are a stock entitlement that allows shareholders to purchase additional shares at a predetermined price. Shares are considered cum rights while the rights have not been exercised or expired.

The nil paid price of a right is the theoretical price an investor would receive if they sold their right to subscribe to new shares. This price is calculated by subtracting the subscription price from the theoretical ex-right price.

Question 13

The market price of a share is £4. A 1 for 4 rights issue at £3 per share is announced

The theoretical nil price paid price of the right is:
A) £1.00
B) £0.80
C) £0.75
D) £0.20

Answer 13

B - £0.80

The nil paid price of a right is the theoretical price an investor would receive if they sold their right to subscribe to new shares. This price is calculated by subtracting the subscription price (what the company is offering in the rights issue) from the theoretical ex-right price (price after the rights issue).

So
Theoretical ex-rights price = [(4 x £4) + (1 x £3)] / 5 = £3.80
Theoretical nil-paid price = £3.80 - £3.00 = £0.80

Question 14

A company makes a 1 for 3 rights issue at 25p
If the cum-rights price is 55p, what are the ex-rights price and the value of a right respectively?
A) 50p / 25p
B) 47.5p / 22.5p
C) 32.5p / 7.5p
D) 30p / 5p

Answer 14

B - 47.5p (ex-rights price) and 22.5p (value of the right)

3 shares x cum rights price (55p) = £1.65
1 share x Subscription price (25p) = £0.25

After rights issue we have 4 shares worth a total of £1.90. Therefore ex-rights price = £1.90/4 shares = 47.5p

Value of the right (nil paid price) = TERP - Subscription price
= 47.5p - 25p = 22.5p

Question 15

An investor owns 1,000 shares of ABS plc worth £2.20 each. ABS plc undergoes a 1:10 scrip followed by a 1:6 scrip

What is the change in value of the investor’s holding in ABS plc?
A) £nil
B) £1,000.00
C) £500.00
D) £100.00

Answer 15

A - £nil

Scrip issues (AKA bonus or capitalisation issues) do NOT raise capital for the company, and therefore do NOT change the TOTAL value of the shareholders holding. What is does change is the price per share as they now have more shares for the value they invested.

Question 16

A company pays a dividend of 20p per share
If the share price is 200p, what is the gross dividend yield?
A) 10%
B) 12%
C) 11.11%
D) 13%

Answer 16

A - 10%

Dividend yield = Dividend (20p) / Price (200p) = 0.10 so 10%

Question 17

Total returns are usually calculated as:
A) Change in market price
B) Change in market price PLUS income received (and reinvested)
C) Change in market price PLUS income received (and reinvested) DIVIDED by market price at the START of the period
D) Change in the market price PLUS income received (and reinvested) DIVIDED by the market price at the END of the period

Answer 17

C - Change in market price PLUS income received (and reinvested) DIVIDED by market price at the START of the period

A meaure of total return is “Holding Period Return)

Question 18

Which of the following is NOT true regarding rights?
A) They can be sold
B) If underwritten, the underwriters must buy any shares that are NOT taken up by shareholders
C) The existing shareholders must take them up
D) They can be issued as a deep discount as an alternative to being underwritten

Answer 18

C - The existing shareholders must take them up

Shareholders cannot be forced to act on the rights issue, they can also sell the rights issue if they choose

Question 19

If an individual holds 200,000 shares and the company makes a 1 for 4 rights issue
How many more shares is the individual entitled to?
A) 50,000
B) 250,000
C) 800,000
D) 5,000

Answer 19

A - 50,000

200,000 shares / 4 x 1 = 50,000 shares

Question 20

Which of the following describes an intermediaries offer?
A) A placing that falls below the threshold level
B) A placing through more than one broker
C) A subscription offer
D) An offer for sale to the general public

Answer 20

B - A placing through more than one broker

Question 21

In what currency are ADRs traded?
A) US Dollars
B) Australian Dollars
C) African Dollars
D) Argentine Pesos

Answer 21

A - US Dollars

American Depositary Receipts (ADRs), are financial instruments that allow investors in the United States to invest in foreign companies. Whereby the a Banking Institute invests in the foreign company and deals with the exchange rate risk and pays investors dividends which relates to the income from the investment. An ADR is a negotiable certificate that represents ownership of a certain number of shares in a foreign company.

Question 22

There is a 1 for 25 scrip issue. A holder has 5,000 shares at 75p each
What is the change in the share price after the scrip issue?
A) Nil
B) Increase by £150
C) Decrease by £150
D) Decrease by 3p

Answer 22

D - Decreased by 3p

(75p x 25) / 26 = Ex-scrip price = 72p

Hence the change in the SHARE price (the dilution) is 3p / share

Question 23

A company paid a gross dividend of 20p per share last year, its dividend cover was 8 and the gross dividend yield was 6%

What was the PE ratio of the company?
A) 3.33
B) 2.08
C) 1.6
D) 0.2

Answer 23

B - 2.08

PE Ratio = Price / EPS

STEP 1: GET THE PRICE
Calculate the price via the dividend yield
Dividend yield = Dividend / Price
0.06 = £0.20 / Price SO Price = £0.20/0.06 = £3.33

STEP 2: GET THE EPS
Calculate EPS via the dividend cover
Dividend cover = EPS/DPS
8 = EPS/£0.20 SO EPS = 8 x £0.20 = £1.60

STEP 3: GET THE PE
THEREFORE PE = £3.33 / £1.60 = 2.08

Question 24

What does “cum div” mean?
A) The purchaser of the share is entitled to the next dividend
B) The seller of the share retains the right to the next dividend
C) The share is assumed ex-dividend unless it is marked with a C
D) Stripping the dividends from the principle

Answer 24

A - The purchaser of the share is entitled to the next dividend

Cum dividend is a term used to describe a stock that has a dividend that has been declared but not yet paid out. The term “cum” is a Latin prefix that means “with”.

The ex-dividend date for stocks is usually set as the record date or one business day before if the record date is not a business day. If you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. Instead, the seller gets the dividend.

Question 25

What is the main method by which UK companies traditionally raise long-term finance? A) Oridinary Shares B) Long term fixed interest loans C) Retained profits D) Bank Overdraft

Answer 25

**B - Long term fixed interest loans**

Question 26

Which of the following is NOT a primary method of issuing shares? A) Placing B) Offer for sale C) Rights Issue D) Intermeditary offer

Answer 26

**C - Rights Issue** Options 1, 2 and 4 are examples of IPOs (initial public offering). Rights issues are used to raise capital by companies that are already listed and have issued shares by offering existing shareholders to buy additional shares. * A share placing (or placement) is when new equity shares are issued to individual investors, corporate entities, or small groups of investors for capital. * Offer for Sale means the promoters (owners) sell their shares to raise additional funds for the company. The primary purpose of selling shares to outside investors is to gain access to funds for various purposes, including growth and expansion. * Intermeditary offer is a placing through more than one broker

Question 27

*A share is bought for 500p and is sold for 400p after one year just after a dividend of 20p is received* What is the holding period return? A) +19% B) -19% C) +16% D) -16%

Answer 27

**D: -16%** Holding period return = (current share price 400p + dividend 20p - past share price 500p) / past share price 500p = 0.16 i.e. 16%

Question 28

*A firm maintains a constant dividend payout ratio of 40% and last year earned 20 pence per share. Earnings are expected to grow at 8% pa* If an investor require a return of 10% pa for holding this share, what is the share price immediately after the last dividend payment? A) 1,080p B) 432p C) 400p D) 200p

Answer 28

**B - 432p** Using Gordon's Growth Model: Ex Div share price P = D1/(r-g) D1 = 0.4 x 20p x 1.08 = 8.64p Therefore, P = 8.64p/(0.1-0.08) = 432p

Question 29

*A company whose shares have a nominal value of £1 splits these such that the nominal value is 20p* How many new shares were the old shares split into? A) 2 B) 5 C) 10 D) 20

Answer 29

**B - 5** 1.00/0.20 = 5

Question 30

*A company's dividend is currently 20p and is expected to grow at 6% pa indefinitely* If investor's require 10%, what is the cum-div market value of the share? A) 500p B) 520p C) 530p D) 550p

Answer 30

**D - 550p** Using Gordon's growth model: Ex-div price = D1/(r-g) Ex-Div price = (20px1.06)/(0.1-0.06) = 530p Cum-div price is therefore 530p + 20p = 550p (add the dividend to the ex-div price)

Question 31

*A share is quoted at 85p ex-div and the current dividend is 6p* If dividends and profits have grown consistently at 5 per cent over the last 10 years, what is the implied required return from holding such a share over the next year? A) 12.06% B) 12.41% C) 5.07% D) 5.82%

Answer 31

**B - 12.41%** Using Gordon's Growth Model P = D1/(r-g) Rearranged = r (D1/P) + g r - [(£0.06 x 1.05)/£0.85] + 0.05] = 0.1241 i.e. 12.41%

Question 32

*An investor bought 100 shares at 297 pence each and one year later received dividends of £20 in total. At the end of the following year she recieved dividends of £40 in total and sold the shares at 300 pence each* The internal rate of return on the investment is: A) 10.41% B) 11.51% C) 9.81% D) 8.11%

Answer 32

**A - 10.41%** A trial and error approach is required, so start with one of the middle two numbers and if wrong adjust accordingly. Need to find the discount rate that gives a NPV of zero for the following cash flows: NPV = -£297 + £20/(1+r) + [(£300 + £40)/(1+r)^2 You will find that 10.41 will give you a zero NPV Remember working off £… 297p = £2.97 x 100 shares = £297. 300p = £3.00 x 100 = £300

Question 33

*A company has distributable earnings of £1.5 million and 5 million ordinary shares in issue* If the payout ratio is 0.5, what is the dividend per share? A) 12p B) 15p C) 16p D) 19p

Answer 33

**B - 15p** Dividend per share = (£1.5m x 0.5) / 5m = £0.15

Question 34

*The current share price is £1.50. The company undergoes a 1:4 rights issue* If the ex-rights price is £1.30, what was the subscription price? A) £1.80 B) £1.50 C) £1 D) 50p

Answer 34

**D - 50p** Subscription price = [(5 x £1.30) - (4 x £1.50)]/1 = £0.50

Question 35

*Boxo shares are currently priced ex-dividend at 165p each, they were issued two years ago at 200p, dividends in the first year totalled 11p per share and this year are expected to be 6p per share* What is the holding period return of boxo A) 9% B) -9% C) 8.5% D) 3.6%

Answer 35

**B: - 9%** HRP = (Capita gain or loss) + income / initial cost HRP = (165p + 11p + 6p - 200p)/200p = -0.09 i.e. -9%

Question 36

*Last year's dividend, at 10p per share, has just been paid; the rate of interest is 9%, and the price of the share is 277 pence* What is the assumed dividend growth rate? A) 5.2% B) 6.4% C) 8.0% D) 9.0%

Answer 36

**A - 5.20%** Using Gordon's Growth Model: P = D1/(r-g) 277p = 10p(1+g)/(0.09-g) Rearranging: 24.93 - 277 = 10 + 10g 14.93 = 287g g = 14.93/287 = 0.052 Alternatively a trial and error could be used, going for one of the middle numbers first and adjusting appropriately

Question 37

If a company's dividend yield equals 16%, its dividends cover equals 3 and its price equals 200p, what are its earnings per share (ignore tax)? A) 96p B) 32p C) 11p D) 200p

Answer 37

**A - 96p** Dividend yield = Dividend share/price Rearranged: Dividend per share = Price (200p) x dividend yield (0.16) = 32p Dividend cover = EPS / Dividend per share Rearranged: Dividend cover (3) x Dividend per share (32p) = 96p

Question 38

*A company retains 75% of its latest earnings of 40p. Its dividends are expected to grow by 5% p.a. indefinitely and investors require an 8% return* What is the company's P/E ratio? A) 8.75 times B) 35 times C) 26.25 times D) 3.5 times

Answer 38

**A - 8.75 times** Using the Gordon's Growth Model: P = D1/(r-g) P = (0.25 x 40p x 1.05)/(0.08-0.05) = 350p P/E: Price/EPS P/E = 350p/40p = 8.75

Question 39

What is the effect of a script issue? A) A movement in reserves B) An increase in shareholders funds C) A decrease in shareholders funds D) An increase in liabilities

Answer 39

**A - A movement in reserves** The nominal value of the scrip issues moves from the share premium reserve to share capital

Question 40

What is the value of a right in a rights issue? A) The number of rights x the subscription price B) Subscription price - ex rights price C) Ex rights price - subscription price D) Cum rights price - subscription price

Answer 40

**C - Ex rights price - subscription price** The value of the right is the differene between the share price after the rights increase and the price a shareholder is offered to buy the additional shares

Question 41

*Jones plc undertakes a 1 for 4 rights issue at £2.30. Prior to the issue, Jones' shares were trading at £3.00 per share* What is the theoretical ex-rights price of the Jones share assuming the rights issue is fully subscribed for? A) £2.30 B) £3.575 C) £3.00 D) £2.86

Answer 41

**D - £2.86** Theoretical ex rights price = [(4 x £3) + (1x£2.30)]/5 = £2.86

Question 42

*A company pays a dividend of 15p. The dividend yield for this company stands at 7% and its dividend cover is 4* Calculate the associated PE Ratio A) 4.2 B) 1.05 C) 0.28 D) 3.57

Answer 42

**D - 3.57** PE Ratio = Price / EPS The price can be calculated via the dividend yield: Dividend yield = DPS / Price Rearranged: Price = DPS (15p) / Dividend yield (0.07) = 214.29p The EPS can be calculated via the dividend cover: Dividend cover = EPS/DPS Rearranged: EPS = Dividend dover (4) x DPS (15p) = 60p PE = Price (214.29p) / EPS (60p) = 3.57

Question 43

Which of the following methods does NOT raise capital for the company? A) Rights issue B) Scip Issue C) Placing D) Offer for sale

Answer 43

**B - Scrip Issue** A bonus issue, also known as a scrip issue or a capitalization issue, is an offer of free additional shares to existing shareholders. For example, a company may give one bonus share for every five shares held. Companies issue bonus shares to attract further investment and reward shareholders.

Question 44

What is the best definition of a rights issue? A) Gives a company the ability to impose shares on shareholders at a specific price B) Gives the shareholders the ability to purchase additional shares at a discount price C) Gives shareholders more shares for nothing D) Gives shareholders the ability to purchase additional shares at their nominal value

Answer 44

**B - Gives the shareholders the ability to purchase additional shares at a discount price**

Question 45

*For its most recent financial year ABC plc paid dividends per share of 10p and its EPS were 25p* ABC plc's dividend cover was: A) 2.5 B) 1.5 C) 1.75 D) 0.4

Answer 45

**A - 2.5** Dividend cover = EPS / Dividend per share SO £0.25 / £0.10 = 2.5x

Question 46

Earnings per share is based on profit: A) After tax but before preference dividends and extraordinary items B) After tax by before extraordinary items C) After tax and extraordinary items but before ordinary dividends D) After all dividends

Answer 46

**C - After tax and extraordinary items but before ordinary dividends** EPS requires profit AFTER tax, AFTER extraordinary items and AFTER preference dividend (which have a set dividend payout) but BEFORE ordinary dividends *Extraordinary items are accounting terms for infrequent, unusual gains or losses that are not part of a company's typical business operations. They are reported separately in a company's financial statements.*

Question 47

For a growth stock what is the relationship of price earnings ratio to the dividend yield? A) High / Low B) Low / Low C) High / High D) Low / High

Answer 47

**A - High (EPS) to Low (Div Yield)** For a growth stock it would be expected that the current stock price would be relatively high in relation to current profits (earnings) as the stock price reflects the expectation of larger profits in the future. The dividend yield would be low as the stick price is high, trading on the expectations of higher future profits, and the current divided is low due to the low level of current distributable profits or high retention (low payout ratio) to fund the expected future growth in the business. Low dividend (top of the calculation) and high stock price (bottomr of the calculation) will result in a low dividend yield. *Just think about low yields to higher MV for properties*

Question 48

How are earnings per share (EPS) calculated? A) Profit BEFORE tax, extraoridinary items and interest paid, divided by the number of shares B) Profit AFTER all charges but before extraordinary items divided by the number of shares C) Profit AFTER tax, preference dividends and extraordinary items divided by the number of shares D) Profit BEFORE tax and extraordinary items divided by the number of shares

Answer 48

**C - Profit AFTER tax, preference dividends and extraordinary items divided by the number of shares** Key things to remember, profit is AFTER: * Tax * Extraordinary items (accounting term for infrequent, unusual gains or losses that are not part of a company's typical business operations); AND * Preference dividends (set dividend payments)

Question 49

Which of the following COULD dilute EPS? 1. Freehold land 2. Negative cashflow 3. Convertible loan share 4. An acquistion of a business in exchange for equity A) 1 and 2 B) 2 and 3 C) 3 and 4 D) All of them

Answer 49

**C - 3 (Convertible loan share) and 4 (acqusition of a business in exchange for equity)** We are looking for things that could have an impact on earnings and the number of shares. * Convertible loan stock will increase the number of shares and increase earnings (saved interest net of taxation), it is the proportional change in each that will determine whether it is dilutive or not, but note the potential for dilution exists. * An acquisition can dilute earnings per share depending upin the relationship between the amount of additional earnings and the number of shares that were issued to help finance the acquisition

Question 50

Which of the following would NOT cause a change to the number of shares in issue? A) A call on partly paid shares B) Exercise of warrants C) Rights issue D) Bons issue

Answer 50

**A - A call on partly paid shares** * Opt A (Call on partly paid shares) - No further shares are created here - the holder of the shares simple pays the remaining amount due * Opt B (Exercise of warrants) - This would increase the number of shares when the holder exercised the warrant - their right to buy more shares issued by the company * Opt C (Rights issue) - A rights issue would increase the number of shares - existing shareholders are invited to buy more newly created shares * Opt D (Bonus issue) - A bonus issue (AKA scrip issue) will create new shares

Question 51

Which of the following statements relating to preference shares is/are TRUE? 1. They pay a dividend that is a fixed percentage of the nominal value 2. They take priority over subordinated bonds on liquidation of a company's assets 3. They take priority over the equity shares on the dividend payments and on liquidation of the company assets 4. They are considered less risky than subordinated debt A) 1 and 2 only B) 1 and 3 only C) 2 and 3 only D) 3 and 4 only

Answer 51

**B - 1 (fixed % div) and 3 (priority over equity shares)**

Question 52

*XYZ plc has a current share price of £4.20 and a dividend per share of £0.20. If an analyst estimates that future dividends for this company will grow indefinitely by 5%.* What would be the expected return on this stock according to the Gordon's Growth Model? A) 5% B) 20% C) 15% D) 10%

Answer 52

**D - 10%** (0.20(1.05)) / (0.1 - 0.05) = £4.20 - *Use trial and error on the answers until you get £4.20 as the answer* Gordons growth model is **P0 = D1 / (R - g)**, whereby: * **P0** is current price (T0) - so in the example given £4.20 * **D0** is CURRENT year dividend (T0) - which is is £0.20 in the example * **D1** is the dividend's in ONE YEAR'S TIME (T1) - not given in the example * **R** is the Investor's required return - which you are trying to find * **g** is the growth rate of the dividend - which is 5% in the example GGM **needs** D1 to be calculated and as only D0 was given, you need to ADD ON 1 YEARS GROWTH so **D1 = D0(1 + g)** You can combine both GGM and this by doing: **P0 = (D0 (1 + g)) / (R - g)**

Question 53

*Company X has a price-earnings (PE) ratio of 24 whereas its closest competitor, company Y has a PE of 22.* Which of the following could explain this difference? A) Company X is undervalued B) Company Y is expected to achieve lower earnings growth C) Company Y has just pruchased some new assets and has a resulting larger depreciation charge D) Company X has a poorer management track record

Answer 53

**B - Company Y is expected to achieve lower earnings growth** Company X is more expensive than company Y on the PE ratio measure. This could be because the market expects company Y to achieve lower growth going forward.

Question 54

*Given an industry average price price-earnings (PE) ratio of 12, a company JKL had earnings per share (EPS) last year of £0.25.* What would be a fair valuation of JKL based on PE? A) £1.50 B) £3.00 C) £4.80 D) £48.00

Answer 54

**B - £3.00** PE Ratio = Price / Earnings (EPS) 12 = Price / £0.25 You are looking to isolate the Price so rearranged Price = PE x EPS = £3.00 *When rearranging an A = B / C equation - to get B (numerator) you you multiple the two given (A & C), to get C (denominator) you swap A and C round*

Question 55

A company has a debt to equity ratio of 0.4. If long-term debt is currently £2.4m, what is the company's equity? A) £0.167m B) £0.96m C) £6m D) £9.6m

Answer 55

**C - £6m** £2.4m / 0.4 = £6m Debt to Equity Ratio = Debt / Equity You are looking to isolate equity (denominator) so rearranged: Equity = Debt / Debt to Equity Ratio *When rearranging an A = B / C equation - to get B (numerator) you you multiple the two given (A & C), to get C (denominator) you swap A and C round*

Question 56

*PQR plc decides to pay a 'one for 10' scrip dividend to shareholders. An investor current owns 500 shares and thus is entitled to 50 new shares* If the shares are currently trading at £6.30, what will be the ex-scrip price? A) £5.50 B) £5.73 C) £6.98 D) £7.21

Answer 56

**B - £5.73** ( (500 x £6.30) + (50 x £0 *no capital raised*) ) / 550 = £5.73 Scrip issue are free of charge so NO CAPITAL RAISED, so total value before the scrip issue will be the same as the total value after but it will be shared across more shares.

Question 57

*RST plc paid a dividend of £4m with a dividend cover of four times. It als paid tax of £3m and interest payments of £7m* What is the firms operating profit? A) £10m B) £16m C) £19m D) £26m

Answer 57

**D - £26m** Earnings (NET PROFIT) = Dividend x dividend cover = £4m x 4 = £16m Operating Profit (EBIT) so earnings BEFORE tax and interest = Earnings (NET PROFIT) + Interest + Tax **so £16m + £3m + £7m = £26m** ## Footnote Dividend Cover (x) = EPS / DPS. To isolate EPS (numerator) it is EPS = Div Cover x DPS *When rearranging an A = B / C equation - to get B (numerator) you you multiple the two given (A & C), to get C (denominator) you swap A and C round*