Ch. 3 - Valuing Bonds

Question 1

Calculating PV using real interest rate to discount real cash flows results in a different value than using nominal rate to discount nominal cashflows

True/False

Answer 1

False: as long as one is consistent in using real or nominal terms, the value will be equivalent

Question 2

The price of a stock is determined as the:

A) PV of growth opportunities
B) PV of future dividends
C) PV of expected earnings

Answer 2

B) PV of future dividends

Question 3

What is the market capitalisation rate?
It is mathematically defined as:

Market Cap Rate = Dividend yield + growth

Market Cap rate = Div_1/P_0 + g

Answer 3

The market capitalisation rate is the expected return (the cost of equity capital for a firm)

Note, the market cap rate is equal to the Constant growth DCF model, where r is isolated

P0= Div1/r-g
r= (DIV1/ P0) + g

Question 4

What is the plowback ratio?

Answer 4

The plowback ratio is the percentage of earnings retained in the firm - i.e., not paid out as dividends

Question 5

Which of the following statements are not true about growth stocks?

A) They are stocks where investors expect a capital gain based on future growth in earnings
B) investors expect that the price of the stock will increase in future
C) they pay very high cash dividends thus justifying their high trading prices
D) they sell at a high price-earnings ratio because investors are willing to pay more now for expected superior returns in the future

Answer 5

C) they pay very high cash dividends thus justifying their high trading prices

This is the case for income stocks

Question 6

Under which assumption can a firm’s value (PV) be calculated based on earnings rather than FCFs?

Answer 6

Normally, one would discount FCFs in order to get the value of the firm. However, if we assume that the firm pays out 100% of its earnings as dividends, it allows us to discount earnings to get the value

Question 7

When computing PV of a firm, you (as the default case) discount:

A) Earnings
B) Dividends
C) FCFs

Answer 7

FCFs

Question 8

Firms with different earnings may have the same value depending on their pay-out policy

True/ False

Answer 8

True

Question 9

When the growth rate and the ROIC is higher than the market cap rate (discount rate), following is NOT true:
A) implies the acceptance of positive NPV investments
B) earnings are reinvested in projects with expected return higher than cost of capital
C) growth is value-adding
D) growth is value destroying

Answer 9

FALSE:
D) growth is value destroying

Question 10

In general, one can think of the stock price as a sum of assets in place and present value of growth opportunities

True/ False

Answer 10

True