Chapter 9

Question 1

Which of the following is not a way that a firm can increase its dividend?
A) By increasing its retention rate
B) By decreasing its shares outstanding
C) By increasing its earnings (net income)
D) By increasing its dividend payout rate

Answer 1

A

Question 2

Which of the following statements is false regarding profitable and unprofitable growth?
A) If a firm wants to increase its share price, it must cut its dividend and invest more.
B) If the firm retains more earnings, it will be able to pay out less of those earnings, which means that the firm will have to reduce its dividend.
C) A firm can increase its growth rate by retaining more of its earnings.
D) Cutting the firm’s dividend to increase investment will raise the stock price if, and only if, the new investments have a positive NPV.

Answer 2

A

Question 3

Which of the following statements is false?
A) Estimating dividends, especially for the distant future, is difficult.
B) A firm can only pay out its earnings to investors or reinvest their earnings.
C) Successful young firms often have high initial earnings growth rates.
D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.

Answer 3

D

Question 4

We cannot use the general dividend discount model to value the stock of a firm with rapid or changing growth.
B) As firms mature, their growth slows to rates more typical of established companies.
C) The dividend discount model values the stock based on a forecast of the future dividends paid to shareholders.
D) The simplest forecast for the firm’s future dividends states that they will grow at a constant rate, g, forever.

Answer 4

A

Question 5

Which of the following statements is false?
A) A common approximation is to assume that in the long run, dividends will grow at a constant rate.
B) The dividend each year is the firm’s earnings per share (EPS) multiplied by its dividend payout rate.
C) There is a tremendous amount of uncertainty associated with any forecast of a firm’s future dividends.
D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends.

Answer 5

D

Question 6

Which of the following statements is false?
A) As firms mature, their earnings exceed their investment needs and they begin to pay dividends.
B) Total return equals earnings multiplied by the dividend payout rate.
C) Cutting the firm’s dividend to increase investment will raise the stock price if, and only if, the new investments have a positive NPV.
D) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.

Answer 6

B

Question 7

Which of the following statements is false?
A) There are two potential sources of cash flows from owning a stock.
B) An investor will be willing to pay a price today for a share of stock up to the point that this transaction has a zero NPV.
C) An investor might generate cash by choosing to sell the shares at some future date.
D) Because the cash flows from stock are known with certainty, we can discount them using the risk-free interest rate.

Answer 7

D

Question 8

When discounting dividends you should use
A) the weighted average cost of capital.
B) the after tax weighted average cost of capital.
C) the equity cost of capital.
D) the before tax cost of debt.

Answer 8

C

Question 9

Which of the following statements is false?
A) The equity cost of capital for a stock is the expected return of other investments available in the market with equivalent risk to the firm’s shares.
B) The price of a share of stock is equal to the present value of the expected future dividends it will pay.
C) If the current stock price were less than P0 = , it would be a negative NPV investment, and we would expect investors to rush in and sell it, driving down the stocks price.

D) The law of one price implies that to value any security, we must determine the expected cash flows an investor will receive from owning it.

Answer 9

C

Question 10

Which of the following statements is false?
A) We must discount the cash flows from stock based on the equity cost of capital for the stock.
B) The divided yield is the percentage return the investor expects to earn from the dividend paid by the stock.
C) The firm might pay out cash to its shareholders in the form of a dividend.
D) The dividend yield is the expected annual dividend of a stock, divided by its expected future sale price.

Answer 10

D

Question 11

Which of the following statements is false?
A) Future dividend payments and stock prices are not known with certainty; rather these values are based on the investor’s expectations at the time the stock is purchased.
B) The capital gain is the difference between the expected sale price and the purchase price of the stock.
C) The sum of the dividend yield and the capital gain rate is called the total return of the stock.
D) We divide the capital gain by the expected future stock price to calculate the capital gain rate.

Answer 11

D

Question 12

Which of the following statements is false?
A) An investor will be willing to pay up to the point at which the current price of a share of stock equals the present value of the expected future dividends an expected future sale price.
B) The expected total return of a stock should equal the expected return of other investments available in the market with equivalent risk.
C) The total amount received in dividends and from selling the stock will depend on the investor’s investment horizon.
D) If the current stock price were greater than P0 = , it would be a positive NPV investment, and we would expect investors to rush in and buy it, driving up the stocks price.

Answer 12

D

Question 13

Which of the following statements is false?
A) The total payout model allows us to ignore the firm’s choice between dividends and share repurchases.
B) By repurchasing shares, the firm increases its share count, which decreases its earning and dividends on a per-share basis.
C) The total payout model discounts the total payouts that the firm makes to shareholders, which is the total amount spent on both dividends and share repurchases.
D) In the dividend discount model we implicitly assume that any cash paid out to the shareholders takes the form of a dividend.

Answer 13

B

Question 14

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) enterprise value model.
B) total payout model.
C) dividend discount model.
D) discounted free cash flow model.

Answer 14

C

Question 15

If you want to value a firm that has consistent earnings grow, but varies how it pays out these earnings to shareholders between dividends and repurchases, the simplest model for you to use is the
A) enterprise value model.
B) dividend discount model.
C) total payout model.
D) discounted free cash flow model.

Answer 15

C

Question 16

If you want to value a firm but don't want to explicitly forecast its dividends, share repurchases, or its use of debt, what is the simplest model for you to use?
A) Discounted free cash flow model
B) Dividend discount model
C) Enterprise value model
D) Total payout model

Answer 16

A

Question 17

Which of the following statements is false?
A) In a share repurchase, the firm uses excess cash to buy back its own stock.
B) The discounted free cash flow model begins by determining the value of the firm’s equity.
C) The discounted free cash flow model focuses on the cash flows to all of the firm’s investors, both debt and equity holders, and allows us to avoid estimating the impact of the firm’s borrowing decisions on earnings.
D) In recent years an increasing number of firms have replaced dividend payouts with share repurchases.

Answer 17

B

Question 18

Which of the following statements is false?
A) To estimate a firm’s enterprise value, we compute the present value of the free cash flows (FCF) that the firm has available to pay equity holders.
B) The NPV of any individual project represents its contribution to the firm’s enterprise value.
C) When using the total payout model, we discount total dividends and share repurchases, and use the growth rate in earnings when forecasting the growth of the firm’s payout.
D) In the total payout model, we first value the firm’s equity, rather than just a single share.

Answer 18

A

Question 19

Which of the following statements is false?
A) The more cash the firm uses to repurchase shares, the less it has available to pay dividends.
B) Free cash flow measures the cash generated by the firm after payments to debt or equity holders are considered.
C) We estimate a firm’s current enterprise value by computing the present value of the firm’s free cash flow.
D) We can interpret the enterprise value as the net cost of acquiring the firm’s equity, taking its cash and paying off all debts.

Answer 19

B

Question 20

The firm’s weighted average cost of capital (WACC) 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 the 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 the 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 the firm’s equity cost of capital.

Answer 20

D

Question 21

A firm’s net investment is
A) its capital expenditures in excess of depreciation.
B) its free cash flow net of increases in working capital.
C) its enterprise value in excess of debt owed.
D) the market value of equity plus debt.

Answer 21

A

Question 22

Which of the following statements is false?
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 the 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 the firm’s scale to the value of the firm.

Answer 22

D

Question 23

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

Answer 23

B

Question 24

Which of the following statements is false?
A) We can estimate the value of a firm’s shares by multiplying its current earnings per share by the average P/E ratio of comparable firms.
B) For valuation purposes, the trailing P/E ratio is generally preferred, since it is based on actual not expected earnings.
C) Forward earnings are the expected earnings over the coming 12 months.
D) Trailing earnings are the earnings over the previous 12 months.

Answer 24

B

Question 25

Which of the following statements is false?
A) Because the enterprise value represents the entire value of the firm before the firm pays its debt, to form an appropriate multiple, we divide it by a measure of earnings or cash flows after interest payments are made.
B) We can compute a firm’s P/E ratio by using either trailing earnings or forward earnings with the resulting ratio called the trailing P/E or forward P/E.
C) It is common practice to use valuation multiples based on the firm’s enterprise value.
D) Using a valuation multiple based on comparables is best viewed as a “shortcut” to the discounted cash flow method of valuation.

Answer 25

A

Question 26

Which of the following statements is false?
A) The fact that a firm has an exceptional management team, has developed an efficient manufacturing process, or has just secured a patient on a new technology is ignored when we apply a valuation multiple.
B) Valuation multiples have the advantage that they allow us to incorporate specific information about the firm’s cost of capital or future growth.
C) For firms with substantial tangible assets, the ratio of price to book value of equity per share is sometimes used.
D) Using multiples will not help us determine if an entire industry is overvalued.

Answer 26

B

Question 27

Which of the following statements is false?
A) Because capital expenditures can vary substantially from period to period, most practitioners rely on enterprise value to free cash flow multiples.
B) Common multiples to consider are enterprise value to EBIT, EBITDA, and free cash flow.
C) If two stocks have the same payout and EPS growth rates as well as equivalent risk, then they should have the same P/E ratio.
D) Looking at enterprise value as a multiple of sales can be useful if it is reasonable to assume that the firms will maintain similar margins in the future.

Answer 27

A

Question 28

Which of the following statements is false?
A) Many managers make the mistake of focusing on accounting earnings as opposed to free cash flows.
B) Given accurate information about any two of these variables (a firm’s future cash flows, its cost of capital, and its share price) a valuation model allows use to make inferences about the third variable.
C) A valuation model will tell us the most about the variable for which our prior information is the least reliable.
D) The idea that investors are able to identify positive NPV trading opportunities is referred to as the efficient markets hypothesis.

Answer 28

D

Question 29

Which of the following statements is false?
A) Stock markets aggregate the information and view of many different investors.
B) Only in the relatively rare case in which we have some superior information that other investors lack regarding the firm’s cash flows and cost of capital would it make sense to second-guess the market stock price.
C) In most situations, a valuation model is best applied to tell us something about the value of the firm’s stock.
D) The efficient market hypothesis implies that securities will be fairly priced, based on their future cash flows, given all information that is available to investors.

Answer 29

C