CHAPTER 9

Question 1

By increasing its dividend payout rate a firm can increase its dividend.

Answer 1

YES

Question 2

By increasing its earnings (net income) a firm can increase its dividend.

Answer 2

YES

Question 3

By increasing its retention rate a firm can increase its dividend.

Answer 3

NO

Question 4

By decreasing its shares outstanding a firm can increase its dividend.

Answer 4

YES

Question 5

Successful young firms often have high initial earnings growth rates.

Answer 5

YES

Question 6

Estimating dividends, especially for the distant future, is difficult.

Answer 6

YES

Question 7

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
growth rate.

Answer 7

NO

Question 8

A firm can only pay out its earnings to investors or reinvest their earnings.

Answer 8

YES

Question 9

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 9

NO

Question 10

There is a tremendous amount of uncertainty associated with any forecast of a
firm’s future dividends.

Answer 10

YES

Question 11

A common approximation is to assume that in the long run, dividends will grow
at a constant rate.

Answer 11

YES

Question 12

The dividend each year is the firm’s earnings per share (EPS) multiplied by its
dividend payout rate.

Answer 12

YES

Question 13

g = retention rate × return on new investment

Answer 13

YES

Question 14

rE= Div1 / P0 - g

Answer 14

NO

Question 15

P0= Div1 / (rE - g)

Answer 15

YES

Question 16

Divt = EPSt × Dividend Payout Rate

Answer 16

YES

Question 17

When discounting dividends you should use the equity cost of capital.

Answer 17

YES

Question 18

The divided yield is the percentage return the investor expects to earn from the
dividend paid by the stock.

Answer 18

YES

Question 19

We must discount the cash flows from stock based on the equity cost of capital
for the stock.

Answer 19

YES

Question 20

The firm might pay out cash to its shareholders in the form of a dividend.

Answer 20

YES

Question 21

The dividend yield is the expected annual dividend of a stock, divided by its
expected future sale price.

Answer 21

NO

Question 22

The dividend yield is the annual dividend divided by the current
price.

Answer 22

YES

Question 23

The expected total return of a stock should equal the expected return of other
investments available in the market with equivalent risk.

Answer 23

YES

Question 24

The total amount received in dividends and from selling the stock will depend
on the investor’s investment horizon.

Answer 24

YES

Question 25

If the current stock price were greater than P0 = Div1 + P1 / 1 + rE , it would be a positive NPV investment, and we would expect investors to rush in and buy it, driving
up the stocks price.

Answer 25

NO

Question 26

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.

Answer 26

YES

Question 27

In the dividend discount model we implicitly assume that any cash paid out to
the shareholders takes the form of a dividend.

Answer 27

YES

Question 28

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.

Answer 28

YES

Question 29

By repurchasing shares, the firm increases its share count, which decreases its
earning and dividends on a per-share basis.

Answer 29

NO

Question 30

The total payout model allows us to ignore the firm’s choice between dividends
and share repurchases.

Answer 30

YES

Question 31

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 total payout model.

Answer 31

YES

Question 32

In recent years an increasing number of firms have replaced dividend payouts
with share repurchases.

Answer 32

YES

Question 33

The discounted free cash flow model begins by determining the value of the
firm’s equity.

Answer 33

NO

Question 34

In a share repurchase, the firm uses excess cash to buy back its own stock.

Answer 34

YES

Question 35

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.

Answer 35

YES

Question 36

The more cash the firm uses to repurchase shares, the less it has available to pay
dividends.

Answer 36

YES

Question 37

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 37

YES

Question 38

Free cash flow measures the cash generated by the firm after payments to debt or
equity holders are considered.

Answer 38

NO

Question 39

We estimate a firm’s current enterprise value by computing the present value of
the firm’s free cash flow.

Answer 39

YES

Question 40

The long-run growth rate gFCF is typically based on the expected long-run
growth rate of the firm’s revenues.

Answer 40

YES

Question 41

Because the firm’s free cash flow is equal to the sum of the free cash flows from
the firm’s current and future investments, we can interpret the firm’s enterprise value as the total NPV that the firm will earn from continuing its existing projects and initiating new ones.

Answer 41

YES

Question 42

When using the discounted free cash flow model, we forecast the firm’s free cash flow up to some horizon, together with some terminal (continuation) value of the enterprise.

Answer 42

YES

Question 43

If the firm has no debt then rwacc = the risk-free rate of return.

Answer 43

NO

Question 44

If the firm has no debt then rwacc = the cost of equity.

Answer 44

YES

Question 45

A valuation multiple is a ratio of some measure of the firm’s scale to the value of
the firm.

Answer 45

NO

Question 46

A valuation multiple is a ratio of the value of the firm to some measure of the firm’s scale.

Answer 46

YES

Question 47

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.

Answer 47

YES

Question 48

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.

Answer 48

YES

Question 49

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.

Answer 49

YES

Question 50

Trailing earnings are the earnings over the previous 12 months.

Answer 50

YES

Question 51

For valuation purposes, the trailing P/E ratio is generally preferred, since it is based on actual not expected earnings.

Answer 51

NO

Question 52

For valuation purposes, the leading P/E ratio is generally preferred, since it is based on the expected earnings.

Answer 52

YES

Question 53

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.

Answer 53

YES

Question 54

Forward earnings are the expected earnings over the coming 12 months.

Answer 54

YES

Question 55

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.

Answer 55

YES

Question 56

For firms with substantial tangible assets, the ratio of price to book value of
equity per share is sometimes used.

Answer 56

YES

Question 57

Valuation multiples have the advantage that they allow us to incorporate specific
information about the firm’s cost of capital or future growth.

Answer 57

NO

Question 58

Discounted cash flows methods have the advantage that they allow
us to incorporate specific information about the firm’s cost of capital
or future growth.

Answer 58

YES

Question 59

Using multiples will not help us determine if an entire industry is overvalued.

Answer 59

YES

Question 60

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 60

YES

Question 61

In most situations, a valuation model is best applied to tell us something about
the value of the firm’s stock.

Answer 61

NO

Question 62

Stock markets aggregate the information and view of many different investors.

Answer 62

YES

Question 63

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.

Answer 63

YES