Reading 41: dividends, splits, and repurchases Flashcards
An analyst estimates a value of $45 for a stock with a market price of $50. The analyst is most likely to conclude that a stock is overvalued if:
few analysts follow the stock and the analyst has less confidence in his model inputs.
few analysts follow the stock and the analyst is confident in his model inputs.
many analysts follow the stock and the analyst is confident in his model inputs.
If the analyst is more confident of his input values, he is more likely to conclude that the security is overvalued. The market price is more likely to be correct for a security followed by many analysts and less likely correct when few analysts follow the security. (LOS 41.a)
A valuation model based on free cash flow to equity is most likely to be:
a multiplier model.
an asset-based model.
a present value model.
One example of a present value model is valuation based on the present value of future cash flows available to equity holders. (LOS 41.b)
A company is evaluating the likely effects on its share price of declaring a 50% stock dividend or a 3-for-2 stock split. Other things equal, which of these will result in a lower share price?
3-for-2 stock split.
50% stock dividend.
Both should have the same effect.
Both a 50% stock dividend and a 3-for-2 stock split will increase the number of shares by 50%, while neither will affect value of the company. Therefore, the decrease in the share price should be the same in either case. (LOS 41.c)
The first date on which the purchaser of a stock will not receive a dividend that has been declared is:
the declaration date.
the ex-dividend date.
the holder-of-record date.
The chronology of a dividend payout is declaration date, ex-dividend date, holder-of-record date, and payment date. The ex-dividend date is the cutoff date for receiving the dividend: stocks purchased on or after the ex-dividend date will not receive the dividend. (LOS 41.d)
The constant growth model requires which of the following?
g < k.
g > k.
g ≠ k.
For the constant growth model, the constant growth rate (g) must be less than the required rate of return (k). (LOS 41.e)
What would an investor be willing to pay for a share of preferred stock that pays an annual $7 dividend if the required return is 7.75%?
$77.50.
$87.50.
$90.32.
The share value is 7.0 / 0.0775 = $90.32. (LOS 41.g)
An analyst estimates that a stock will pay a $2 dividend next year and that it will sell for $40 at year-end. If the required rate of return is 15%, what is the value of the stock?
$33.54.
$36.52.
$43.95.
($40 + $2) / 1.15 = $36.52. (LOS 41.h)
What is the intrinsic value of a company’s stock if dividends are expected to grow at 5%, the most recent dividend was $1, and investors’ required rate of return for this stock is 10%?
$20.00.
$21.00.
$22.05.
Using the constant growth model, $1(1.05) / (0.10 − 0.05) = $21.00. (LOS 41.h)
Assume that a stock is expected to pay dividends at the end of Year 1 and Year 2 of $1.25 and $1.56, respectively. Dividends are expected to grow at a 5% rate thereafter. Assuming that ke is 11%, the value of the stock is closest to:
$22.30.
$23.42.
$24.55.
($1.25 / 1.11) + [1.56 / (0.11 − 0.05)] / 1.11 = $24.55. (LOS 41.h)
An analyst feels that Brown Company’s earnings and dividends will grow at 25% for two years, after which growth will fall to a constant rate of 6%. If the projected discount rate is 10%, and Brown’s most recently paid dividend was $1, the value of Brown’s stock using the multistage dividend discount model is closest to:
$31.25.
$33.54.
$36.65.
$1(1.25) / 1.1 + [$1(1.25)2 / (0.10 − 0.06)] / 1.1 = $36.65. (LOS 41.h)
Which of the following firms would most likely be appropriately valued using the constant growth DDM?
An auto manufacturer.
A producer of bread and snack foods.
A biotechnology firm in existence for two years.
The constant growth DDM assumes that the dividend growth rate is constant. The most likely choice here is the bread and snack producer. Auto manufacturers are more likely to be cyclical than to experience constant growth. A biotechnology firm in existence for two years is unlikely to pay a dividend, and if it does, dividend growth is unlikely to be constant. (LOS 41.i)
Which of the following is least likely a rationale for using price multiples?
Price multiples are easily calculated.
The fundamental P/E ratio is insensitive to its inputs.
The use of forward values in the divisor provides an incorporation of the future.
The fundamental P/E ratio is sensitive to its inputs. It uses the DDM as its framework, and the denominator k − g in both has a large impact on the calculated P/E or stock value. (LOS 41.j)
A firm has an expected dividend payout ratio of 60% and an expected future growth rate of 7%. What should the firm’s fundamental price-to-earnings (P/E) ratio be if the required rate of return on stocks of this type is 15%?
5.0×.
7.5×.
10.0×.
Using the earnings multiplier model, 0.6 / (0.15 − 0.07) = 7.5×. (LOS 41.k)
Enterprise value is defined as the market value of equity plus:
the face value of debt minus cash and short-term investments.
the market value of debt minus cash and short-term investments.
cash and short-term investments minus the market value of debt.
Enterprise value is market value of equity plus market value of debt minus cash and short-term investments. (LOS 41.l)
Which of the following firms would most appropriately be valued using an asset-based model?
An energy exploration firm in financial distress that owns drilling rights for offshore areas.
A paper firm located in a country that is experiencing high inflation.
A software firm that invests heavily in research and development and frequently introduces new products.
The energy exploration firm would be most appropriately valued using an asset-based model. Its near-term cash flows are likely negative, so a forward-looking model is of limited use. Furthermore, it has valuable assets in the form of drilling rights that likely have a readily determined market value. The paper firm would likely not be appropriately valued using an asset-based model because high inflation makes the values of a firm’s assets more difficult to estimate. An asset-based model would not be appropriate to value the software firm because the firm’s value largely consists of internally developed intangible assets. (LOS 41.m)
