Stock Valuation and Risk

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Chapter 11
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Stock Valuation and Risk

1.The common price-earnings valuation method applied the ______ price-earnings ratio to ________ earnings per share in order to value the firm’s stock. A)firm’s; industry
B)firm’s; firm’s
C)average industry; industry
D)average industry; firm’s

ANSWER: D

2. A firm is expected to generate earnings of $2.22 per share next year. The mean ratio of share price to expected earnings of competitors in the same industry is 15. Based on this information, the valuation of the firm’s shares based on the price-earnings (PE) method is A) $2.22.

B) $6.76.
C) $33.30.
D) none of the above

ANSWER:C

3. The PE method to stock valuation may result in an inaccurate valuation for a firm if errors are made in forecasting the firm’s future earnings or in choosing the industry composite used to derive the PE ratio. A) True

B) False

ANSWER:A

4. Bolwork Inc. is expected to pay a dividend of $5 per share next year. Bolwork’s dividends are expected to grow by 3 percent annually. The required rate of return for Bolwork stock is 15 percent. Based on the dividend discount model, a fair value for Bolwork stock is $_______ per share. A) 33.33

B) 166.67
C) 41.67
D) 60.00

ANSWER:C

5. Protsky Inc. just paid a dividend of $2.20 per share. The dividend growth rate for Protsky’s dividends is 3 percent per year. If the required rate of return on Protsky stock is 12 percent, the stock should be valued at $_______ per share according to the dividend discount model. A) 24.44

B) 25.18
C) 18.88
D) 75.53

ANSWER:B

6. The limitations of the dividend discount mode are more pronounced when valuing stocks A) that pay most of their earnings as dividends.
B) that retain most of their earnings.
C) that have a long history of dividends.
D) that have constant earnings growth.

ANSWER:B

7. Hancock Inc. retains most of its earnings. The company currently has earnings per share of $11. Hancock expects its earnings to grow at a constant rate of 2 percent per year. Furthermore, the average PE ratio of all other firms in Hancock’s industry is 12. Hancock is expected to pay dividends per share of $3.50 during each of the next three years. If investors require a 10 percent rate of return on Hancock stock, a fair price for Hancock stock today is $________. A) 113.95

B) 111.32
C) 105.25
D) none of the above

ANSWER:A

8.When evaluating stock performance, ______ measures variability that is systematically related to market returns; ______ measures total variability of a stock’s returns. A)beta; standard deviation

B)standard deviation; beta

C)intercept; beta
D)beta; error term

ANSWER: A

9. The ___________ is commonly used as a proxy for the risk-free rate in the Capital Asset Pricing Model.
A) Treasury bond rate
B) prime rate
C) discount rate
D) federal funds rate

ANSWER:A

10. Arbitrage pricing theory (APT) suggests that a stock’s price is influenced only by a stock’s beta.
A) True
B) False

ANSWER:B

11. Stock prices of U.S. firms primarily involved in exporting are likely to be ________ affected by a weak dollar and __________ affected by a strong dollar.
A) favorably; adversely
B) adversely; adversely
C) favorably; favorably
D) adversely; favorably

ANSWER:A

12. A weak dollar may enhance the value of a U.S. firm whose sales are dependent on the U.S. economy.
A) True
B) False

ANSWER:A

13. The January effect refers to the __________ pressure on ______ stocks in January of every year.
A) downward; large
B) upward; large
C) downward; small
D) upward; small

ANSWER:D

14. The expected acquisition of a firm typically results in ____________ in the target’s stock price.
A) an...
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