1 .Ananalyst gathered the following information about an industry. The industry betais 0.9. The industry profit margin is 8%, the total asset turnover ratio is1.5, and the leverage multiplier is 2. The dividend payout ratio of theindustry is 50%. The risk-free rate is 7% and the expected market return is15%. The industry P/E is closest to:
A)12.00.
B)14.20.
C)22.73.
The correct answer wasC
Using the CAPM: ki =7% + 0.9(0.15 ? 0.07) = 14.2%.
Using the DuPontequation: ROE = 8% × 1.5 × 2 = 24%.
g = retention ratio ×ROE = 0.50 × 24% = 12%.
P/E = 0.5/(0.142 ?0.12) = 22.73.
2 . If the return onequity for a firm is 15% and the retention rate is 40%, the firm’s sustainablegrowth rate is closest to:
A)6%.
B)15%.
C)9%.
The correct answerwas: A
g = (RR)(ROE)
= (0.15)(0.40)
= 0.06 or 6%
3 . Johnson Companyshuts down and is liquidated. Bob Smith owns 100 common shares of Johnson, buthas a lower priority of claims than Al Jones, who also owns 100 common shares.Smith most likely owns:
A)Class B shares.
B)non-participatingshares.
C)non-cumulativeshares.
The correct answerwas: A
Some firms havedifferent classes of common stock (e.g., Class A and Class B shares). Theseclasses may be distinguished by factors such as voting rights and priority inthe event of liquidation. Participating and non-participating, cumulative andnon-cumulative refer to characteristics of preferred stock.
4 . An argumentagainst using the price to cash flow (P/CF) valuation approach is that:
A)non-cash revenue andnet changes in working capital are ignored when using earnings per share (EPS)plus non-cash charges as an estimate.
B)cash flows are notas easy to manipulate or distort as EPS and book value.
C)price to cash flowratios are not as volatile as price-to-earnings (P/E) multiples.
The correct answerwas: A
Items affecting actualcash flow from operations are ignored when the EPS plus non-cash chargesestimate is used. For example, non-cash revenue and net changes in workingcapital are ignored. Both remaining responses are arguments in favor of usingthe price to cash flow approach.
5 . An investor isconsidering acquiring a common stock that he would like to hold for one year.He expects to receive both $1.50 in dividends and $26 from the sale of thestock at the end of the year. What is the maximum price he should pay for thestock today to earn a 15 percent return?
A)$27.30.
B)$24.11.
C)$23.91.
The correct answer wasC
By discounting thecash flows for one period at the required return of 15% we get: x = (26 + 1.50)/ (1+.15)1
(x)(1.15) = 26 + 1.50
x = 27.50 / 1.15
x = $23.91
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