1 .Thecompetitive forces identified by Michael Porter include:
A)threat of substituteproducts and rivalry among suppliers.
B)rivalry amongexisting competitors and bargaining power of buyers.
C)bargaining power ofexisting competitors and threat of new entrants.
The correct answer wasB
Porter’s fivecompetitive forces are: (1) rivalry among existing competitors; (2) threat ofnew entrants; (3) threat of substitute products; (4) bargaining power ofbuyers; (5) bargaining power of suppliers.
2 . An analystestimates that a stock’s value is €22.50. If the market price of this stock is€25.00 the analyst believes the stock is:
A)fairly valued.
B)overvalued.
C)undervalued.
The correct answer wasB
If a stock’s intrinsicvalue is less than its market value, the stock is overvalued.
3 . An analyst hasgathered the following data for Webco, Inc:
§ Retention = 40%
§ ROE = 25%
§ k = 14%
Using the infiniteperiod, or constant growth, dividend discount model, calculate the price ofWebco’s stock assuming that next years earnings will be $4.25.
A)$55.00.
B)$125.00.
C)$63.75.
The correct answer wasC
g = (ROE)(RR) =(0.25)(0.4) = 10%
V = D1 / (k – g)
D1 = 4.25 (1 ? 0.4) =2.55
G = 0.10
K – g = 0.14 ? 0.10 =0.04
V = 2.55 / 0.04 =63.75
4 . A company has 6%preferred stock outstanding with a par value of $100. The required return onthe preferred is 8%. What is the value of the preferred stock?
A)$92.59.
B)$75.00.
C)$100.00.
The correct answer wasB
The annual dividend onthe preferred is $100(.06) = $6.00. The value of the preferred is $6.00/0.08 =$75.00.
5 . Which of thefollowing changes would most likely cause a firm’s return on equity toincrease?
A)Net income increasesby 5% and average book value of equity increases by 10%.
B)Net income increasesby 5% and average book value of equity increases by 5%.
C)Net income decreasesby 5% and average book value of equity decreases by 10%.
The correct answer wasC
Return on equity isnet income divided by average book value of equity. If the book value of equitydecreases relatively more than net income decreases, return on equity willincrease. This illustrates that an increase in ROE is not necessarily positivefor the firm. An analyst must examine the reasons for changes in ROE.
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