1 .Which of the following types ofindustries is typically characterized by above-normal expansion in sales andprofits independent of the business cycle?
A)Defensive.
B)Counter-cyclical.
C)Growth.
Thecorrect answer was C
Agrowth industry is typically characterized by above-normal expansion in salesand profits independent of the business cycle.
2. The earnings multiplier model, derived from the dividend discount model,expresses a stock’s P/E ratio (P0/E1) as the :
A)expecteddividend payout ratio divided by the difference between the required return onequity and the expected dividend growth rate.
B)expecteddividend payout ratio divided by the sum of the expected dividend growth rateand the required return on equity.
C)expecteddividend in one year divided by the difference between the required return onequity and the expected dividend growth rate.
Thecorrect answer was: A
Startingwith the dividend discount model P0 = D1/(ke ? g), and dividing both sides byE1 yields: P0/E1 = (D1/E1)/(ke ? g)
Thus,the P/E ratio is determined by:
§ The expected dividend payout ratio (D1/E1).
§ The required rate of return on the stock(ke).
§ The expected growth rate of dividends (g).
3. Calculate the value of a common stock that last paid a $2.00 dividend if therequired rate of return on the stock is 14 percent and the expected growth rateof dividends and earnings is 6 percent. What growth model is an example of this calculation?
Value of stock Growth model
A) $26.50 Supernormal growth
B) $25.00 Gordon growth
C) $26.50 Gordon growth
Thecorrect answer was C
$26.50 Gordongrowth
$2(1.06)/0.14- 0.06 = $26.50.
Thiscalculation is an example of the Gordon Growth Model also known as the constantgrowth model.
4. If an analyst estimates the intrinsic value for a security that is differentfrom its market value, the analyst should most likely take an investmentposition based on this difference if:
A)themodel used is not highly sensitive to its input values.
B)manyanalysts independently evaluate the security.
C)thesecurity lacks a liquid market and trades infrequently.
Thecorrect answer was: A
Ingeneral, an analyst can be more confident about an estimate of intrinsic valueif the model used is not highly sensitive to changes in its inputs. If a largenumber of analysts follow a security, its market value is more likely to be areliable estimate of its intrinsic value. A security that does not tradefrequently or in a liquid market may remain mispriced for an extended time, andthus may not result in a profit within the investment horizon even if theanalyst’s estimate of intrinsic value is correct.
5. If a company can convince its suppliers to offer better terms on theirproducts leading to a higher profit margin, the return on equity (ROE) willmost likely:
A)increaseand the stock price will increase
B)increaseand the stock price will decline.
C)decreaseand the stock price will increase.
Thecorrect answer was: A
Bettersupplier terms lead to increased profitability. Better profit margins lead toan increase in ROE. This leads to an increase in the dividend growth rate. Thedifference between the cost of equity and the dividend growth rate willdecline, causing the stock price to increase.
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