CFA一级模块练习-权益投资
1 . One advantage ofusing price-to-book value (PBV) multiples for stock valuation is that:
A most of the time itis close to the market value.
B)it is a stable andsimple benchmark for comparison to the market price.
C)book value of a firmcan never be negative.
The correct answer wasB
Book value provides arelatively stable measure of value that can be compared to the market price.For investors who mistrust the discounted cash flow estimates of value, itprovides a much simpler benchmark for comparison. Book value may or may not becloser to the market value. A firm may have negative book value if it showsaccounting losses consistently.
2 . The threat ofsubstitute products is most likely to be low for a firm that:
A)produces a commodityproduct in an industry with significant unused capacity.
B)operates in afragmented market with little unused capacity.
C)produces adifferentiated product with high switching costs.
The correct answer wasC
The threat ofcompetition from substitute products is likely to be low for a firm thatproduces a differentiated product
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with high switching costs. Unused capacityand low industry concentration (a fragmented market) tend to intensify rivalryamong industry competitors but are not directly related to the threat ofsubstitute products.
3 . Given thefollowing estimated financial results, value the stock of FishnChips, Inc.,using the infinite period dividend discount model (DDM).
§ Sales of $1,000,000.
§ Earnings of $150,000.
§ Total assets of $800,000.
§ Equity of $400,000.
§ Dividend payout ratio of 60.0%.
§ Average shares outstanding of 75,000.
§ Real risk free interest rate of 4.0%.
§ Expected inflation rate of 3.0%.
§ Expected market return of 13.0%.
§ Stock Beta at 2.1.
The per share value ofFishnChips stock is approximately: (Note: Carry calculations out to at least 3decimal places.)
A)$26.86.
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B)Unable to calculatestock value because ke < g.
C)$17.91.
The correct answer was:A
Here, we are given allthe inputs we need. Use the following steps to calculate the value of thestock:
First, expand theinfinite period DDM:
DDM formula: P0 = D1 /(ke – g)
D1 = (Earnings × Payout ratio) / average number ofshares outstanding
= ($150,000 × 0.60) / 75,000 = $1.20
ke = nominal risk free rate + [beta × (expectedmarket return – nominal risk free rate)]
Note: Nominal risk-free rate = (1 + real risk free rate) × (1 +expected inflation) – 1
= (1.04)×(1.03) – 1 =0.0712, or 7.12%.
ke = 7.12% + [2.1 × (13.0% ? 7.12%)] = 0.19468
g = (retention rate × ROE)
Retention = (1 – Payout) = 1 – 0.60 = 0.40.
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ROE =(net income / sales)(sales / total assets)(total assets / equity)
= (150,000 / 1,000,000)(1,000,000/ 800,000)(800,000 / 400,000)
= 0.375
g = 0.375 × 0.40 = 0.15
Then, calculate: P0 =D1 / (ke – g) = $1.20 / (0.19468 ? 0.15) = 26.86.
4 . The free cash flowto equity model is best described as a(n):
A)single-factor model.
B)present value model.
C)enterprise valuemodel.
The correct answer wasB
The free cash flow toequity model is one type of present value model or discounted cash flow model.It estimates a stock’s value as the present value of cash available to commonshareholders. The enterprise value model is an example of a multiplier model.
5 . For relativevaluation, a peer group is best described as companies:
A)in a similar sectoror industry classification.
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B)at a similar stageof the industry life cycle.
C)with similarbusiness activities and competitive factors.
The correct answer wasC
An analyst should formpeer groups of companies that have similar business activities, drivers ofdemand and costs, and access to capital. Companies in the same industry orsector and companies at the same stage of the industry life cycle are notnecessarily comparable for equity valuation purposes.
1 .The last dividend paid on a common stock was $2.00, thegrowth rate is 5% and investors require a 10% return. Using the infinite perioddividend discount model, calculate the value of the stock.
A)$42.00.
B)$40.00.
C)$13.33.
The correct answer was:A
2(1.05) / (0.10 - 0.05)= $42.00
2 . A firm’s cost ofequity capital is least accurately described as the:
A)ratio of the firm’snet income to its average book value.
B)minimum rate of returninvestors require to invest in the firm’s equity securities.
C)expected total returnon the firm’s equity shares in equilibrium.
The correct answer was:A
The ratio of the firm’snet income to its average book value is the firm’s return on equity, which canbe greater than, equal to, or less than the firm’s cost of equity. Cost ofequity for a firm can be defined as the expected
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equilibrium total return inthe market on its equity shares, or as minimum rate of return that investorsrequire as compensation for the risk of the firm’s equity securities.
3 . Baker Computerearned $6.00 per share last year, has a retention ratio of 55%, and a return onequity (ROE) of 20%. Assuming their required rate of return is 15%, how muchwould an investor pay for Baker on the basis of the earnings multiplier model?
A)$40.00.
B)$173.90.
C)$74.93.
The correct answer was C
g = Retention × ROE =(0.55) × (0.2) = 0.11
P0/E1 = 0.45 / (0.15 ?0.11) = 11.25
Next year's earnings E1= E0 × (1 + g) = (6.00) × (1.11) = $6.66
P0 = 11.25($6.66) =$74.93
4 . Assuming a discountrate of 15%, a preferred stock with a perpetual dividend of $10 is valued atapproximately:
A)$66.67.
B)$1.50.
C)$8.70.
The correct answer was:A
The formula for thevalue of preferred stock with a perpetual dividend is: D / kp, or 10.0 / 0.15 =$66.67.
5 . The price to bookvalue ratio (P/BV) is a helpful valuation technique when examining firms:
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A)with older assetscompared to those with newer assets.
B)that hold primarilyliquid assets.
C)with the same stockprices.
The correct answer was B
P/BV analysis works bestfor firms that hold primarily liquid assets.
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.
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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.
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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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1 .Ananalyst estimates the intrinsic value of a stock to be equal to ?1,567 pershare. If the current market value of the stock is ?1,487 per share, the stockis:
A)overvalued.
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B)undervalued.
C)fairly valued.
The correct answer wasB
If a stock’s intrinsicvalue is greater than its market value, the stock is undervalued.
2 . Witronix is arapidly growing U.S. company that has increased free cash flow to equity anddividends at an average rate of 25% per year for the last four years. Thepresent value model that is most appropriate for estimating the value of thiscompany is a:
A)multistage dividenddiscount model.
B)Gordon growth model.
C)single stage freecash flow to equity model.
The correct answerwas: A
A multistage model isthe most appropriate model because the company is growing dividends at a higherrate than can be sustained in the long run. Though the company may be able togrow dividends at a
higher-than-sustainable 25% annual rate for a finiteperiod, at some point dividend growth will have to slow to a lower, moresustainable rate. The Gordon growth model is appropriate to use for maturecompanies that have a history of increasing their dividend at a steady andsustainable rate. A single stage free cash flow to equity model is similar tothe Gordon growth model, but values future free cash flow to equity rather thandividends.
3 . All else equal, ifa firm’s return on equity (ROE) increases, the stock’s value as estimated bythe constant growth dividend discount model (DDM) will most likely:
A)increase.
B)not change.
C)decrease.
The correct answerwas: A
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Increase in ROE: ROEis a component of g. As g increases, the spread between ke and g, or the P/Edenominator, will decrease, and the P/E ratio will increase.
4 . Assuming that acompany's return on equity (ROE) is 12% and the required rate of return is 10%,which of the following would most likely cause the company's P/E ratio to rise?
A)The firm's ROEfalls.
B)The inflation ratefalls.
C)The firm's dividendpayout rises.
The correct answer wasB
§ Decrease in the expected inflation rate. Theexpected inflation rate is a component of ke (through the nominal risk freerate). ke can be represented by the following: nominal risk free rate + stockrisk premium, where nominal risk free rate = [(1 + real risk free rate)(1 +expected inflation rate)] – 1.
§ If the rate of inflation decreases, thenominal risk free rate will decrease.
§ ke will decrease.
§ The spread between ke and g, or the P/Edenominator, will decrease.
§ P/E ratio will increase.
(An increase in thestock risk premium would have the opposite effect.)
§ Decrease in ROE: ROE is a component of g. Asg decreases, the spread between ke and g, or the P/E denominator, willincrease, and the P/E ratio will decrease.
§ Increase in dividend payout/reduction inearnings retention. In this case, an increase in the dividend payout willlikely decrease the P/E ratio because a decrease in earnings retention willlikely lower the P/E ratio. The logic is as follows: Because earnings retentionimpacts both the numerator (dividend payout) and denominator (g) of the P/Eratio, the impact of a change in earnings retention depends upon therelationship of ke and ROE. If the company is earning a higher rate on newprojects than the rate required by the market (ROE> ke), investors
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willlikely prefer that the company retain more earnings. Since an increase in thedividend payout would decrease earnings retention, the P/E ratio would fall, asinvestors will value the company lower if it retains a lower percentage ofearnings.
5 . Which of thefollowing is NOT a determinant of the expected price/earnings (P/E) ratio?
A)Expected dividendpayout ratio (D/E).
B)Average debt tocapital ratio (D/C).
C)Expected growth ratein dividends (g).
The correct answer wasB
The P/E ratio isdetermined by payout ratio D/E, required return Ke, and expected growth g.
1 .Anequity valuation model that values a firm based on the market value of itsoutstanding debt and equity securities, relative to a firm fundamental, isa(n):
A)asset-based model.
B)enterprise valuemodel.
C)market multiplemodel.
The correct answer wasB
An enterprise valuemodel relates a firm’s enterprise value (the market value of its outstandingequity and debt securities minus its cash and marketable securities holdings)to its EBITDA, operating earnings, or revenue.
2 . Dividends onnon-participating preference shares are typically:
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A)a fixed percentageof par value.
B)a contractualobligation of the company.
C)lower than thedividends on common shares.
The correct answer wasA
Similar to theinterest payments on a debt security, dividends on non-participating preferenceshares (preferred stock) are typically fixed. Unlike the interest payments on adebt security, the company is not contractually obligated to pay preferreddividends. Preferred dividends are typically higher than a firm’s commondividends.
3 . A firm has aprofit margin of 10%, an asset turnover of 1.2, an equity multiplier of 1.3,and an earnings retention ratio of 0.5. What is the firm's internal growthrate?
A)7.8%.
B)6.7%.
C)4.5%.
The correct answer was A
ROE = (Net Income /Sales)(Sales / Total Assets)(Total Assets / Total Equity)
ROE = (0.1)(1.2)(1.3)= 0.156
g = (retentionratio)(ROE) = 0.5(0.156) = 0.078 or 7.8%
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4 . Liquidity ofprivate equity is most likely:
A)greater thanliquidity of public equity.
B)less than liquidityof public equity.
C)about equal toliquidity of public equity.
The correct answer wasB
Private equitysecurities are not registered to be traded in a public market, and thereforeare less liquid that public equity.
5 . In its latest annualreport, a company reported the following:
Net income = $1,000,000
Total equity = $5,000,000
Total assets = $10,000,000
Dividend payout ratio = 40%
Based on thesustainable growth model, the most likely forecast of the company’s futureearnings growth rate is:
A)6%.
B)12%.
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C)8%.
The correct answer wasB
g = (RR)(ROE)
RR = 1 ? dividendpayout ratio = 1 ? 0.4 = 0.6
ROE = NI / TotalEquity = 1,000,000 / 5,000,000 = 1 / 5 = 0.2
Note: This is the\"simple\" calculation of ROE. Since we are only given these inputs,these are what you should use. Also, if given beginning and ending equitybalances, use the average in the denominator.
g = (0.6)(0.2) = 0.12or 12%
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