Select the best answer: THEORIES 1. Statement 1. The intrinsic value of the stock pertains to its “true value” which can readily be observed. Statement 2. The market value of the stock changes in relation to the company fundamentals and the movement of market as a whole. A. B. C. D. True, True True, False False, True False, False 2. Statement 1. The methods of stock valuation, both using dividends and free-cash-flow, primarily rest on the concept of present value of future cash flows. Statement 2. An assumption in the discounted dividend model is that the dividend flow or dividend stream goes on perpetually in the same way as the life of the corporation. A. B. C. D. True, True True, False False, True False, False 3. Which of the following situations depict an equilibrium: i. ii. iii. iv. Market Value of a stock equals its Intrinsic Value The Expected Return of a stock equals its Required Return The stock’s Growth Rate equals its Required Return The yearly dividends shall be the same indefinitely. A. B. C. D. Statements i and ii Statements i and iii Statements i, ii and iii None of the above 4. The change in growth rate is a factor of A. market or economic conditions B. company-specific or firm C. both market and company-specific D. the stock’s Beta 5. In an equilibrium condition and during a constant growth phase, the stock’s growth rate should equal the A. B. C. D. dividend yield capital gains yield required return corrected closing stock price 6. In estimating a stock’s growth rate, which of the following financial statement ratios would be directly useful? i. ii. iii. iv. Return on Equity Pay-out/Plowback Ratio Price-Earnings Ratio Accounts Receivable Turnover A. B. C. D. Ratios i, ii and iv Ratio iii and iv Ratio i only Ratio i and ii 7. The process of estimating the intrinsic value of a preferred stock generally shows an example of A. B. C. D. an indefinitely increasing stock a perpetuity zero-growth stock both B and C 8. When a stock is undervalued, i. ii. iii. iv. An analyst might advise a “buy” order on the stock. The stock’s intrinsic value exceeds that of its market value. The stock’s market value exceeds that of its intrinsic value. An analyst might issue a “sell” order on the stock. A. B. C. D. Statement i Statement i and iii Statement i and ii Statement iii and iv 9. Free cash flow is an amount of the company’s current earnings which is available for distribution to all the securities holders of the company. Which of the following is not an intended recipient of the free cash flow? A. B. C. D. Common shareholders Preferred shareholders Chief Finance Officer Bondholders 10. The weighted-average cost of capital or (WACC) serves as the equivalent of the cost of equity or required return in the corporate valuation model. Which of the following is an element of WACC? A. B. C. D. Cost of common equity Cost of preferred equity Cost of debt Tax-adjusted cost of debt 11. The terminal value of a non-constant growth stock should be discounted using which of the following periods? A. B. C. D. The last period (year) of the constant growth phase. The first period (year) of the non-constant growth phase. The midpoint period (year) of the non-constant growth phase. The last period (year) of the non-constant growth phase. 12. Which of the following is not a common stockholder’s legal right and privileges? A. B. C. D. Right to elect the corporation’s directors Subordinate to preferred shareholders in terms of dividend distribution Right to be elected as a director of the corporation Right to first receive the dividends before all other shareholders receive their share 13. The analysis of estimating a stock’s intrinsic value is assumed to be performed by the A. B. C. D. Optimistic Investor Perfect Investor Pessimistic Investor Marginal Investor 14. A negative growth rate is also referred to as A. B. C. D. Declining growth Upstream growth Supernormal growth Zero growth 15. Complete the sentence: The marginal investor is an investor who is at the margin and would be willing to _____ if the stock price was slightly lower or to sell if the price was slightly _____. A. B. C. D. sell; lower hold; higher buy; higher buy; lower 16. The considerations associated with stock valuation do not include: A. B. C. D. the expected future dividend performance of the stock the estimated selling time and price of the stock the exchange on which the stock is traded the market return on stocks of that type 17. The market value of common stock is primarily based on A. B. C. D. the firm's future earnings. book value. total assets. retained earnings. 18. In the constant-growth model, the market return must be ____ the dividend growth rate in order for the formula price to be meaningful. A. B. C. D. less than equal to greater than proportional to 19. You are considering investing in ABC, Inc.'s stock which is selling at P45.95. Similar stocks return 16%. ABC's last dividend ABC was P4.50 and a 6% constant growth rate is anticipated. Should you purchase ABC, Inc.? A. No, because the stock is overpriced by P1.75 B. No, because the stock is overpriced by P3.85 C. Yes, because the stock is underpriced by P1.75 D. Yes, because the stock is underpriced by P3.85 20. Statement 1. A stock's total return is realized from two principal sources, its dividend yield and any gain from the increase in its selling price over the original purchase price of the stock. Statement 2. The dividend yield is the annual dividend at the end of the period divided by the current stock's price. A. B. C. D. True, True True, False False, True False, False 21. Statement 1. The component costs of capital are market-determined variables in as much as they are based on investors' required returns. Statement 2. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt. A. B. C. D. True, True True, False False, True False, False 22. Statement 1. The firm's cost of external equity capital is the same as the required rate of return on the firm's outstanding common stock. Statement 2. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors. A. B. C. D. True, True True, False False, True False, False 23. Statement 1. The cost of equity capital from the sale of new common stock (ke) is generally equal to the cost of equity capital from retention of earnings (rs), divided by one minus the flotation cost as a percentage of sales price (1 - F). Statement 2. Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, but capital raised by selling new stock or bonds does have a cost. A. True, True B. True, False C. False, True D. False, False 24. Statement 1. The weighted average cost of capital increases if the total funds required call for an amount of equity in excess of what can be obtained as retained earnings. Statement 2. The marginal cost of capital (MCC) is the cost of the last peso of new capital that the firm raises, and the marginal cost declines as more and more of a specific type of capital is raised during a given period. A. B. C. D. True, True True, False False, True False, False 25. .Statement 1. Even if a firm obtains all of its common equity from retained earnings, its MCC schedule might still increase if very large amounts of new capital are needed. Statement 2. The cost of capital is the firm's average cost funds given what the market demands be paid to attract the funds. A. B. C. D. True, True True, False False, True False, False 26. Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting? A. B. C. D. Long-term debt Short-term debt Common stock Preferred stock 27. Which of the following factors in the discounted cash flow (DCF) approach to estimating the cost of common equity is the least difficult to estimate? A. Expected growth rate, g B. Required return, rs � C. Dividend yield, �1 0 D. Expected rate of return, �� 28. If a firm can shift its capital structure so as to change its weighted average cost of capital (WACC), which of the following results would be preferred? A. The firm should try to decrease the WACC because such an action will increase the value of the firm. B. The firm should try to increase the WACC because such an action will increase the value of the firm. C. The firm should try to decrease the WACC because such an action will decrease the value of the firm. D. The firm should try to increase the WACC because such an action will decrease the value of the firm. 29. The before-tax cost of debt, rd, is the same as the A. B. C. D. average yield to maturity (YTM) associated with the firm's bonds. dividend yield associated with the firm's common stock. average coupon rate of the firm's bonds. re if the firm has no preferred stock. 30. Under normal circumstances, the weighted average cost of capital is used as the firm's required rate of return because A. as long as the firm's investments earn returns greater than the cost of capital, the value of the firm will not decrease. B. returns below the cost of capital will cover all the fixed costs associated with capital and provide excess returns to the firm's stockholders. C. it is comparable to the average of all the interest rates on debt that currently prevail in the financial markets. D. it is an indication of the return the firm is earning from all of its assets in combination. 31. Statement 1. The cost of capital used in capital budgeting must be determined using the specific financing used to fund that particular project. Statement 2. A firm's capital structure has no impact on the firm's weighted average cost of capital. A. B. C. D. True, True True, False False, True False, False 32. Statement 1. The after tax cost of debt is used to calculate the weighted average cost of capital since we are concerned with the after-tax cash flows of the firm. Statement 2. Tax adjustments to the cost of preferred stock must be made when determining the cost of capital since dividend expenses on preferred stocks are tax deductible. A. B. C. D. True, True True, False False, True False, False 33. Statement 1. If a firm cannot invest retained earnings and earn at least the cost of equity, it should pay these funds to shareholders and let them invest directly in other assets that do provide this return. Statement 2. Flotation costs associated with issuing new equity cause the cost of external equity to be lower than the cost of retained earnings. A. B. C. D. True, True True, False False, True False, False 34. Statement 1. The cost of debt, rd, is always less than rs, so rd(1 - T) will certainly be less than rs. Therefore, since a firm cannot be 100% debt financed, the weighted average cost of capital will always be greater than rd(1 - T). Statement 2. Firms should use their weighted average cost of capital (WACC) when they are funding their capital projects with a variety of sources. However, when the firm plans on using only debt or only equity to fund a particular project, it should use the after-tax cost of the specific source of capital to evaluate that project. A. B. C. D. True, True True, False False, True False, False 35. Estimating the cost of common equity using the discounted cash flow approach may be difficult to evaluate because A. B. C. D. the dividend yield is extremely difficult to estimate. the proper growth rate is difficult to establish. the common equity is always changing making it difficult to determine. All of the above are difficult to estimate.
