Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Exam Questions – Chapter 5-7
1. The present value of the terminal (continuation) value cash flow that begins in 9 years is
$10,000,000 assuming a cost of equity equal to 14%. The year 9 free cash flow
(beginning of the growing perpetuity) is $3,137,860. What is the growth rate required for
the continuation value term?
a. 1%
b. 2%
c. 3%
d. 4%
e. 5%
2. The present value of the terminal (continuation) value cash flow that begins in 9 years is
$10,000,000 assuming a cost of equity equal to 8%. The year 11 free cash flow
(beginning of the growing perpetuity) is $1,295,355. What is the growth rate required for
the continuation value term?
a. 1%
b. 2%
c. 3%
d. 4%
e. 5%
3. The present value (today) of the terminal (continuation) value cash flow that begins in 7
years is $20,000,000 assuming a cost of equity equal to 18%. The year 7 free cash flow
(beginning of the growing perpetuity) is $8,638,573. What is the growth rate required for
the continuation value term?
a. 1%
b. 2%
c. 3%
d. 4%
e. 5%
4. Which of the following increases free cash flows to the firm (both equity and debt)?
a. An increase in net profit margins
b. An increase in inventories
c. An increase in accounts receivable
d. A decrease in accounts payable
e. A decrease in Plant, Property and Equipment
5. Which of the following decreases free cash flows to the firm (both equity and debt)?
f. An increase in gross margins
g. An increase in inventories
h. A decrease in accounts receivable
i. A decrease in accounts payable
j. A decrease in Plant, Property and Equipment
6. Which of the following situations will most likely result in managers deciding to increase
the outlays for working capital?
a. they expect that the sales will shrink in the future,
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Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
b. they expect that operating efficiency will improve
c. the way of doing business is not likely to change
d. Working Capital Turnover is projected to decrease due to declining sales.
e. Days Sales Outstanding is expected to decrease despite no change in sales.
7. Which of the following situations will most likely result in managers deciding to increase
the outlays for working capital?
f. they expect that the sales will shrink in the future,
g. they expect that operating efficiency will improve with constant sales
h. Total fixed assets are projected to decline due to the planned selling off of unproductive
divisions
i. Working Capital Turnover is projected to increase despite declining projected sales.
j. Days Sales Outstanding is expected to increase despite no change in sales.
8. Consider a company with the following: Value of debt is 200 with kd of 12%. Before Tax
value of firm is 300 and the before tax WACC is 14%. How much is the ke for the firm.
a. 12%
b. 42%
c. 08%
d. 14%
e. 18%
9. Consider a following company: VD is 100 with kd of 10%. VE is 600 and WACCBT is
13.4%. ke is 14% and the tax rate is 30%. Compute the after tax WACC for the firm.
a. 12%
b. 22%
c. 9.4%
d. 14%
e. 18%
10. Consider a company with the following: Value of debt is 200 with kd of 12%. Value of the
firm is 600; ke is 18% and rf = 4% and T = 30%. The computed WACCAT would be:
f. 4%
g. 12%
h. 14.8%
i. 16%
j. 18%
11. Assume the market return and risk-free rate remain unchanged. Which of the following
must be true if the firm’s Beta suddenly changes from 1.8 to 0.9?
a. The firms cost of equity declines by 50%
b. The firm’s cost of debt increases in direct proportion to the decrease in the cost of
equity because the WACC must remain constant
c. The WACC of the firm increases
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Post Exam 2 (Regular Semester) Sample Problems
d. The value of the equity increases
e. The share price will decrease
FSA3321 (Moore)
12. You have just computed the Beta of a stock to be 2.5 and the estimate of the relevant riskfree rate is 3%. The expected market return next period is 6% and your estimate of K e is
23%. What is the appropriate long-run market risk premium?
a. 3.0%
b. 7.0%
c. 7.5%
d. 8.0%
e. 9.0%
13. Assume next period’s dividend is forecast to be $1.20 per share; that WACC = .18; the cost
of equity is 20%; the cost of debt is 14%; the risk-free rate is 5% and the long-run
dividend growth rate is expected to be 8% . The best estimate the today’s share value
using the discounted dividends method is:
a. $6.67
b. $12.00
c. $6.00
d. $10.00
e. $24.00
14. From an empirical (estimation) perspective, the main problem of the discounted dividends
valuation model (as compared to free cash flows and residual income) is that:
a. Dividend payments are too variable compared with price variability
b. The implied investment horizon to recover value is unrealistically short.
c. The amount of price variability explained by dividend variability is relatively small.
d. Next period’s dividends are relatively difficult to predict.
e. Special dividends are difficult to incorporate when firms pay regular dividends
15. Discounted dividends valuation models require which of the following discount factors?
a. WACC and the dividend growth rate
b. Cost of Debt and Cost of Equity
c. Cost of Debt and the dividend growth rate
d. Cost of Equity and the dividend growth rate
e. Cost of Equity and WACC
16. The major benefit of using the method of comparables as a stock price screening tool is:
a. It provides consistent results
b. It is grounded in financial theory
c. It requires extensive forecasts and analysis
d. It requires little judgment
e. It is quick and easy to implement
17. Which of the following is true regarding the sensitivity of the Free Cash Flow valuation
model to errors?
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Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
a. The future terminal (continuation) cash flow is extremely sensitive to forecasting and
growth rate errors.
b. All else being equal, a terminal (continuation) value computed 10 years from today with
a 3% overstatement in the growth rate will bias the intrinsic valuation more than if the
terminal (continuation) value computation were made in 6 years with a 3%
overstatement in growth.
c. Financial statements after the year 2002 provide less accurate information regarding
the market value of debt than financial statements prepared in the late 1980’s.
d. Cash flow based statements provide more forward looking information than do accrual
based statements and valuation methods.
e. Free Cash Flow valuations are riddled with errors and do a poorer job of explaining and
forecasting stock prices that the Discounted Dividends model.
18. The firm’s spread and net financial leverage:
a. Move in the same direction
b. Move in opposite directions
c. Are independent of one another
d. Are two terms that mean the same thing
e. Are controlled by the investment management function
19. Which of the following actions would increase a company’s sustainable growth rate?
a. Decreasing Inventory turnover
b. Purchasing Fixed Assets
c. Decreasing Cost of Goods Sold
d. Increasing Accounts Payable Turnover
e. Issuing more executive stock options
20. Which of the following is not a driver of growth and profitability that is associated with
product market strategies?
a. Investment Management
b. Managing Working Capital
c. Acquiring the appropriate Fixed Assets
d. Finding the most efficient method of financing Fixed Assets
e. Developing effective marketing strategies
21. When comparing the firm’s performance with that of its competitors:
a. The analyst should perform time-series analysis
b. The analyst should use all the average of all members of the industry as a benchmark
c. The analyst should randomly select a member of the industry as a benchmark
d. The analyst should compare the firm with direct competitors or from segments of the
industry that are direct competitors (in terms of product market strategies).
e. The analyst should compare the firm’s ROA with the return on the S&P 500
22. Which of the following types of businesses do you expect to show the highest degree of
seasonality in quarterly earnings?
a. Fast Food Restaurants (e.g. McDonalds).
b. Supermarkets and Grocery Stores
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Post Exam 2 (Regular Semester) Sample Problems
c. Diversified Freight and Transport Companies
d. Prescription Pharmacies
e. Cotton Farming
FSA3321 (Moore)
23. Which of the following types of businesses do you expect to show the lowest degree of
seasonality in quarterly earnings?
a. Consumer Electronics
b. Coal Mining and Extraction
c. Cotton Farming
d. Commercial Passenger Airlines
e. Manufacturers of allergy medicine
Computation of Valuations Models Section
Use the following summary financial statement information and forecasts provided by TTU
Value-Metrics to answer the valuation questions in this section about Hi-Flyer Corp.
All Per Share
EPS
DPS
BVE (year end)
CFFO
CFFI
CFFF
BV Liabilities
Ke
Kd
WACC
Actual
31 Dec 2004
4.50
1.10
25.00
5.00
-3.00
-2.00
25.00
0.10
0.05
0.08
Estimated
31 Dec 2005
5.25
1.50
Estimated
31 Dec 2006
3.60
1.80
Estimated
31 Dec 2007
4.80
2.00
6.00
-2.50
-4.00
4.00
-4.00
2.00
6.00
-5.00
2.00
CFFO = Cash Flow from operating activities
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Post Exam 2 (Regular Semester) Sample Problems
CFFI = Cash Flow from investing activities
CFFF = Cash Flow from financing activities
FSA3321 (Moore)
1. Using the TTU Value-Metrics forecasts, determine the intrinsic value of High Flyer shares.
Use the discounted dividends model; assume the forecast dividend payment in 2008 is
$2.25 and that is will growth by 4% per year in perpetuity. The appropriate intrinsic value
is:
a. $29.95
b. $37.50
c. $41.85
d. $26.85
e. $35.35
2. (Sensitivity Analysis). You know that dividend growth rates are estimated with error. In
the previous problem, the dividend growth perpetuity was assumed to be 4% per year.
What would be the impact on share price if the growth rate were assumed to be 6% (all
other information remains the same).
a. $15.49 higher
b. $15.49 lower
c. $18.75 higher
d. $18.75 lower
e. cannot be determined from the information provided
3. (Free Cash Flow Valuation). Compute the free cash flow per share to the firm in 2007.
a. $6.00
b. $0.75
c. $1.00
d. $7.50
e. $10.00
4. (Free Cash Flow Valuation). Assume that free cash flow per share to the firm per share is
forecast to be $2.00 per share in 2008 and that it is expected to grow by 6% per year
thereafter. The estimated intrinsic value per share is:
a. 78.13
b. 103.93
c. $3.93
d. $50.13
e. $75.13
5. What would the impact on your estimated share price be in the previous question if the
growth rate in the terminal value perpetuity were zero?
a. $56.35 increase
b. $56.35 decrease
c. $25.00 increase
d. $25.00 decrease
e. $18.78 decrease
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Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Use the following information to solve the following three (3) problems
Valuation with P/E and P/B multiples
CrossTex Industries is a west Texas based natural gas producer and distributor that you are
trying to value. Using the method of comparables, assess the value of CrossTex. Information
is provided concerning the current share price (PPS), current earnings per share (EPS) and the
current book value of equity per share (BPS) for Cross-Tex and three of its competitors.
Required: Value CrossTex using the P/E and P/B multiples.
CrossTex Industries
RGC Resources
Atmos Engergy Corp.
Kinder Morgan
PPS
24.33
25.75
63.40
EPS
2.83
1.78
1.55
3.11
BPS
28.13
17.82
18.15
21.75
6. Using the Price earnings multiple, what is the value per share for Value CrossTex Industries
when performing a valuation based on the method of comparables?
a. $6.08
b. $16.89
c. $47.80
d. $46.28
e. $49.87
7. Using the Price-to-book multiple, what is the value per share for Value CrossTex Industries
when performing a valuation based on the method of comparables?
a. $55.30
b. $541.22
c. $19.24
d. $50.52
e. $53.44
8. Which company appears to be an “outlier” which should be omitted when computing the
industry average market-to-book ratio?
a. CrossTex Industries
b. RGC Resources
c. Atmos Engergy Corp.
d. Kinder Morgan
e. None of the firms appear to be an outlier
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Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Exam 4 Based Questions
Third Exam – Summer II
8. Manufactured Earnings is a "darling" of Wall Street analysts. Its current market price is $15
per share, and its book value is $5 per share. Analysts forecast that the firm’s book value will
grow by 10 percent per year indefinitely. The cost of equity is estimated to be 15%. You
have just estimated the long-term average ROE for the firm to be 30% per year. What is the
appropriate intrinsic valuation of the firm you would have computed?
a. $15 per share
b. $20 per share
c. $25 per share
d. $30 per share
e. $35 per share
Use the following information for Question 9
Accounting-based valuation suggests that the stock price (a numerator of the PE ratio) can be viewed as
the sum of the current book value per share plus the discounted expected future abnormal earnings per
share.
 E ROE t 1  rE  Et ROE t  2  rE 1  g t 1  Et ROE t 3  rE 1  g t 1 1  g t  2 

PPSt  BVE t 1  t


 
2
3
1  rE 
1  rE 
1  rE 


9. How can a company with a low ROE have a high PE ratio?
a. Cost of equity capital is low; expected growth of book value is high; and expected
future ROE is high (relative to current period ROE).
b. Cost of equity capital is high; expected growth of book value is low; and expected
future ROE is low (relative to current period ROE).
c. Cost of equity capital is low; expected growth of book value is low; and expected future
ROE is low (relative to current period ROE).
d. Cost of equity capital is high; expected growth of book value is low; and expected
future ROE is low (relative to current period ROE).
e. Cost of equity capital is high; expected growth of book value is high; and expected
future ROE is low (relative to current period ROE).
11. Consider a company with the following attributes. Value of debt is 200 with kd of 12%.
Value of the firm is 300 and the WACC is 14%. How much is the ke for the firm.
k. 12%
l. 42%
m. 08%
n. 14%
o. 18%
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Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
19. Which of the following is false regarding the Residual Income Valuation Model.
a. It is grounded in financial theory
b. It has the least explanatory and predictive power of the models we have considered
c. It links accounting valuations of equity to market valuations of equity
d. Normalized earnings are based upon the equity investment and cost of equity
e. It is a flexible model that allows the analyst to focus on specific business elements
20. Assume you had just performed a valuation using the residual income model. You found
that 15% of the value was supported by the current book value; that 15% of the value was
supported by residual income forecast annual for the next 7 years and the remainder was
associated with terminal value computations. What type of firm are you valuing?
a. A manufacturer within a stable, mature industry
b. A public utilities company
c. A high tech company in a growing industry
d. A major retailer such as Wal-Mart
e. A healthcare provider such as a hospital
Short Problem # 2 (Show all work to receive full credit) – 10 Points
Value General Electric at the beginning of 1999. Assume that kd = 5% and that ke = 10%
Assume after 2002 that residual income is expected to grow at 4% per year.
Make sure to show all components of the valuation. Decompose into value derived from
assets-in-place; forecast residual income and terminal value. Also, comment on your results.
1
99
20.73
4.36
1.7
23.39
2.073
2.287
0.909
2.08
Actual
Ke
g
0.10
0.04
BVEo
EPS
DPS
BVEe
Norm Inc
Resid Inc
PV Factor
PV Res Inc.
20.73
BVE
PV Forecast RI
TV Perpetuity
PV TV Perp
Value of Equity
20.73
4.45
% Values
34.53%
7.42%
34.85
60.03
58.05%
100.00%
2
0
23.39
4.85
1.92
26.32
2.339
2.511
0.826
2.08
3
1
26.32
3.03
2.08
27.27
2.632
0.398
0.751
0.30
4
2
27.27
5.51
2.32
30.46
2.727
2.783
46.38
General Electric Co.
Actual
1998
Forecast
1999
Forecast
2000
Forecast
2001
Forecast
2002
EPS
3.75
4.36
4.85
3.03
5.51
DPS
1.46
1.70
1.92
2.08
2.32
BPS
20.73
Forecast year, t
Fourth Exam – Summer II (Moore)
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Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
1. Which of the following types of market return measures would be most appropriate for
estimating Beta for a large firm (greater than $4 billion market capitalization)?
f. S&P 500 monthly return
g. New York Stock Exchange Monthly Return
h. Dow Jones Industrial Average’s monthly return
i. A broad-based market composite return with representation of small, medium and large
cap firms
j. The 3-month treasury yield
2. What is the main disadvantage of using daily returns to compute the firm’s Beta?
f. The data is not available to the public
g. Daily returns are inconsistent with the theoretical model
h. Daily returns are computed only on a Monday through Friday basis, and weekends
(when markets are closed) renders the model useless
i. Daily returns are “noisy” and provide less explanatory power than longer-term
measures.
j. The true value of a firm’s Beta changes on a daily basis.
3. Assume the market return and risk-free rate remain unchanged. Which of the following
must be true if the firm’s Beta suddenly changes from 1.8 to 0.9?
k. The firms cost of equity declines by 50%
l. The firm’s cost of debt increases in direct proportion to the decrease in the cost of
equity because the WACC must remain constant
m. The WACC of the firm decreases
n. The value of the equity doubles
o. The share price will decrease
4. Which is incorrect regarding the Abnormal Earnings Growth valuation model?
a. Although the model incorporates cumulative dividend earnings, it is still appropriate for
valuing firms that don’t pay dividends
b. A firm that, on average, has earned more than its Ke has negative AEG
c. A firm that, on average, has earned less than its Ke has negative AEG
d. A firm with forecast earnings growth less than Ke will increase shareholder value by
increasing dividends.
e. A decrease in the cost of sales percentage will increase the AEG
8. Old Reliable Manufacturing Company's stock has a market price of $20 per share and a
book value of $10 per share. If its cost of equity capital is 15 percent and its book value is
expected to grow at 5 percent per year indefinitely, what is the market’s assessment of its
steady state return on equity?
f. 25%
g. 30%
h. 35%
i. 40%
j. 45%
- 10 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
9. YouPay is a publicly traded internet-based garage sale intermediary. It’s Market-to-Book
ratio is 7. Assuming YouPay has a cost of equity capital of 15% and that its Return on
equity has been consistently at 21% for the past 3 years. What growth rate in book value
(per year) must YouPay average in the long run in order to support its current stock price?
a. 2%
b. 5%
c. 6%
d. 10%
e. 14%
10. You have just computed the Beta of a stock to be 1.5 and the estimate of the relevant riskfree rate is 3%. The expected market return next period is 2% and the long-run market
risk premium is expected to hold at its historical level of 7%. What is the appropriate
estimate of the firm’s Ke?
f. 1.5%
g. 3%
h. 7%
i. 10.5%
j. 13.5%
16. The intrinsic P/E multiple would be computed using:
a. Trailing EPS
b. The Current market price you observe
c. The Forecast Book value per share you prepare
d. The Intrinsic Market Price you estimate
e. The normal earnings you estimate
17. You are comparing the published P/E multiple with the intrinsic P/E multiple based on your
valuation of a company and they differ. Both ratios use the same earnings denominator.
Which of the following must be true.
a. Intrinsic P/E > Published P/E implies you believe the firm is overvalued
b. Intrinsic P/E < Published P/E implies you believe the firm is undervalued
c. The published P/E must be wrong
d. The intrinsic P/E must be wrong
e. None of the above must be true
18. You used the AEG model to value a non-dividend paying company that has Ke of 10% and
assumed the AEG after year 7 would be equal to zero. In performing sensitivity analysis,
you want to see the effect including a constant AEG perpetuity from year 8 onward of
$0.20 per share. The incremental impact on your intrinsic valuation would be:
a. $0.20 increase in the price per share
b. $2.00 increase in the price per share
c. $1.13 increase in the price per share
d. $11.30 increase in the price per share
e. $20.00 increase in the price per share
Short Problem 1 (Show all work)
- 11 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Use the AEG model and the following information to estimate a share value for General Motors
at the end of 1986. Assume dividends are paid on the last day of the year.
General Electric Co.
In this case, abnormal earnings growth is expected to grow at a 5 percent rate after 1989. Assume a
cost of equity equal to 15% - Can’t be done with the provided information
Forecasts of EPS DPS
1986 1987 1988
1989
Dps
Eps
1.33
3.20
1.46
3.75
1.70
4.36
Problem 3 (10 Points) – Show all work for full credit
Value General Electric at the beginning of 1998. Assume that kd = 5% and that ke = 14%
Assume after 2002 that residual income is expected to grow at 3% per year.
Make sure to show all components of the valuation. Decompose into value derived from
assets-in-place; forecast residual income and terminal value. Also, comment on your results.
General Electric Co.
Forecast
1998
Forecast
1999
Forecast
2000
Forecast
2001
Forecast
2002
EPS
3.75
4.36
4.85
3.03
5.51
DPS
1.46
1.70
1.92
2.08
2.32
Forecast year, t
BPS
Actual
1997
18.44
Actual
Ke
g
0.14
0.03
BVEo
EPS
DPS
BVEe
Norm Inc
Resid Inc
PV Factor
PV Res Inc.
BVE
PV Forecast RI
TV Perpetuity
PV TV Perp
Value of Equity
18.44
1
99
18.44
4.36
1.7
21.1
1.844
2.516
0.909
2.29
18.44
5.02
% Values
30.72%
8.37%
20.57
44.04
34.27%
73.35%
2
0
21.1
4.85
1.92
24.03
2.11
2.74
0.826
2.26
3
1
24.03
3.03
2.08
24.98
2.403
0.627
0.751
0.47
4
2
24.98
5.51
2.32
28.17
2.498
3.012
27.38
Problem 4 (10 Points) – Show all work for full credit
- 12 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Use the AEG model and the following information to estimate a share value for General Electric
at the end of 1986. Assume dividends are paid on the last day of the year.
General Electric Co.
In this case, abnormal earnings growth is expected to grow at a 3 percent rate after 1989. Assume a
cost of equity equal to 10%- Can’t be done with the provided information
Forecasts of EPS DPS
1986 1987 1988
1989
Dps
Eps
1.30
3.20
1.40
3.80
1.50
4.40
Third Exam – Fall 2004 (Moore)
1. Which of the following types of market return measures would be most appropriate for
estimating Beta for a medium sized high-tech firm ($100 million market capitalization)?
k. S&P 500 monthly return
l. New York Stock Exchange Monthly Return
m. Dow Jones Industrial Average’s monthly return
n. A broad-based market composite return with representation of small, medium and large
cap firms
o. The 3-month treasury yield
2. Assume the market return and risk-free rate (both positive) remain unchanged. Which of
the following must be true if the firm’s Beta suddenly changes from 0.75 to 1.50?
p. The firms cost of equity doubles
q. The firm’s cost of debt decreases in direct proportion to the increase in the cost of
equity because the WACC must remain constant
r. The WACC of the firm increases
s. The value of the equity is reduced by half
t. The share price will increase
5.Old Reliable Manufacturing Company's stock has a book value of $15 per share. You have
estimated its cost of equity capital to be 6 percent and its book value is expected to grow at 1
percent per year indefinitely. Compute Old Reliable’s intrinsic share value using the long run
average residual income perpetuity method? - Can’t be done with the provided information
k. $25.00
l. $25.56
m. $500.00
n. $70.00
o. $178.57
6.Old Reliable Manufacturing Company's stock has a market price of $52.50 per share and a
book value of $15 per share. You have estimated its steady state ROE to be 4 percent per year
and its cost of equity capital is 8 percent. What expected growth rate in book value (in
perpetuity) supports the current stock price? - Can’t be done with the provided information
- 13 -
Post Exam 2 (Regular Semester) Sample Problems
a. 5%
b. 4%
c. 3%
d. 2%
e. 1%
FSA3321 (Moore)
7. You have just computed the Beta of a stock to be 2.0 and the estimate of the relevant riskfree rate is 3%. The expected market return next period is 2% and the long-run market
risk premium is expected to hold at its historical level of 4%. What is the appropriate
estimate of the firm’s Ke?
k. 1.0%
l. 4%
m. 9%
n. 11%
o. 13%
14. You are comparing the published P/E multiple with the intrinsic P/E multiple based on your
valuation of a company and they differ. Both ratios use the same earnings denominator.
Which of the following must be true?
f. Intrinsic P/E > Published P/E implies you believe the firm is overvalued
g. Intrinsic P/E < Published P/E implies you believe the firm is undervalued
h. The published P/E must be wrong
i. The intrinsic P/E must be wrong
j. None of the above must be true
Use the following information to answer questions 19-20
You have made the following forecast of EPS and DPS for Hi-Flyer Corp. Note the cost of
equity is estimated to be 10%
Ke
0.1
2004
eps
dps
2005(E)
2.00
0.50
1
2006(E)
2.50
0.50
2
2007(E)
2.75
0.50
19. Use the AEG model to value High-Flyer. Assume no abnormal earnings growth after 2007.
What is the estimated price per share for High-Flyer at the end of 2004?
a. $3.59
b. $20.00
c. $21.77
d. $23.59
e. $27.70
20. After computing (19), you want to assess the impact of potential terminal value AEG in
perpetuity. How much would the share price increase if AEG were assumed to be $0.05
per year from 2008 on? (again, this is the impact on your end of 2004 valuation)
a. $0.05
b. $0.50
c. $0.41
- 14 -
Post Exam 2 (Regular Semester) Sample Problems
d. $4.13
e. $5.36
FSA3321 (Moore)
Second Examination – Spring 2005 (Moore)
8. From an empirical (estimation) perspective, the main problem of the discounted dividends
valuation model (as compared to free cash flows and residual income) is that:
a. Dividend payments are too variable compared with price variability
b. The implied investment horizon to recover value is unrealistically short.
c. The amount of price variability explained by dividend variability is relatively small.
d. Next period’s dividends are relatively difficult to predict.
e. Special dividends are difficult to incorporate when firms pay regular dividends
Use the following information for Question 9
Accounting-based valuation suggests that the stock price (a numerator of the PE ratio) can be
viewed as the sum of the current book value per share plus the discounted expected future
abnormal earnings per share:
 E ROE t 1  rE  Et ROE t  2  rE 1  g t 1  Et ROE t 3  rE 1  g t 1 1  g t  2 

PPSt  BVE t 1  t


 
2
3
1  rE 
1  rE 
1  rE 


or
PPSt  BVE t 
Et ROE  k E 
k E  g 
9. How can a company with a low ROE have a high PE ratio?
p. Cost of equity capital is low; expected growth of book value is high; and expected
future ROE is high (relative to current period ROE).
q. Cost of equity capital is high; expected growth of book value is low; and expected
future ROE is low (relative to current period ROE).
r. Cost of equity capital is low; expected growth of book value is low; and expected future
ROE is low (relative to current period ROE).
s. Cost of equity capital is high; expected growth of book value is low; and expected
future ROE is low (relative to current period ROE).
t. Cost of equity capital is high; expected growth of book value is high; and expected
future ROE is low (relative to current period ROE).
Final Exam – Spring 2005
19. The main benefit of the residual income valuation model (as compared to free cash flows
and discounted dividends) is that:
a. Dividend payments are too variable compared with price variability
b. The implied investment horizon to recover value is unrealistically short.
c. The price variability explained by residual income variability is relatively small.
- 15 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
d. The valuation is not as sensitive to terminal value growth rates as compared to free
cash flow and dividend valuation models.
e. Residual income is easier to predict than the other measures.
20. The present value (today) of the terminal (continuation) value cash flow that begins in 7
years is $20,000,000 assuming a cost of equity equal to 18%. The year 7 free cash flow
(beginning of the growing perpetuity) is $8,638,573. What is the growth rate required for
the continuation value term?
a. 1%
b. 2%
c. 3%
d. 4%
e. 5%
22. Which is correct regarding the Abnormal Earnings Growth valuation model?
f. Although the model incorporates cumulative dividend earnings, it is still appropriate for
valuing firms that don’t pay dividends.
g. A firm that, on average, has earned more than its Ke has negative AEG.
h. During periods when Residual Income is growing, AEG is constant for those periods.
i. A firm with forecast earnings growth less than Ke will increase shareholder value by
decreasing dividends.
j. A decrease in the cost of sales percentage will increase the AEG
25. Old Reliable Manufacturing Company's stock has a market price of $40 per share and the
market’s assessment of its steady state return on equity is 25% per year. If its cost of equity
capital is 10 percent and its book value is expected to grow at 5 percent per year indefinitely,
what is the current book value per share?
u. $3.00
v. $4.00
w. $10.00
x. $30.00
y. $40.00
26. You have just computed the Beta of a stock to be 2.5 and the estimate of the relevant riskfree rate is 3%. The expected market return next period is 6% and your estimate of K e is
23%. What is the appropriate long-run market risk premium?
p. 3.0%
q. 7.0%
r. 7.5%
s. 8.0%
t. 9.0%
Computation of Valuations Models Section
Use the following summary financial statement information and forecasts provided by TTU
Value-Metrics to answer the valuation questions in this section about Hi-Flyer Corp.
All Per Share
EPS
Actual
31 Dec 2004
4.50
- 16 -
Estimated
31 Dec 2005
5.25
Estimated
31 Dec 2006
3.60
Estimated
31 Dec 2007
4.80
Post Exam 2 (Regular Semester) Sample Problems
DPS
BVE (year end)
CFFO
CFFI
CFFF
BV Liabilities
Ke
Kd
WACC
1.10
25.00
5.00
-3.00
-2.00
25.00
0.10
0.05
0.08
FSA3321 (Moore)
1.50
28.75
1.80
30.55
6.00
-2.50
-4.00
2.00
33.35
4.00
-4.00
2.00
6.00
-5.00
2.00
CFFO = Cash Flow from operating activities
CFFI = Cash Flow from investing activities
CFFF = Cash Flow from financing activities
36. (Residual Income Valuation). Compute the book value of equity at the end of 2007.
a. $26.95
b. $30.55
c. $25.00
d. $33.35
e. $28.75
37. (Residual Income Valuation). Compute the normal income for 2006.
a. $2.88
b. $3.03
c. $0.73
d. $3.60
e. $4.41
38. (Residual Income Valuation). Compute the intrinsic value of Hi-Flyer’s shares at the end of
2004. Assume residual income will be $2.00 in 2008 and no growth.
a. $29.41
b. $44.44
c. $30.03
d. $40.03
e. $49.41
39. (Residual Income Valuation - sensitivity). Assume the residual income perpetuity in the
previous problem was changed to $1.50 beginning in 2008 with a 2% growth rate. By how
much will this change the estimated share price computed in the previous problem?
a. $5.00 lower
b. $3.76 lower
c. $1.76 lower
d. $0.94 lower
e. $0.75 lower
40. (AEG Valuation). Compute the dividend reinvestment income (DRIP) for 2007.
a. $1.02
b. $1.80
c. $1.98
d. $0.15
e. $0.18
- 17 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
41. (AEG Valuation). Assume the dividend reinvestment income (DRIP) in 2006 is $0.15,
compute the AEG for 2006.
a. -$1.84
b. -$2.03
c. $1.02
d. $0.84
e. -$1.88
42. (AEG Valuation). Assume that AEG is forecast to be $0.05 per year from 2008 onwards.
Estimate the intrinsic value of Hi-Flyer’s shares at the end of 2004.
a. $39.60
b. $46.65
c. $4.67
d. $52.50
e. $5.25
End of Valuation Model Computation Section
43. Old Reliable Manufacturing Company's stock has a book value of $15 per share. You have
estimated its cost of equity capital to be 6 percent and its book value is expected to grow at 1
percent per year indefinitely. Compute Old Reliable’s intrinsic share value using the long run
average residual income perpetuity method? – Can’t do (whoops)
a. $25.00
b. $25.56
c. $500.00
d. $70.00
e. $178.57
44. Old Reliable Manufacturing Company's stock has a market price of $52.50 per share and a
book value of $15 per share. You have estimated its steady state ROE to be 4 percent per year
and its cost of equity capital is 8 percent. What expected growth rate in book value (in
perpetuity) supports the current stock price? – Can’t do (whoops)
f. 5%
g. 4%
h. 3%
i. 2%
j. 1%
- 18 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
4. Which of the following will cause estimated before-tax WACC to be most severely biased
upwards?
a. P/B > 1 and using the book value of liabilities instead of market value of liabilities.
b. P/B < 1 and using the book value of liabilities instead of market value of liabilities.
c. P/B > 1 and using the book value of equity instead of market value of equity.
d. P/B < 1 and using the book value of equity instead of market value of equity.
e. P/B > 1 and using the market value of equity instead of book value of equity.
5. Which of the following is true regarding the Residual Income Valuation Model.
a. It is devoid of financial theory
b. It has the least explanatory and predictive power of the models we have considered
c. It links accounting valuations of equity to market valuations of equity
d. Normalized earnings are based upon the equity investment and DRIP income
e. It has limited interpretations since it cannot be decomposed into value drivers
6. Assume you had just performed a valuation using the residual income model. You found
that 15% of the value was supported by the current book value; that 25% of the value was
supported by residual income forecast annual for the next 7 years and the remainder was
associated with terminal value computations. What type of firm are you valuing?
a. A manufacturer within a stable, mature industry
b. A new restaurant chain
c. A high tech company in a growing industry
d. A major retailer such as Wal-Mart
e. A University such as Texas Tech
7. The intrinsic P/B (Price to Book) multiple would be computed using:
f. The Discounted Dividends Model
g. The Discounted Free Cash Flow Model
h. The Discounted Residual Income Model
i. The Long-run Residual Income Perpetuity Model
j. The Standard Method of Comparable method based on industry averages
8. Old Reliable Manufacturing Company's stock has a market price of $60 per share and a
book value of $10 per share. If its steady state return on equity is 20 percent and its book
value is expected to grow at 8 percent per year indefinitely, what is the cost of equity?
z. 5%
aa. 10%
bb. 15%
cc. 20%
dd. 25%
- 19 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
9. EPAY is expected to begin paying a $3.00 per share annual dividend in 3 years. Its cost of
equity is 14%, before tax WACC is 10% and the annual dividend growth rate is expected
to be 4%. Determine the appropriate current share price for EPAY.
f. $8.09
g. $13.67
h. $20.25
i. $26.32
j. $30.00
10. The following information is available for JKL corp and its competitors. Price JKL using the
PEG ratio. Assume JKL’s income is expected to grow at 7.653% next year. Is JKL under or
over valued relative to the observed price of $52.36(5 Points)
Firm
ABC
DEF
GHI
JKL
PPS
25.32
38.41
42.68
52.36
EPS
3.00
2.50
1.70
4.00
BPS
12.52
20.05
25.76
26.48
PEG
Ratio
1.86
1.96
2.06
Problem 1 (Free Cash Flow Valuation) – 25 Points
- 20 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Use the following summary financial statement information and forecasts provided by TTU
Value-Metrics to value Hi-Flyer Corp. as at June 1, 2007. Assume the Free Cash Flow
estimated for 2009 is the beginning of a perpetuity that will grow at 2% per year.
All Per Share
EPS
DPS
BVE (year end)
CFFO
CFFI
CFFF
BV Liabilities
Ke
Kd
WACC-Before Tax
WACC-After Tax
Actual
31-Dec-06
6.00
0.40
20.00
6.00
-3.00
-2.00
80.00
0.15
0.08
0.10
0.085
Estimated
31-Dec-07
6.3
0.40
Estimated
31-Dec-08
7.20
0.50
Estimated
31-Dec-09
7.80
0.50
7.00
-2.50
-4.00
8.00
-4.00
2.00
9.00
-5.00
3.00
CFFO = Cash Flow from operating activities
CFFI = Cash Flow from investing activities
CFFF = Cash Flow from financing activities
Problem 2 (Residual Income Valuation) – 25 Points
- 21 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Use the following summary financial statement information and forecasts provided by TTU
Value-Metrics to value Hi-Flyer Corp. as at June 1, 2007. Assume the terminal value
perpetuity beginning in 2010 is $2.80 and that it will decline at 20% per year.
All Per Share
EPS
DPS
BVE (year end)
CFFO
CFFI
CFFF
BV Liabilities
Ke
Kd
WACC-Before Tax
WACC-After Tax
Actual
31-Dec-06
6.00
0.40
20.00
6.00
-3.00
-2.00
80.00
0.15
0.08
0.10
0.085
Estimated
31-Dec-07
6.30
0.40
Estimated
31-Dec-08
7.20
0.50
Estimated
31-Dec-09
7.80
0.50
7.00
-2.50
-4.00
8.00
-4.00
2.00
9.00
-5.00
3.00
CFFO = Cash Flow from operating activities
CFFI = Cash Flow from investing activities
CFFF = Cash Flow from financing activities
- 22 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
17. AEG valuation models require which of the following discount factors?
a. WACC and the dividend growth rate
b. Cost of Debt and Cost of Equity
c. Cost of Debt and the dividend growth rate
d. Cost of Equity and the terminal value growth rate
e. Cost of Equity and WACC
18. Assume a firm will pay its first dividend in 3 years. This initial period’s dividend is forecast
to be $3.00 per share and is expected to grow at 6% per year in perpetuity. Assume
WACC = 12%; the cost of equity is 14%; the cost of debt is 8% and the risk-free rate is
5%. The best estimate the today’s share value using the discounted dividends method is:
a. $12.40
b. $19.60
c. $25.31
d. $28.86
e. $37.50
19. The main benefit of the residual income valuation model (as compared to free cash flows
and discounted dividends) is that:
a. Dividend payments are too variable compared with price variability
b. The implied investment horizon to recover value is unrealistically short.
c. The price variability explained by residual income variability is relatively small.
d. The valuation is not as sensitive to terminal value growth rates as compared to free
cash flow and dividend valuation models.
e. Residual income is easier to predict than the other measures.
20. The present value (today) of the terminal (continuation) value cash flow that begins in 7
years is $20,000,000 assuming a cost of equity equal to 18%. The year 7 free cash flow
(beginning of the growing perpetuity) is $8,638,573. What is the growth rate required for
the continuation value term?
a. 1%
b. 2%
c. 3%
d. 4%
e. 5%
21. Assume the market return and risk-free rate remain unchanged. Which of the following
must be true if the firm’s Beta suddenly changes from 1.8 to 0.9?
f. The firms cost of equity declines by 50%
g. The firm’s cost of debt increases in direct proportion to the decrease in the cost of
equity because the WACC must remain constant
h. The WACC of the firm increases
i. The value of the equity increases
j. The share price will decrease
- 23 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
22. Which is correct regarding the Abnormal Earnings Growth valuation model?
k. Although the model incorporates cumulative dividend earnings, it is still appropriate for
valuing firms that don’t pay dividends.
l. A firm that, on average, has earned more than its Ke has negative AEG.
m. During periods when Residual Income is growing, AEG is constant for those periods.
n. A firm with forecast earnings growth less than Ke will increase shareholder value by
decreasing dividends.
o. A decrease in the cost of sales percentage will increase the AEG
23. Assume a firm’s revenues and net income are projected to grow by 10% per year into the
foreseeable future. What terminal value growth rate is most appropriate for the free cash
flow valuation model?
a. -40%
b. -10%
c. 0%
d. 5%
e. 15%
24. Assume a firm’s revenues and net income are projected to grow by 10% per year into the
foreseeable future. What terminal value growth rate is most appropriate for the AEG valuation
model?
f. -30%
g. 0%
h. 5%
i. 15%
j. 40%
25. Old Reliable Manufacturing Company's stock has a market price of $60 per share and the
market’s assessment of its steady state return on equity is 25% per year. If its cost of equity
capital is 10 percent and its book value is expected to grow at 5 percent per year indefinitely,
what is the current book value per share?
ee. $15.00
ff. $20.00
gg. $28.86
hh. $37.50
ii. $60.00
26. You have just computed the Beta of a stock to be 2.5 and the estimate of the relevant riskfree rate is 5%. The expected market return next period is 6% and your estimate of K e is
23%. What is the appropriate long-run market risk premium?
u. 7.0%
v. 7.2%
w. 7.5%
x. 8.0%
y. 9.0%
- 24 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Use the following summary financial statement information and forecasts provided by TTU
Value-Metrics to answer the valuation questions in this section about Hi-Flyer Corp.
All Per Share
EPS
DPS
BVE (year end)
CFFO
CFFI
CFFF
BV Liabilities
Ke
Kd
WACC
Actual
31-Dec-06
6.25
2.25
20.00
15.00
-7.00
-5.00
50.00
0.14
0.10
0.12
Estimated
31-Dec-07
8.75
2.75
Estimated
31-Dec-08
9.65
3.00
Estimated
31-Dec-09
11.80
4.25
16.00
-8.00
4.00
18.00
-12.00
-8.00
20.00
-6.00
6.00
CFFO = Cash Flow from operating activities
CFFI = Cash Flow from investing activities
CFFF = Cash Flow from financing activities
31. Using the TTU Value-Metrics forecasts, determine the intrinsic value of High Flyer shares.
Use the discounted dividends model; assume the forecast dividend payment in 2010 is
$5.25 and that it will growth by 9% per year in perpetuity. The appropriate intrinsic value
is:
a. $15.25
b. $17.50
c. $25.31
d. $78.46
e. $112.59
32. (Sensitivity Analysis). You know that dividend growth rates are estimated with error. In
the previous problem, the dividend growth perpetuity was assumed to be 9% per year.
What would be the impact on share price if the growth rate were assumed to be 6% (all
other information remains the same).
a. $26.58 lower
b. $39.37 lower
c. $44.29 lower
d. $65.63 lower
e. $70.87 lower
33. (Free Cash Flow Valuation). Compute the free cash flow per share to the firm in 2008.
a. $6.00
b. $10.00
c. $12.00
d. $20.00
e. ($2.00)
- 25 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
34. (Free Cash Flow Valuation). Assume that free cash flow per share to the firm per share is
forecast to be $15.00 per share in 2010 and that it is expected to grow by 5% per year
thereafter. The estimated intrinsic value per share is:
a. $78.13
b. $124.42
c. $152.52
d. $174.42
e. $214.29
35. What would the impact on your estimated share price be in the previous question if the
growth rate in the terminal value perpetuity were zero?
a. $63.55 decrease
b. $88.97 decrease
c. $89.29 decrease
d. $124.42 decrease
e. $152.52 decrease
36. (Residual Income Valuation). Compute the book value of equity at the beginning of 2008.
a. $20.00
b. $26.00
c. $28.75
d. $32.65
e. $40.20
37. (Residual Income Valuation). Compute the normal income for 2009.
a. $3.64
b. $4.57
c. $5.95
d. $6.01
e. $7.23
38. (Residual Income Valuation). Compute the intrinsic value of Hi-Flyer’s shares at the end of
2006. Assume residual income will be $7.50 in 2010 (perpetuity start) and no growth.
a. $34.95
b. $49.68
c. $51.79
d. $69.68
e. $86.51
39. (Residual Income Valuation - sensitivity). Assume the residual income perpetuity in the
previous problem was changed to a -40% growth rate. By how much will this change the
estimated share price computed in the previous problem?
a. $9.06 lower
b. $13.43 lower
c. $23.79 lower
d. $25.89 lower
e. $34.95 lower
- 26 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
40. (AEG Valuation). Compute the dividend reinvestment income (DRIP) for 2009.
a. $0.300
b. $0.315
c. $0.385
d. $0.420
e. $0.595
41. (AEG Valuation). Assume the dividend reinvestment income (DRIP) in 2008 is $0.385,
compute the AEG for 2008.
a. $0.060
b. $0.385
c. $1.220
d. $9.975
e. $10.04
42. (AEG Valuation). Assume that AEG is forecast to be $0.80 in 2010 and will decline by 50%
per year, onwards. Estimate the intrinsic value of Hi-Flyer’s shares at the end of 2006.
a. $70.87
b. $71.43
c. $74.86
d. $76.69
e. $78.46
End of Valuation Model Computation Section
43. Old Reliable Manufacturing Company's stock has a book value of $15 per share and a longrun ROE = 25%. You have estimated its cost of equity capital to be 16% and its book value is
expected to grow at 12% per year indefinitely. Compute Old Reliable’s intrinsic share value
using the long run average residual income perpetuity method?
f. $25.00
g. $25.56
h. $33.75
i. $48.75
j. $78.57
44. Old Reliable Manufacturing Company's stock has a market price of $52.50 per share and a
book value of $15 per share. You have estimated its steady state ROE to be 20 percent per
year and its expected growth rate in book value (in perpetuity) is 12%. What cost of equity
supports the current stock price?
k. 10.15%
l. 12.33%
m. 13.82%
n. 14.29%
o. 16.48%
- 27 -
Post Exam 2 (Regular Semester) Sample Problems
FSA3321 (Moore)
Use the following information to solve the following three (3) problems
Valuation with P/EBITDA, P/B and PEG multiples (Questions 45-47)
Ball Corp. is a manufacturer of packaging materials that you are trying to value. Using the
method of comparables, assess the value of Ball Corp. Information is provided concerning the
current share price (PPS), forward earnings per share (EPS), the current book value of equity
per share (BPS), EBITDA per share and the one-year ahead earnings growth rate for Ball Corp.
and three of its listed competitors.
Do not eliminate potential outliers in the following valuations.
Sealed Air Corp
Ball Corp
PactIV Corp
Crown Holdings
PPS
32.91
51.54
34.68
24.69
EPS
1.74
3.54
1.84
1.37
BPS
11.01
11.64
6.22
<3.14>
45. Value Ball Corp Using the Price to Book Ratio.
a. $2.72 per share
b. $14.93 per share
c. $49.85 per share
d. $50.41 per share
e. $51.54 per share
46. Value Ball Corp Using the Price to EBITDA Ratio.
a. $7.27 per share
b. $47.04 per share
c. $48.16 per share
d. $53.33 per share
e. $54.22 per share
47. Value Ball Corp Using the PEG Ratio.
a. $33.98 per share
b. $44.98 per share
c. $45.87 per share
d. $51.20 per share
e. $52.46 per share
- 28 -
EBITDA
4.83
7.46
4.49
5.64
1 Year ahead
Earnings Growth
13.2%
9.6%
12.0%
20.5%