Questions and Answers of Fundamentals Of Investments Valuation

Frank Myers, CFA, is a fixed-income portfolio manager for a large pension fund. A member of the Investment Committee, Fred Spice, is very interested in learning about the management of fixed-income
Identify a McDonald’s (MCD) corporate bond and examine its valuation metrics.
Suppose a bond has 20 years to maturity and a coupon rate of 8 percent. The bond’s yield to maturity is 7 percent. What’s the price?
a. What does duration measure?b. What is the duration of a zero coupon bond?c. What happens to a bond’s duration as its maturity grows?
Consider a five-year bond with a 10 percent coupon that is presently trading at a yield to maturity of 8 percent. If market interest rates do not change, one year from now the price of this
Based on the historical record, if you invest in longterm U.S. Treasury bonds, what is the approximate probability that your return will be below −3.8 percent in a given year? What range of returns
In our previous example (Example 2.6), at what price per share would you be subject to a margin call?Example 2.6You shorted 5,000 shares of Layton Industries at a price of $30 per share. The initial
In Problem 14, suppose that Douglas McDonnell shareholders approve a 3-for-1 stock split on January 1, 2023. What is the new divisor for the index? Calculate the rate of return on the index for the
You believe that Thorn Enterprises stock is going to fall, so you have decided to short sell 1,000 shares at a price of $32. Assuming the initial margin requirement is 50 percent, construct the
Suppose again that a stock pays three annual dividends of $100 per year and the discount rate is k = 15 percent. In this case, what is the price of the stock today?
a. What is fundamental analysis?b. What is a “rich” stock? What is a “cheap” stock?c. Why does valuing a stock necessarily involve predicting the future?
Suppose the Titanic Ice Cube Co.’s dividend grows at a 20 percent rate for the next three years. Thereafter, it grows at a 12 percent rate. What value would we place on Titanic assuming a 15
Collect information on the historical growth rate for MMM.
Suppose Al’s Infrared Sandwich Company has a current book value of $10.85 per share. The most recent earnings per share (EPS) was $2.96, and earnings are expected to grow at 6 percent forever. The
Conduct a DuPont analysis of Proctor & Gamble’s (PG) return on equity.
a. How is it possible for a company to have negative earnings but still have positive free cash flow?b. Why is a firm’s equity beta different from its asset beta? When would these two measures of
In applying the constant growth dividend discount model, a stock’s intrinsic value will do which of the following when the required rate of return is lowered?a. Decreaseb. Increasec. Remain
To illustrate how the geometric average and the arithmetic average of historical dividend growth can differ, consider the following dividends paid by the Joltin’ Joe Company:Because the starting
Analyze the PE ratio of Intel (INTC) relative to its peers.
a. Why are high-PE stocks sometimes called growth stocks?b. Why might an analyst prefer a price-cash flow ratio to a price-earnings ratio?
The constant growth dividend discount model would typically be most appropriate for valuing the stock of which of the following?a. A new venture expected to retain all earnings for several
Use the dividend discount model to estimate a value for ExxonMobil (XOM).
In 2021, American Electric Power (AEP) had a return on equity (ROE) of 11.74 percent, had earnings per share (EPS) of $4.97, and paid dividends of D0 = $3.00. What was AEP’s retention rate? Its
Can you calculate the growth rate in earnings that would be necessary to provide a RIM valuation equivalent to the market’s current price?
As a result of the Tax Cuts and Jobs Act of 2017, corporate tax rates were reduced. Under the dividend discount model, how would the tax rate reduction impact stock values?
Using AEP’s rounded sustainable growth rate of 4.65 percent (see Example 6.6) as an estimate of perpetual dividend growth and its current dividend of $3.00, what is the value of AEP’s stock
Which of the following assumptions does the constant growth dividend discount model require?I. Dividends grow at a constant rate.II. The dividend growth rate continues indefinitely.III. The required
In 2021, DTE had an ROE of 8.15 percent, EPS of $4.69, and a per-share dividend of D0 = $3.56. Assuming a 5.5 percent discount rate, what is the value of DTE’s stock?
A stock will not pay dividends until three years from now. The dividend then will be $2.00 per share, the dividend payout ratio will be 40 percent, and return on equity will be 15 percent. If the
Suppose a firm has a current dividend of D0 = $5, which is expected to “shrink” at the rate g1 = −10 percent for T = 5 years and thereafter grow at the rate g2 = 4 percent. With a discount rate
Assume that at the end of the next year, Company A will pay a $2.00 dividend per share, an increase from the current dividend of $1.50 per share. After that, the dividend is expected to increase at a
American Express trades on the New York Stock Exchange under the ticker symbol AXP. In 2021, AXP was paying a dividend of $1.72 and analysts forecasted five-year growth rates of 14 percent for AXP
A share of stock will pay a dividend of $1.00 one year from now, with dividend growth of 5 percent thereafter. In the context of a dividend discount model, the stock is correctly priced at $10 today.
Pepsi shares trade on the Nasdaq under the ticker symbol PEP. In 2021, Pepsi was paying a dividend of $4.25 and analysts forecasted a five-year growth rate of 7.48 percent for Pepsi and a 6 percent
firm has EBIT of $275 million, which is net of $52 million in depreciation. In addition, the firm had $81 million in capital expenditures and an increase in net working capital of $5 million. The
Chain Reaction, Inc., has been growing at a phenomenal rate of 30 percent per year because of its rapid expansion and explosive sales. You believe that this growth rate will last for three more years
Suppose we are evaluating Gibraltar Industries, Inc. (ROCK). In our analysis, we find that ROCK currently pays no dividends, so we conclude that we cannot use a dividend discount model. Thus, we
A firm had a free cash f low (FCF) in t he prior year of $125 million. The FCF is expected to grow at 3 per cent per year into perpetuity. The appropriate discount rate is 12 percent. What is t he
Using the relevant data in Example 6.13 and the residual income model, what discount rate, k, results in a price for ROCK of $66.68?Example 6.13Suppose we are evaluating Gibraltar Industries, Inc.
Two similar companies acquire substantial new production facilities, which they both will depreciate over a 10-year period. However, Company A uses accelerated depreciation while Company B uses
An analyst estimates the earnings per share and price-to-earnings ratio for a stock market series to be $43.50 and 26 times, respectively. The dividend payout ratio for the series is 65 percent. The
Landon Air is a new airline that makes roundtrip flights just between Indianapolis and Boston. It has EBIT of $45 million, interest expense of $6.54 million, no change in net working capital,
Table 6.2 contains information about Southwest Airlines (LUV). Calculate expected share prices using each of the three price ratio approaches.Table 6.2 Price Ratio Analysis for Southwest Airlines
Which of the following is an advantage of the enterprise value ratio as compared to price ratios?a. The EV ratio excludes interest expense.b. The EV ratio adds the value of the firm’s cash
A company’s return on equity is greater than its required return on equity. The earnings multiplier (PE) for that company’s stock is most likely to be positively related to the:a. Risk-free
The residual income model separates the value of the firm into two basic components. What are these two components?a. The current book value and the present value of future earningsb. The value of
Residual income is:a. The actual earnings less expected earnings.b. Any increase in the value of the firm.c. The value of profitable investment projects.d. The value added by economical use of
The clean surplus relationship says that:a. Assets minus liabilities minus shareholder’s equity equals the change in current assets plus debt payments.b. The difference between earnings and
A stock has a required return of 15 percent, a constant growth rate of 10 percent, and a dividend payout ratio of 50 percent. What should the stock’s PE ratio be?a. 3.0b. 4.5c. 9.0d. 11.0
Given the information below for Seger Corporation, compute the expected share price at the end of 2022 using price ratio analysis. Assume that the historical (arithmetic) average growth rates will
Given the information below for HooYah! Corporation, compute the expected share price at the end of 2022 using price ratio analysis. Assume that the historical (arithmetic) average growth rates will
Given the information below for Start Up Co., compute the expected share price at the end of 2022 using price ratio analysis.
Suppose Tesla is currently trading at $300. You think that if it reaches $310, it will continue to climb, so you want to buy it if and when it gets there. Should you submit a limit order to buy at
Find the weighted average cost of capital for Ford (F).
The constant growth dividend discount model will not produce a finite value if the dividend growth rate is which of the following?a. Above its historical averageb. Above the required rate of
The table below contains some information about the Jordan Air Co. Provide expected share prices using each of the three price ratio approaches we have discussed. Price Ratio Analysis for Jordan Air
a. What does the residual income model do that the perpetual constant growth model cannot do?b. What is the critical assumption that makes the residual income model mathematically equal to the
In 2021, the utility company DTE Energy (DTE) paid a $3.56 dividend. Using D0 = $3.56, k = 5.35 percent, and an industry average growth rate of g = 3 percent, calculate a present value estimate for
A common stock pays an annual dividend per share of $2.10. The risk-free rate is 7 percent and the risk premium for this stock is 4 percent. If the annual dividend is expected to remain at $2.10, the
a. What are the three parts of a CAPM-determined discount rate?b. Under what circumstances is a two-stage dividend discount model appropriate?
Suppose dividends for a particular company are projected to grow at 5 percent forever. If the discount rate is 15 percent and the current dividend is $10, what is the value of the stock?
Suppose instead that the stock pays three annual dividends of $10, $20, and $30 in Years 1, 2, and 3, respectively, and the discount rate is k = 10 percent. What is the price of the stock today?
a. Compare the dividend discount model, the constant growth model, and the constant perpetual growth model. How are they alike? How do they differ?b. What is a geometric average growth rate? How is
If the return on equity for a firm is 15 percent and the retention ratio is 40 percent, the sustainable growth rate of earnings and dividends is which of the following?a. 6 percentb. 9
In our example for Walmart, suppose a put option with a strike price of $150 is also available, with a premium of $7.50. Calculate your percentage return for the three-month holding period if the
Using semiannual compounding, what would be the price of a 15-year, zero coupon bond that has a par value of $1,000 and a required return of 8 percent?a. $308b. $315c. $464d. $555.
A bond has a Macaulay duration of 11 years and its yield increases from 8 percent to 8.5 percent. What will happen to the price of the bond?
a. What are the two effects on the target date value of a dedicated portfolio of a shift in yields? Explain why they tend to offset.b. How can a dedicated portfolio be immunized against shifts in
If an investor’s required return is 12 percent, the value of a 10-year-maturity zero coupon bond with a maturity value of $1,000 is closest to:a. $312b. $688c. $1,000d. $1,312.
A bond has a Macaulay duration of 8.5 years and a yield to maturity of 9 percent. What is its modified duration?
Another term for bond duration is:a. Actual maturity.b. Effective maturity.c. Calculated maturity.d. Near-term maturity.
A bond has a modified duration of seven years. Suppose its yield increases from 8 percent to 8.5 percent. What happens to its price?
Which of the following is not a property of duration?a. A longer maturity generally yields a longer duration.b. Duration generally increases at a decreasing rate as maturity lengthens.c. A bigger
Which statement is true for the Macaulay duration of a zero coupon bond?a. It is equal to the bond’s maturity in years.b. It is equal to one-half the bond’s maturity in years.c. It is equal to
A bond has a yield to maturity of 7 percent. It matures in 12 years, and its coupon rate is 6 percent. What is its modified duration?
Which of the following states the correct relationship between Macaulay duration and modified duration?a. Modified duration = Macaulay duration/(1 + YTM/2)b. Modified duration = Macaulay duration
The bond in Example 10.11 has a modified duration of 8.27 years. What is its dollar value of an 01? What is its yield value of a 32nd?Example 10.11A bond has a yield to maturity of 7 percent. It
Which one of the following bonds has the shortest duration?a. Zero coupon, 10-year maturityb. Zero coupon, 13-year maturityc. 8 percent coupon, 10-year maturityd. 8 percent coupon, 13-year
Identify the bond that has the longest duration (no calculations necessary).a. 20-year maturity with an 8 percent couponb. 20-year maturity with a 12 percent couponc. 15-year maturity with a 0
Which bond has the longest duration?a. 8-year maturity, 6 percent couponb. 8-year maturity, 11 percent couponc. 15-year maturity, 6 percent coupond. 15-year maturity, 11 percent coupon.
The duration of a bond normally increases with an increase in:a. Term to maturity.b. Yield to maturity.c. Coupon rate.d. All of the above.
When interest rates decline, what happens to the duration of a 30-year bond selling at a premium?a. It increases.b. It decreases.c. It remains the same.d. It increases at first, then declines.
An 8 percent, 20-year corporate bond is priced to yield 9 percent. The Macaulay duration for this bond is 8.85 years. Given this information, how many years is the bond’s modified
A 9-year bond has a yield to maturity of 10 percent and a modified duration of 6.54 years. If the market yield changes by 50 basis points, what is the change in the bond’s price?a. 3.27
A 6 percent coupon bond paying interest semiannually has a modified duration of 10 years, sells for $800, and is priced at a yield to maturity (YTM) of 8 percent. If the YTM increases to 9 percent,
Which of the following strategies is most likely to yield the best interest rate risk immunization results for a bond portfolio?a. Maturity matchingb. Duration matchingc. Buy and holdd. Investing
Consider two dedicated bond portfolios, both with the same 10-year target dates. One is managed using a buy-and-hold strategy with reinvested coupons. The other is managed using a dynamic
A zero coupon bond paying $100 at maturity 10 years from now has a current price of $50. Its yield to maturity is closest to which of the following?a. 5 percentb. 6 percentc. 7 percentd. 8
A newly issued 10-year option-free bond is valued at par on June 1, 2018. The bond has an annual coupon of 8.0 percent. On June 1, 2021, the bond has a yield to maturity of 7.1 percent. The price of
Calculate the expected returns for Roten and Bradley. State of Economy Bust Boom Probability of State of Economy .40 .60 1.00 Security Returns if State Occurs Roten -10% 40 Bradley 30% 10
The interest rate risk of a noncallable bond is most likely to be positively related to the:a. Risk-free rate.b. Bond’s coupon rate.c. Bond’s time to maturity.d. Bond’s yield to maturity.
Look again at Tables 11.1 and 11.2. Suppose you thought a boom would occur 20 percent of the time instead of 50 percent. What are the expected returns on Starcents and Jpod in this case? If the
Starcents has an expected return of 25 percent and Jpod has an expected return of 20 percent. What is the likely investment decision for a risk-averse investor?a. Invest all funds in
Calculate the standard deviations for Roten and Bradley. State of Economy Bust Boom Probability of State of Economy .40 .60 1.00 Security Returns if State Occurs Roten -10% 40 Bradley 30% 10
Examine the historical volatility of Pfizer (PFE) stock.
Going back to Table 11.3 in Example 11.1, what are the variances on our two stocks once we have unequal probabilities? What are the standard deviations?Table 11.3 Calculating Expected
Starcents experiences returns of 5 percent or 45 percent, each with an equal probability. What is the return standard deviation for Starcents?a. 30 percentb. 25 percentc. 20 percentd. 10 percent.
Calculate the expected return on a portfolio of 50 percent Roten and 50 percent Bradley. State of Economy Bust Boom Probability of State of Economy .40 .60 1.00 Security Returns if State
Review the correlation of Walmart (WMT) relative to its peers.
Suppose we had the following projections on three stocks:We want to calculate portfolio expected returns in two cases. First, what would be the expected return on a portfolio with equal amounts

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