CorporateFinance:TheCore(Berk/DeMarzo)

Chapter9-ValuingStocks

1)Whendiscountingdividendsyoushoulduse?
A)theweightedaveragecostofcapital.
B)theaftertaxweightedaveragecostofcapital.
C)theequitycostofcapital.
D)thebeforetaxcostofdebt.
Answer:C
Explanation: A)
B)
C)
D)
Diff:1
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Conceptual

2)Whichofthefollowingstatementsisfalse?
A)Theequitycostofcapitalforastockistheexpectedreturnofotherinvestmentsavailableinthemarket
withequivalentrisktothefirmsshares.
B)Thepriceofashareofstockisequaltothepresentvalueoftheexpectedfuturedividendsitwillpay.
Div1 + P1
C)
IfthecurrentstockpricewerelessthanP0=
,itwouldbeanegativeNPVinvestment,andwe
1 + rE
wouldexpectinvestorstorushinandsellit,drivingdownthestocksprice.
D)Thelawofonepriceimpliesthattovalueanysecurity,wemustdeterminetheexpectedcashflowsan
investorwillreceivefromowningit.
Answer:C
Explanation: A)
B)
C)Inthiscasethestockwouldbeundervaluedandwewouldexpectinvestorstobuyit.
D)
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Conceptual

3)Whichofthefollowingstatementsisfalse?
A)Wemustdiscountthecashflowsfromstockbasedontheequitycostofcapitalforthestock.
B)Thedividedyieldisthepercentagereturntheinvestorexpectstoearnfromthedividendpaidbythe
stock.
C)Thefirmmightpayoutcashtoitsshareholdersintheformofadividend.
D)Thedividendyieldistheexpectedannualdividendofastock,dividedbyitsexpectedfuturesaleprice.
Answer:D
Explanation: A)
B)
C)
D)Thedividendyieldistheannualdividenddividedbythecurrentprice.
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Conceptual


4)Whichofthefollowingstatementsisfalse?
A)Futuredividendpaymentsandstockpricesarenotknownwithcertainty;ratherthesevaluesarebased
ontheinvestorsexpectationsatthetimethestockispurchased.
B)Thecapitalgainisthedifferencebetweentheexpectedsalepriceandthepurchasepriceofthestock.
C)Thesumofthedividendyieldandthecapitalgainrateiscalledthetotalreturnofthestock.
D)Wedividethecapitalgainbytheexpectedfuturestockpricetocalculatethecapitalgainrate.
Answer:D
Explanation: A)
B)
C)
D)Thecapitalgainsrateisthecapitalgaindividedbythecurrentstockprice.
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Conceptual

5)Whichofthefollowingstatementsisfalse?
A)Aninvestorwillbewillingtopayuptothepointatwhichthecurrentpriceofashareofstockequals
thepresentvalueoftheexpectedfuturedividendsanexpectedfuturesaleprice.
B)Theexpectedtotalreturnofastockshouldequaltheexpectedreturnofotherinvestmentsavailablein
themarketwithequivalentrisk.
C)Thetotalamountreceivedindividendsandfromsellingthestockwilldependontheinvestors
investmenthorizon.
Div1 + P1
D)
IfthecurrentstockpriceweregreaterthanP0=
,itwouldbeapositiveNPVinvestment,and
1 + rE
wewouldexpectinvestorstorushinandbuyit,drivingupthestocksprice.
Answer:D
Explanation: A)
B)
C)
D)ItwouldbeanegativeNPVinvestment.
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Conceptual

6)Whichofthefollowingformulasisincorrect?
P P
A)
CapitalGainsRate= 0 1
P0
Div1
B)
DividendYield=
P0
Div1
Div2 + P2
C)
+
P0=
1 + rE
(1 + rE )2

D)rE=CapitalGainsRate+DividendYield
Answer:A
P P
Explanation: A)
CapitalGainsRate= 1 0
P0
B)
C)
D)
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Conceptual

7)Whichofthefollowingformulasisincorrect?
Div1
Div2 + P2
A)
Div N
P0=
+
+...+
2
1 + rE
(1 + rE )
(1 + rE ) N
B)
P0=

n =1

Divn
(1 + rE ) n

Div1 + P0
C)
rE=
P1
Div1 + P1
D)
P0=
1 + rE

Answer:C
Explanation: A)
B)
Div1 + P1
C)
rE=
P0
D)
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Conceptual

Usetheinformationforthequestion(s)below.

VonBoraCorporationisexpectedpayadividendof$1.40pershareattheendofthisyearanda$1.50pershareattheend
ofthesecondyear.YouexpectVonBorasstockpricetobe$25.00attheendoftwoyears.VonBorasequitycostof
capitalis10%

WS1)ThepriceyouwouldbewillingtopaytodayforashareofVonBorastock,ifyouplantoholdthestockfor
twoyearsisclosestto:
A)$23.15
B)$20.65
C)$21.95
D)$21.90
Answer:A
Div1
Explanation: A)
Div2 + P2
1.40
1.50 + 25.00
P0=
+
=
+
=$23.17
2
1
+
.10
1 + rE
(1 + rE )
(1 + .10) 2
B)
C)
D)
8)SupposeyouplantoholdVonBorastockforoneyear.Thepricewouldwouldexpecttobeabletosella
shareofVonBorastockinoneyearisclosestto:
A)$26.50
B)$22.70
C)$23.15
D)$24.10
Answer:D
Explanation: A)
B)
C)
Div2 + P2
D)
1.50 + 25.00
P1=
=
=$24.10
1
(1 + rE )
(1 + .10) 2
Diff:2

Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Analytical

9)SupposeyouplantoholdVonBorastockforonlyoneyear.YourcapitalgainfromholdingVonBorastock
forthefirstyearisclosestto:
A)$0.95
B)$1.40
C)$1.85
D)$1.25
Answer:A
Div2 + P2
Explanation: A)
1.50 + 25.00
=
=$24.10
P1=
1
(1 + .10)
(1 + rE )
P0=

Div1
Div2 + P2
1.40
1.50 + 25.00
+
=
+
=$23.17
2
1 + .10
1 + rE
(1 + .10) 2
(1 + rE )

CapitalGain=P1-P0=24.10-23.17=$0.93
B)
C)
D)
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Analytical

10)SupposeyouplantoholdVonBorastockforonlyoneyear.YourcapitalgainratefromholdingVonBora
stockforthefirstyearisclosestto:
A)3.5%
B)4.0%
C)6.0%
D)4.5%
Answer:B
Explanation: A)
Div2 + P2
B)
1.50 + 25.00
P1=
=
=$24.10
1
(1 + .10)
(1 + rE )
P0=

Div1
Div2 + P2
1.40
1.50 + 25.00
+
=
+
=$23.17
2
1
+
.10
1 + rE
(1 + .10) 2
(1 + rE )

CapitalGain=P1-P0=24.10-23.17=$0.93
CapitalGainrate=capitalgain/P0=0.93/23.17=.0401or4.0%
C)
D)
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Analytical

11)SupposeyouplantoholdVonBorastockforonlyoneyear.YourdividendyieldfromholdingVonBora
stockforthefirstyearisclosestto:
A)6.0%
B)4.0%
C)6.5%
D)5.5%
Answer:A

Div1
Explanation: A)
Div2 + P2
1.40
1.50 + 25.00
+
=
+
=$23.17
P0=
2
1 + .10
1 + rE
(1 + .10) 2
(1 + rE )

Dividendyield=Div1/P0=$1.40/23.17=.0604or6.0%
B)
C)
D)
Diff:2
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Analytical

WS2)SupposeyouplanonpurchasingVonBorastockinoneyear,rightafterthe$1.40dividendispaid.Youthen
planonsellingyourstockattheendofyeartwo,rightafterthe$1.50dividendispaid.Thecapitalgainrate
thatyouwillreceiveonyourinvestmentisclosestto:
A)4.00%
B)3.75%
C)6.25%
D)3.50%
Answer:B
Explanation: A)
Div2 + P2
B)
1.50 + 25.00
P1==
=
=$24.10
1
(1 + .10)
(1 + rE )
Socapitalgainrate=(P2-P1)/P1=($25.00-$24.10)/$24.10=.03734or3.73%
C)
D)
Diff:3
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Analytical

12)SupposeyouplanonpurchasingVonBorastockinoneyear,rightafterthe$1.40dividendispaid.Youthen
planonsellingyourstockattheendofyeartwo,rightafterthe$1.50dividendispaid.Thedividendyield
thatyouwillreceiveonyourinvestmentisclosestto:
A)5.75%
B)6.50%
C)6.25%
D)4.00%
Answer:C
Explanation: A)
B)
Div2 + P2
C)
1.50 + 25.00
P1=
=
=$24.10
1
(1 + .10)
(1 + rE )
Sodividendyield=$1.50/$24.10=.0622or6.22%
D)
Diff:3
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Analytical

13)SupposeyouplanonpurchasingVonBorastockinoneyear,rightafterthe$1.40dividendispaid.Youthen
planonsellingyourstockattheendofyeartwo,rightafterthe$1.50dividendispaid.Thetotalreturnthat
youwillreceiveonyourinvestmentisclosestto:
A)9.50%
B)10.75%
C)10.25%
D)10.00%
Answer:D
Explanation: A)
B)
C)
Div2 + P2
D)
1.50 + 25.00
P1=
=
=$24.10
1
(1 + .10)
(1 + rE )
Sodividendyield=$1.50/$24.10=.0622or6.22%
Socapitalgainrate=(P2-P1)/P1=($25.00-$24.10)/$24.10=.03734or3.73%
Totalreturn=capitalgainsrate+dividendyield=3.73%+6.22%=9.95%
Diff:3
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Analytical

WS3)SupposeyouplantoholdVonBorastockforonlyoneyear.CalculateyourtotalreturnfromholdingVon
Borastockforthefirstyear.
Div2 + P2
Answer:
1.50 + 25.00
P1=
=
=$24.10
1
(1 + .10)
(1 + rE )
P0=

Div1
Div2 + P2
1.40
1.50 + 25.00
+
=
+
=$23.17
2
1 + .10
1 + rE
(1 + rE )
(1 + .10) 2

CapitalGain=P1-P0=24.10-23.17=$0.93
CapitalGainrate=capitalgain/P0=0.93/23.17=.0401or4.0%
Dividendyield=Div1/P0=$1.40/23.17=.0604or6.0%
Totalreturn=capitalgainrate+dividendyield=4.0%+6.0%=10%
Diff:3
Topic:9.1StockPrices,Returns,andtheInvestmentHorizon
Skill:Analytical

9.2TheDividend-DiscountModel

14)Whichofthefollowingformulasisincorrect?
earningst
A)
Divt=
DividendPayoutRate
shares outstandingt
DivN
B)
PN=
rE g

C)earningsgrowthrate=retentionratexreturnonnewinvestment
DivN
DivN +1
Div1
Div2
D)
1
P0=
+
+...+
+

N
N
2
1 + rE
rE g
(1 + rE )
(1 + rE )
(1 + rE )
Answer:B
Explanation: A)
DivN +1
B)
PN=
rE g
C)
D)
Diff:2
Topic:9.2TheDividend-DiscountModel
Skill:Conceptual

15)JRNenterprisesjustannouncedthatitplanstocutitsdividendfrom$2.50to$1.50pershareandusethe
extrafundstoexpanditsoperations.Priortothisannouncement,JRNsdividendswereexpectedtogrowat
4%peryearandJRNsstockwastradingat$25.00pershare.Withthenewexpansion,JRNsdividendsare
expectedtogrowat8%peryearindefinitely.AssumingthatJRNsriskisunchangedbytheexpansion,the
valueofashareofJRNaftertheannouncementisclosestto:
A)$25.00
B)$15.00
C)$31.25
D)$27.50
Answer:A
Explanation: A)Twosteps.
Step#1solveforrE,
rE=Div1/P0+g=2.50/25.00+.04=.14or14%
Step#2
solvefornewstockprice:
P0=Div1/(rE-g)=1.50/(.14-.08)=25.00
B)
C)
D)
16)YouexpectthatBeanEnterpriseswillhaveearningspershareof$2forthecomingyear.Beanplanstoretain
allofitsearningsforthenextthreeyears.Forthesubsequenttwoyears,thefirmplansonretaining50%of
itsearnings.Itwillthenretainonly25%ofitsearningsfromthatpointforward.Retainedearningswillbe
investedinprojectswithanexpectedreturnof20%peryear.IfBeansequitycostofcapitalis12%,thenthe
priceofashareofBeansstockisclosestto:
A)$17.00
B)$10.75
C)$27.75
D)$43.50
Answer:C

Explanation: A)
B)
C)Year
1
2
3
4
5
6

Earnings Dividends
$2.00
$0.00
$2.40
$0.00
$2.88
$0.00
$3.46
$1.73
$3.80
$1.90
$4.18
$3.14

g
20%
20%
20%
10%
10%
5%

P0=1.73/(1.12)4+1.90/1.125+(3.14/(.12-.05))/1.125=27.63
Eachgiscalculatedasthe20%returnontheprojectstheretentionratio.
D)
Diff:3
Topic:9.2TheDividend-DiscountModel
Skill:Analytical

17)MJLTDisexpectedtogrowatvariousratesoverthenextfiveyears.Thecompanyjustpaida$1.00
dividend.Thecompanyexpectstogrowat20%forthenexttwoyears(effectingD1andD2),thenthe
companyexpectstogrowat10%forthreeadditionalyears(D3,D4,D5)afterwhichthecompanyexpectsto
growataconstantrateof5%peryearindefinitely.IftherequiredrateofreturnonMJscommonstockis
12%,thenwhatisashareofMJsstockworth?

Answer:Time
Period
1
2
3
4
5
6

Dividend
$1.00(1.20)
$1.00(1.20)2

PresentValue
$1.00(1.20)/(1.12)=1.071
$1.00(1.20)2/(1.12)2=1.148

$1.00(1.20)2(1.10)1
$1.00(1.20)2(1.10)2

$1.00(1.20)2(1.10)/(1.12)3=1.127
$1.00(1.20)2(1.10)2/(1.12)4=1.107

$1.00(1.20)2(1.10)3
$1.00(1.20)2(1.10)3(1.05)

$1.00(1.20)2(1.10)3/(1.12)5=1.088
$1.00(1.20)2(1.10)3(1.05)/[(.12-.05)(1.12)5]=16.313

CurrentValueofShare=1.071+1.148+1.127+1.107+1.088+16.313=$21.85
Diff:3
Topic:9.2TheDividend-DiscountModel
Skill:Analytical

18)GrowingRealFastCompany(GRF)isexpectedtohavea25percentgrowthrateforthenextfouryears
(effectingD1,D2,D3,andD4).Beginninginyearfive,thegrowthrateisexpectedtodropto7percentper
yearandlastindefinitely.IfGRFjustpaida$2.00dividendandtheappropriatediscountrateis15percent,
thenwhatisthevalueofashareofGRE?

Answer:Time
Period Dividend
PresentValue
1
1
$2.50(1.25)
$2.00(1.25)/(1.15)=2.174
2
$2.00(1.25)2
$2.00(1.25)2/(1.15)2=2.363
3
3
$2.00(1.25)
$2.00(1.25)3/(1.15)3=2.568
4
$2.00(1.25)4
$2.00(1.25)4/(1.15)4=2.792
4
5
$2.00(1.25) (1.07)
$2.00(1.25)4(1.07)/[(.15-.07)(1.15)4]=37.34

CurrentValueof Share=2.174+2.363+2.568+2.792+37.34=$47.24
Diff:3
Topic:9.2TheDividend-DiscountModel
Skill:Analytical

9.3TotalPayoutandFreeCashFlowValuationModels

19)Whichofthefollowingequationsisincorrect?
V0 + Debt - Cash
A)
P0=
Shares Outstanding
FCFN
VN
FCF1
FCF2
B)
+
+...+
+
V0=
2
N
1 + rwacc
(1 + rwacc )
(1 + rwacc )
(1 + rwacc ) N

C)FreeCashFlow=EBIT(1-c)+Depreciation-CapitalExpenditures-DNWC
D)EnterpriseValue=MarketValueofEquity+Debt-Cash
Answer:A
V + Debt - Cash
Explanation: A)
P0= 0
Shares Outstanding
B)
C)
D)
Diff:2
Topic:9.3TotalPayoutandFreeCashFlowValuationModels
Skill:Conceptual

20)TheRufusCorporationhas125millionsharesoutstandingandanalystsexpectRufustohaveearningsof
$500millionthisyear.Rufusplanstopayout40%ofitsearningsindividendsandtheyexpecttouse
another20%oftheirearningstorepurchaseshares.IfRufusequitycostofcapitalis15%andRufus
earningsareexpectedtogrowatarateof3%peryear,thenthevalueofashareofRufusstockisclosestto:
A)$13.35
B)$33.50
C)$20.00
D)$16.00
Answer:C
Explanation: A)
B)
C)Dividends=$500.40=$200million
Repurchases=$500.20=$100million
PV(FutureTotalDividendsandRepurchases)=($200+$100)/(.15-.03)=$2,500million
P0=$2,500million/125millionshares=$20pershare
D)
Diff:2
Topic:9.3TotalPayoutandFreeCashFlowValuationModels
Skill:Analytical

Usetheinformationforthequestion(s)below.

YouexpectCCMCorporationtogeneratethefollowingfreecashflowsoverthenextfiveyears:
Year
FCF($millions)

1
25

2
28

3
32

4
37

5
40

Followingyearfive,youestimatethatCCMsfreecashflowswillgrowat5%peryearandthatCCMsweightedaverage
costofcapitalis13%.

21)TheenterprisevalueofCCMcorporationisclosestto:
A)$396million
B)$290million
C)$382million
D)$350million
Answer:A
FCFN
VN
FCF1
FCF2
Explanation: A)
V0=
+
+...+
+
2
N
1 + rwacc
(1 + rwacc )
(1 + rwacc )
(1 + rwacc ) N
40
25
28
32
37
V0=
+
+
+
+ .13 .05 =395.58million
1 + .13
(1 + .13) 2
(1 + .13)3
(1 + .13) 4
(1 + .13) 4

B)
C)
D)
Diff:2
Topic:9.3TotalPayoutandFreeCashFlowValuationModels
Skill:Analytical

22)IfCCMhas$150millionofdebtand12millionsharesofstockoutstanding,thenthesharepriceforCCMis
closestto:
A)$49.50
B)$11.25
C)$20.50
D)$22.75
Answer:C
Explanation: A)
B)
FCFN
VN
FCF1
FCF2
C)
V0=
+
+...+
+
2
N
1 + rwacc
(1 + rwacc )
(1 + rwacc )
(1 + rwacc ) N
40
25
28
32
37
.13
.05 =395.58millionor396million.
+
+
+
V0=
+
2
3
4
1 + .13
(1 + .13)
(1 + .13)
(1 + .13)
(1 + .13) 4

Equityvalue=$396-$150(debt)=$246million/12millionshares=$20.50
D)
Diff:2
Topic:9.3TotalPayoutandFreeCashFlowValuationModels
Skill:Analytical


Usetheinformationforthequestion(s)below.

YouexpectDMCorporationtogeneratethefollowingfreecashflowsoverthenextfiveyears:
Year
FCF($millions)

1
75

2
84

3
96

4
111

5
120

Beginningwithyearsix,youestimatethatDMsfreecashflowswillgrowat6%peryearandthatDMsweightedaverage
costofcapitalis15%.

23)IfDMhas$500millionofdebtand14millionsharesofstockoutstanding,thenwhatisthepricepersharefor
DMCorporation?

a) 37.00
b) 38.00
c) 39.00
d) 40.00

FCFN
VN
FCF1
FCF2
Answer:
V0=
+
+...+
+
2
N
1 + rwacc
(1 + rwacc )
(1 + rwacc )
(1 + rwacc ) N
120
75
84
96
111
120
.15
.06 =1017.66millionor$1018
V0=
+
+
+
+
+
2
3
4
5
1 + .15
(1 + .15)
(1 + .15)
(1 + .15)
(1 + .15)
(1 + .15)5

million
Equityvalue=$1018-$500(debt)=$518million/14millionshares=$37.00
Diff:3
Topic:9.3TotalPayoutandFreeCashFlowValuationModels
Skill:Analytical

9.4ValuationBasedonComparableFirms

24)Whichofthefollowingstatementsisfalse?
A)Thefactthatafirmhasanexceptionalmanagementteam,hasdevelopedanefficientmanufacturing
process,orhasjustsecuredapatientonanewtechnologyisignoredwhenweapplyavaluation
multiple.
B)Valuationmultipleshavetheadvantagethattheyallowustoincorporatespecificinformationaboutthe
firmscostofcapitalorfuturegrowth.
C)Forfirmswithsubstantialtangibleassets,theratioofpricetobookvalueofequitypershareis
sometimesused.
D)Usingmultipleswillnothelpusdetermineifanentireindustryisovervalued.
Answer:B
Explanation: A)
B)Discountedcashflowsmethodshavetheadvantagethattheyallowustoincorporatespecific
informationaboutthefirmscostofcapitalorfuturegrowth.
C)
D)

Diff:3
Topic:9.4ValuationBasedonComparableFirms
Skill:Conceptual

Usetheinformationforthequestion(s)below.

SupposethatTexasTrucking(TT)hasearningspershareof$3.45andEBITDAof$45million.TTalsohas5millionshares
outstandinganddebto$150million(netofcash).YoubelievethatOklahomaLogisticsandTransport(OLT)is
comparabletoTTintermsofitsunderlyingbusiness,butOLThasnodebt.OLThasaP/Eof12.5andanenterprisevalue
toEBITDAmultipleof7.

25)Baseduponthepriceearningsmultiple,thevalueofashareofTexasTruckingisclosestto:
A)$49.30
B)$43.10
C)$24.15
D)$27.60
Answer:B
Explanation: A)
B)Price=forwardearningsP/E=3.4512.5=43.12
C)
D)
Diff:2
Topic:9.4ValuationBasedonComparableFirms
Skill:Analytical

asedupontheenterprisevaluetoEBITDAratio,thevalueofashareofTexasTruckingisclosestto:
B
1
1
)

A)$33.00
B)$82.50
C)$43.10
D)$21.25
Answer:A
Explanation: A)Enterprisevalue=EBITDAmultiple=$457=$315-$150debt=$165equityvalue/5
millionshares=$33.00pershare
B)
C)
D)
Diff:2
Topic:9.4ValuationBasedonComparableFirms
Skill:Analytical