Equity Valuation pt. 3 Questions and Answers

Equity Valuation pt. 3 Questions and Answers A price earnings ratio that is derived from the Gordon growth model is inversely related to the: A) growth rate. B) dividend payout ratio. C) required rate of return. C) required rate of return. P/E is inversely related to the required rate of return, r, and directly related to the growth rate, g, and the dividend payout ratio, D/E. The primary difference between P/E multiples based on comparables and P/E multiples based on fundamentals is that fundamentals-based P/Es take into account: A) future expectations. B) the law of one price. C) historical information. A) future expectations. Multiples based on comparables are grounded in the law of one price and take into account historical multiple values. In contrast, P/E multiples based on fundamentals can be based on the Gordon growth model, which takes into account future expected dividends. An analyst makes the following statement: "Use of P/E and other multiples for analysis is not effective because the multiples are based on historical data and because not all companies have positive accounting earnings." The analyst's statement is most likely: A) inaccurate with respect to both historical data and earnings. B) accurate with respect to historical data and inaccurate with respect to -5 C) inaccurate with respect to historical data and accurate with respect to earnings. A) inaccurate with respect to both historical data and earnings. The statement is inaccurate in both respects. Although multiples can be calculated from historical data, forecasted values can be used as well. For companies without accounting earnings, several other multiples can be used. These multiples are often specific to a company's industry or sector and include price-to-sales and price-to-cash flow. An analyst has prepared a table of the average trailing twelve-month price-to-earning (P/E), price-to-cash flow (P/CF), and price-to-sales (P/S) for the Tanaka Corporation for the years 2014 to 2017. Year P/E P/CF P/S 2014 4.9 5.4 1.2 2015 6.1 8.6 1.5 2016 8.3 7.3 1.9 2017 9.2 7.9 2.3 As of the date of the valuation in 2018, the trailing twelve-month P/E, P/CF, and P/S are, respectively, 9.2, 8.0, and 2.5. Based on the information provided, the analyst may reasonably conclude that Tanaka shares are most likely: A) overvalued. B) undervalued. C) fairly valued. A is correct. Tanaka shares are most likely overvalued. As the table below shows, all the 2018 multiples are currently above their 2014–2017 average P/E P/CF P/R Average 7.1 7.3 1.7 An analyst has gathered the following information for the Oudin Corporation: Expected earnings per share = €5.70 Expected dividends per share = €2.70 Dividends are expected to grow at 2.75 percent per year indefinitely The required rate of return is 8.35 percent Based on the information provided, the price/earnings multiple for Oudin is closest to: A) 5.7. B) 8.5. C) 9.4. B) 8.5. An analyst gathers the following information about two companies: Alpha Corp. Delta Co. Current price per share $57.32 $18.93 Last year’s EPS $3.82 $1.35 Current year’s estimated EPS $4.75 $1.40 Which of the following statements is most accurate? A) Delta has the higher trailing P/E multiple and lower current estimated P/E multiple. B) Alpha has the higher trailing P/E multiple and lower current estimated P/E multiple. C) Alpha has the higher trailing P/E multiple and higher current estimated P/E multiple. B) Alpha has the higher trailing P/E multiple and lower current estimated P/E multiple. P/E = Current price/EPS, and Estimated P/E = Current price/ Estimated EPS. Alpha P/E = $57.32/$3.82 = 15.01 Alpha estimated P/E = $57.32/4.75 = 12.07 Delta P/E = $18.93/$1.35 = 14.02 Delta estimated P/E = $18.93/$1.40 = 13.52 An analyst gathers the following information about similar companies in the banking sector: First Bank Prime Bank Pioneer Trust P/B 1.10 0.60 0.60 P/E 8.40 11.10 8.30 Which of the companies is most likely to be undervalued? A) First Bank. B) Prime Bank. C) Pioneer Trust. C) Pioneer Trust. Relative to the others, Pioneer Trust has the lowest P/E multiple and the P/B multiple is tied for the lowest with Prime Bank. Given the law of one price, similar companies should trade at similar P/B and P/E levels. Thus, based on the information presented, Pioneer is most likely to be undervalued. The market value of equity for a company can be calculated as enterprise value: A) minus market value of debt, preferred stock, and short-term investments. B) plus market value of debt and preferred stock minus short-term investments. C) minus market value of debt and preferred stock plus short-term investments. C) minus market value of debt and preferred stock plus short-term investments. Enterprise value is calculated as the market value of equity plus the market value of debt and preferred stock minus short-term investments. Therefore, the market value of equity is enterprise value minus the market value of debt and preferred stock plus short-term investments. Which of the following statements regarding the calculation of the enterprise value multiple is most likely correct? A) Operating income may be used instead of EBITDA. B) EBITDA may not be used if company earnings are negative. C) Book value of debt may be used instead of market value of debt. A) Operating income may be used instead of EBITDA. Operating income may be used in place of EBITDA when calculating the enterprise value multiple. EBITDA may be used when company earnings are negative because EBITDA is usually positive. The book value of debt cannot be used in place of market value of debt. An analyst has determined that the appropriate EV/EBITDA for Rainbow Company is 10.2. The analyst has also collected the following forecasted information for Rainbow Company: EBITDA = $22,000,000 Market value of debt = $56,000,000 Cash = $1,500,000 The value of equity for Rainbow Company is closest to: A) $169 million. B) $224 million. C) $281 million. A) $169 million. EV = 10.2 × 22,000,000 = $224,400,000 Equity value = EV - Debt + Cash = 224,400,000 - 56,000,000 + 1,500,000 = $169,900,000 Enterprise value is most often determined as market capitalization of common equity and preferred stock minus the value of cash equivalents plus the: A) book value of debt. B) market value of debt. C) market value of long-term debt. B) market value of debt. The market value of debt must be calculated and taken out of the enterprise value. Enterprise value, sometimes known as the cost of a takeover, is the cost of the purchase of the company, which would include the assumption of the company's debts at market value. Asset-based valuation models are best suited to companies where the capital structure does not have a high proportion of: A) debt. B) intangible assets. C) current assets and liabilities. B) intangible assets. Intangible assets are hard to value. Therefore, asset-based valuation models work best for companies that do not have a high proportion of intangible assets. Which of the following is most likely a reason for using asset-based valuation? A) The analyst is valuing a privately held company. B) The company has a relatively high level of intangible assets. C) The market values of assets and liabilities are different from the balance sheet values. A) The analyst is valuing a privately held company. Asset-based valuations are most often used when an analyst is valuing private enterprises. Both B and C are considerations in asset-based valuations but are more likely to be reasons to avoid that valuation model rather than reasons to use it. A disadvantage of the EV method for valuing equity is that the following information may be difficult to obtain: A) Operating income. B) Market value of debt. C) Market value of equity. B) Market value of debt. According to the reading, analysts may have not have access to market quotations for company debt. Which type of equity valuation model is most likely to be preferable when one is comparing similar companies? A) A multiplier model. B) A present value model. C) An asset-based valuation model A) A multiplier model. Although all models can be used to compare various companies, multiplier models have the advantage of reducing varying fundamental data points into a format that allows direct comparisons. As long as the analyst applies the data in a consistent manner for all the companies, this approach provides useful comparative data. Which of the following is most likely considered a weakness of present value models? A) Present value models cannot be used for companies that do not pay dividends. B) Small changes in model assumptions and inputs can result in large changes in the computed intrinsic value of the security. C) The value of the security depends on the investor's holding period; thus, comparing valuations of different companies for different investors is difficult. B) Small changes in model assumptions and inputs can result in large changes in the computed intrinsic value of the security. Very small changes in inputs, such as required rate of return or dividend growth rate, can result in large changes to the valuation model output. Some present value models, such as FCFE models, can be used to value compa-nies without dividends. Also, the intrinsic value of a security is independent of the investor's holding period.