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EQUITY VALUATION
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questions and answers on CFA level 2 topic. equity valuations on FCFF/FCFE and the gordon constant model.
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1. ______ is the expected value of a share at the end of the investment horizon?A. Terminal value
B. Expected selling price or the terminal stock value
C. A and B are correct.
2. You have accumulated the following information on Delicious Food.
• Current share price: R50
• Current dividend: R1.50
• Delicious Food’s beta: 0.85
• Risk-free interest rate: 4.5%
• Market risk premium: 6.0%
• The dividend is expected to grow at 5% annually.
Using the reduced form of the dividend discount model, calculate the value of Delicious Foods?
A. 30.88
B. 29.88
C. 203.23
3. You are considering acquiring a common stock that you would like to hold for one year. You expect to
receive both R1.25 in dividends and R32 from the sale of the stock at the end of the year. The maximum
price you would pay for the stock today is _____ if you wanted to earn a 10% return.
A. R30.23
B. R24.11
C. R26.52
.10 = (32 - P + 1.25) / P; .10P = 32 - P + 1.25; 1.10 P = 33.25; P = 30.23.
4. Which of the following is least likely a disadvantage for using price multiples?
A. Multiples for cyclical firms may be greatly affected by economic conditions; P/E ratio may be
especially inappropriate.
B. Negative denominator results in a meaningless ratio; the P/E ratio is especially susceptible to
this problem.
C. Can be used in time series and cross-sectional comparisons.
5. Which of the following firms would most likely be appropriately valued using the constant growth
DDM?
A. An auto manufacturer.
B. A producer of bread and snack foods.
C. A biotechnology firm in existence for two years
, 6. Which of the below is least likely a disadvantage for using the Gordon growth model as a discounted
cashflow model in equity valuation analysis?
A. Very sensitive to the k – g denominator
B. Required return on equity must be less than the growth rate and the required return on equity
and growth rate must remain constant.
C. Firm must pay dividends.
7. Which alternative(s) to the Gordon model is (are) least likely to be used by analysts?
A. Use a more robust DDM that allows for varying patterns of growth.
B. Use a cash flow measure other than dividends for valuation purposes or use some other
approach such as a multiplier method to valuation.
C. Extrapolating from no current dividend by assuming that dividends will begin at some future
point in time.
8. Use the following selected financial information to answer the question.
Year 2013 2014 2015 2016 2017
Earnings per share (EPS) R5.08 R6.37 R8.85 R6.74 R7.45
Dividend per share (DPS) R3.0 R3.3 R3.5 R3.6 R3.7
Pay-out ratio 59% 52% 40% 53% 50%
Return on Equity (ROE) 14.6% 18.2% 22.3% 15.9% 15.6%
If analyst estimate of required return is 7.5%, what is the intrinsic value if the growth rate estimate is
lowered to 4.4 percent and the required rate of return estimate is increased to 8.5 percent?
A. 124.61
B. 94.21
C. 134.87
Intrinsic value
3.7(1+ 4.4 %)
=
(8.5 %−4.4 %)
= 94.21
9. Rose Hill Trading Company is expected to have EPS in the upcoming year of R6. The expected ROE is
18%. An appropriate required return on the stock is 14%. If the firm has a retention rate of 70%, the
intrinsic value should be ________.
A. R20.93
B. R69.77
C. R128.57
G= ROE * Retention ratio = 18%* 70% =12.6%
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