INV3701 EXAM PACK 2020
Contains June 2019; October 2019; June 2020 & November 2020
exam questions and answers for exam preparation. (Exam papers
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, UNIVERSITY EXAMINATIONS
October/November 2020
INV3701
Investments Equity Asset Valuation
70 Marks
Duration: 3 Hours
This exam paper consists of 21 pages.
Instructions to students:
1. This examination paper consists of two sections.
SECTION A Multiple-choice questions
• Use the spaces provided to answer this section.
• Circle the correct multiple-choice answer on the answer sheet.
SECTION B Long questions
• Use the spaces provided to answer this section.
• Show all your calculations in the space provided.
2. Make sure that you have answered all the questions.
3. Please write legibly and clearly.
4. Do not use SMS language.
5. Use four decimal places in your calculations and round off your final answer to two
decimal places.
SECTION A: MULTIPLE-CHOICE QUESTIONS (10 MARKS)
This section consists of five questions that are worth two marks each.
,Circle the correct answer for each multiple-choice question (Questions 1 to 5)
1. Which one of the following statements is most likely correct regarding sustainable growth?
1. A share split will increase the sustainable growth rate.
2. A decrease in the debt ratio will increase the sustainable growth rate.
3. A decrease in the quarterly dividends will increase the sustainable growth rate.
G = b x ROE
Implies that the higher the return on equity, the higher the dividend growth rate, all else being
constant. That relation appears to be reliable. Another implication of the expression is that the
lower (higher) the earnings retention ratio, the lower (higher) the growth rate in dividends, holding
all else constant.
Effect on the sustainable Component directly affected (if
growth rate any) and how? (Justify your
(Increase, decrease or no answer.)
effect)
Increase in quarterly Decrease Increase in dividend payout ratio
dividends. reduces amount available for
internal growth
Bond issue Increase Increase in debt increases financial
leverage, resulting in ana increase
in ROE. Increase in ROE increases
growth rate
Share split. No effect A stock split has no
intrinsic effect on dividend growth
rate. Only increases the number of
shares outstanding while
proportionally reducing the value
per share.
2. Which of the following statements regarding the P/E to growth (PEG) valuation approach is the
least accurate? The PEG valuation approach assumes that …
1. there are no risk differences among stocks.
2. there is a linear relationship between price to earnings P/E and growth.
3. stocks with higher PEGs are more attractive than stocks with lower PEGs.
PEG (P/E to Growth)
- A tool used to incorporate the impact of earnings growth to P/E.
- PEG is calculated as the ratio of P/E to the consensus growth forecast.
- PEG is undefined for zero growth companies.
, - Stocks with lower PEG are more attractive than those with a higher PEG all else
equal *more growth on lower PEG stocks.
-
3. Diani Limited has a net profit margin of 26% and a financial leverage of 1.25. The sales of its
products amount to R182 000 while its total assets amount to R260 000. The firm has a dividend
payout of 40%. Therefore, the sustainable growth rate of Diani Limited is
…
1. 9.10%.
2. 13.65%.
3. 17.54%.
ROE = NP Margin x TAT x FL
= 0.26 x 182/260 x 1.25
= 22.75%
G = b x ROE
= (1- 0.4) x 22.75
= 13.65%
4. Which of the following statements is the most accurate about the effect of a decrease in
leverage on a firm’s free cash flow to equity (FCFE)?
1. FCFE is unaffected by changes in leverage.
2. Current year FCFE increases, but future FCFE will be reduced.
3. Current year FCFE decreases but future FCFE will be increased.
An increase in financial leverage will increase net borrowing and, hence, increase FCFE in the
year the borrowing occurred because: FCFE = FCFF – [interest expense] (1 – tax rate) + net
borrowing OR vice versa.
5. Simba Limited announced total liabilities of R800 million and total assets of R1200 million at the
end of 2019. Simba Limited has 40 million shares outstanding, return on equity (ROE) of 15.50%
and dividend payout of 50%. The firm’s required rate of return is 9.20% and its market price is
R74.17. Using a single-stage residual income model, Simba’s shares are most likely:
1. overpriced.
2. fairly priced.
3. underpriced.
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