Multiple Choice - Part 4: Equity Valuation, Multiples, Real Options

4.1 Which is not a way for a firm to increase dividends per share?

A) Increase retention rate

B) Decrease shares outstanding

C) Increase earnings

D) Increase payout rate

A) Increase retention rate

4.2 Which statement about profitable versus unprofitable growth is false?

A) To raise share price a firm must cut dividends and invest more

B) Retaining more earnings forces a lower dividend

C) Higher retention can increase growth

D) Cutting dividends raises price only if new investments have positive NPV

A) To raise share price a firm must cut dividends and invest more

4.3 Which statement about the constant dividend growth model is false?

A) Estimating far future dividends is difficult

B) Earnings can be either paid out or reinvested

C) Successful young firms often have high initial earnings growth

D) In the model value equals current dividend divided by equity cost of capital plus growth

D) In the model value equals current dividend divided by equity cost of capital plus growth

4.4 A stock pays a constant annual dividend of 1.50 forever and equity cost of capital is 12 percent. What is the share value?

A) 10.00

B) 15.00

C) 14.00

D) 12.50

D) 12.50

4.5 Luther Industries has dividend yield 4.5 percent and cost of equity 12 percent with constant dividend growth. What is dividend growth?

A) 7.5 percent

B) 5.5 percent

C) 16.5 percent

D) 12 percent

A) 7.5 percent

4.6 KTI has EPS 3 dividend 1.50 ROE on new investment 15 percent and cost of equity 12 percent. What is the share value?

A) 39.25

B) 20.00

C) 33.35

D) 12.50

C) 33.35

4.7 Kinston cuts dividend from 3 to 2 per share and growth rises from 2 percent to 5 percent. Old price was 37.50. What should the new price be?

A) 20.00

B) 30.00

C) 37.50

D) 40.00

D) 40.00

4.8 Which statement about the method of comparables is false?

A) Comparable firms may differ in size or scale

B) Method of comparables values a firm using similar firms’ values

C) Law of One Price lets us use value of an identical firm as benchmark

D) A valuation multiple is ratio of firm scale to firm value

D) A valuation multiple is ratio of firm scale to firm value

4.9 Which statement about the P E ratio is false?

A) P E is the most common valuation multiple

B) You should be willing to pay proportionally more for a stock with lower current earnings

C) P E equals share price divided by EPS

D) Buying a stock means buying rights to future earnings and scale differences tend to persist

B) You should be willing to pay proportionally more for a stock with lower current earnings

4.10 Which statement about enterprise value multiples is false?

A) Because EV is value before debt we should divide it by earnings after interest

B) P E can be based on trailing or forward earnings

C) EV based multiples are common in practice

D) Comparables based multiples are a shortcut to DCF valuation

A) Because EV is value before debt we should divide it by earnings after interest

4.11 Which statement about the limits of multiples is false?

A) Exceptional management or patents are ignored when applying a simple multiple

B) Multiples allow us to incorporate firm specific cost of capital or growth information

C) For tangible asset heavy firms price to book value per share can be used

D) Multiples do not show whether an entire industry is overvalued

B) Multiples allow us to incorporate firm specific cost of capital or growth information

4.12 Which statement about EV based multiples is false?

A) Because capex varies most practitioners rely on EV to free cash flow multiples

B) Common EV based multiples are EV to EBIT EV to EBITDA and EV to free cash flow

C) If two stocks have same payout EPS growth and risk they should have same P E

D) EV to sales is useful if expected margins are similar

A) Because capex varies most practitioners rely on EV to free cash flow multiples

4.13 Whirlpool has EPS 6.10 and price 87. What is the P E ratio?

A) 17.00

B) 13.50

C) 14.25

D) 7.00

C) 14.25

4.14 Using the comparable P E of 12.5 and EPS 3.45 what is the value per share of Texas Trucking?

A) 49.30

B) 43.10

C) 24.15

D) 27.60

B) 43.10

4.15 Texas Trucking has EBITDA 45 EV EBITDA multiple 7 debt 150 and 5 million shares. What is the value per share from this EV multiple?

A) 33.00

B) 82.50

C) 43.10

D) 21.25

A) 33.00

5.1 Which statement about real options versus financial options is false?

A) Real options add value because they allow choices after information arrives

B) Value of embedded real options must be considered in investment decisions

C) Real options and their underlying assets are often traded in competitive markets

D) Value of a real option can be found by comparing profit with and without the option

C) Real options and their underlying assets are often traded in competitive markets

5.2 Which of the following is not a real option?

A) A stock option

B) An abandonment option

C) An investment timing option

D) An expansion option

A) A stock option

5.3 Which statement about the option to wait is false?

A) Timing can be seen as choosing between invest now or wait

B) Invest today only when NPV today exceeds value of waiting which is positive

C) Without an option to wait it is optimal to invest in any positive NPV project

D) With an option to choose timing it is usually optimal to invest only when NPV is positive but close to zero

D) With an option to choose timing it is usually optimal to invest only when NPV is positive but close to zero

5.4 Which statement about uncertainty and waiting is false?

A) When uncertainty is high the benefit of waiting is reduced

B) In real options the equivalent of dividends is the payoff you give up by waiting

C) Delaying allows decisions based on additional information

D) With an option to wait a currently negative NPV project can still have positive value

A) When uncertainty is high the benefit of waiting is reduced

5.5 Which statement about the value of delay is false?

A) Besides current NPV other factors matter for the decision to wait

B) The option to wait is most valuable when future value is very uncertain

C) The smaller the cost of waiting the less attractive the delay option becomes

D) It is always better to wait unless there is a cost to doing so

C) The smaller the cost of waiting the less attractive the delay option becomes

5.6 Which statement about growth and abandonment options is false?

A) Abandonment usually involves costs

B) A real option to invest in the future is a growth option

C) Growth options contribute to firm value when there are future opportunities

D) Future growth opportunities are a collection of real put options on projects

D) Future growth opportunities are a collection of real put options on projects

5.7 Which is a way firms create value by using real options?

A) Abandon good projects for newer ones

B) Always act quickly when opportunities appear

C) Exercise in the money options immediately

D) Optimally delay or abandon projects

D) Optimally delay or abandon projects

5.8 The idea that managers should not abandon a project once they have invested heavily is called what?

A) Negative NPV fallacy

B) Abandonment fallacy

C) Sunk cost fallacy

D) Dependence fallacy

C) Sunk cost fallacy

5.9 In the abandonment example with two year project and exit option at 95 which of the listed statements I–IV is correct according to the solution?

A) I only

B) II only

C) I and IV only

D) II and IV only

E) III and IV only

B) II only

Which assumption underlies the constant growth DDM?

A) Dividends grow at a constant rate forever after next period

B) Dividends are constant and never grow

C) Dividends follow the business cycle exactly

D) Dividends grow randomly each year

A) Dividends grow at a constant rate forever after next period

Why can a firm with high ROE and high retention have a high P E multiple?

A) Because it is highly leveraged

B) Because reinvested earnings earn more than the cost of equity generating valuable growth opportunities

C) Because it pays no dividends

D) Because its earnings are very volatile

B) Because reinvested earnings earn more than the cost of equity generating valuable growth opportunities

What does the EV to EBITDA multiple conceptually measure?

A) Equity value per unit of net income

B) Firm value per unit of pre tax operating cash flow available to all capital providers

C) Firm value per unit of sales

D) Book value per unit of assets

B) Firm value per unit of pre tax operating cash flow available to all capital providers

When is a P E multiple more suitable than an EV based multiple?

A) When leverage is very different across firms

B) When tax rates vary widely

C) When leverage is similar and interest effects are not the main driver of differences

D) When firms have negative earnings

C) When leverage is similar and interest effects are not the main driver of differences

Which pair of criteria is most important when picking trading comparables?

A) Same currency and same CEO

B) Similar business model and similar growth and profitability

C) Same stock exchange and same auditors

D) Same country and same age

B) Similar business model and similar growth and profitability

Why is EV to EBITDA often preferred to EV to sales?

A) EBITDA ignores depreciation

B) Sales are harder to forecast

C) EBITDA reflects differences in margins while sales do not

D) EV to sales requires net income

C) EBITDA reflects differences in margins while sales do not

Which statement best defines PVGO?

A) Present value of all future dividends

B) Present value of existing assets only

C) Portion of the share price attributable to future growth projects beyond assets in place

D) Present value of tax shields

C) Portion of the share price attributable to future growth projects beyond assets in place

Which is NOT a typical real option embedded in corporate projects?

A) Option to expand capacity

B) Option to delay starting a project

C) Option to abandon a project

D) Option to pay fixed coupons on bonds

D) Option to pay fixed coupons on bonds

Why does a plain DCF analysis undervalue a project with a valuable abandonment option?

A) It overstates tax shields

B) It assumes managers never abandon and continue even in bad states so downside is overstated

C) It ignores initial investment C0

D) It double counts salvage value

B) It assumes managers never abandon and continue even in bad states so downside is overstated

What is the economic interpretation of risk neutral probabilities in a binomial model?

A) True probabilities estimated from history

B) Probabilities that make the expected return on the underlying equal the risk free rate

C) Probabilities used only for equity not for options

D) Probabilities chosen to maximize NPV

B) Probabilities that make the expected return on the underlying equal the risk free rate