Chapter 7 – Prospective Analysis: Valuation Theory and Concepts
Quiz
An analyst produces the following series of annual dividend forecasts for company A: Expected dividend (end of) year t+1 = €10; Expected dividend (end of) year t+2 = €20; Expected dividend (end of) year t+3 = €10. The analyst further expects that company A’s dividends will be zero after year t+3. Company A’s cost of equity equals 10 percent. Under these assumptions, the analyst’s estimate of company A’s equity value at the end of year t is
€31.16
€33.13
€36.36
€40
An analyst predicts that company B’s dividend at the end of year t+1 will equal €10. The analyst further expects that after year t+1 company B’s dividends will grow indefinitely at a rate of 2 percent. Company B’s cost of equity equals 7 percent. Under these assumptions, the analyst’s estimate of company B’s equity value at the end of year t is
€100.00
€111.11
€142.86
€200.00
€228.17
€321.94
€307.96
€345.45
€288.26
€368.67
€499.48
€588.26
Consider the following statement: “The abnormal earnings growth valuation model differs from the free cash flow and abnormal earnings valuation models in that it is not mathematically equivalent to the dividend discount model.” This statement is
True
False
Consider the following statement: “The discounted abnormal NOPAT growth model defines the value of net assets as the sum of the capitalized next-period NOPAT forecast and the present value of forecasted NOPAT beyond the next period.” This statement is
True
False
€50
€45
€41
€20
Consider the following statement: “A disadvantage of the abnormal earnings valuation model is that produces lower equity value estimates for firms that use conservative accounting policies (such as accelerated depreciation) than for firms that use aggressive accounting policies (such as straight-line depreciation).” This statement is
True
false
€112.70
€249.69
€612.70
€1056.66
Consider the following information about company G’s performance and financial position in year t and t+1: - Net profit year t = €60; net profit year t+1 = €80 - Beginning book value of equity year t = €900 - Dividend year t = €20; dividend year t+1 = €50 - Cost of equity = 10 percent Company G’s abnormal earnings growth in year t+1 is
(€70)
€16
€20
€30
Company H’s current return on equity is 12 percent. An analyst assumes that the company’s ROE will grow indefinitely at a rate of 2 percent. Company H’s cost of equity is 10 percent. Under these assumptions, the analyst’s estimate of company H’s equity value-to-book multiple is
1.00
1.10
1.12
1.25
. In the current year, company I’s net profit is €20, its beginning book value of equity is €100, and its ending book value of equity is €110. An analyst predicts that company I’s next year’s net profit will be €50. The analyst further assumes that company I’s cost of equity is 10 percent and its abnormal earnings growth follows the following process:
Abnormal earnings growth in year t+1 = 0.5 x abnormal earnings growth in year t
Under these assumptions, the analyst’s estimate of company I’s equity value is
500.00
515.83
674.17
2590.00
Investors expect that the return on equity of the currently best performing peer is not sustainable in the future.
Investors expect that the return on equity of the currently worst performing peer will improve in the future.
Investors expect that peer 1’s future abnormal earnings growth will be positive.
Statements A and C are correct.
None of the above statements is correct.
Consider the following statement: “The equity value-to-book ratio is a function of (a) future returns on equity, (b) future book value of equity growth rates, and (c) the cost of equity.” This statement is