1. The summary results of the sensitivity analysis for a residual income valuati

Question

1. The summary results of the sensitivity analysis for a residual income valuation are presented in the table below.

Based upon this information, which of the following must be true?

a. At the 12% discount rate, the seed value to the residual income perpetuity must have been negative

b. At the 12% discount rate, the seed value to the residual income perpetuity must have been positive

c. A "10% analyst" would conclude the firm is over-valued

d. A "10% analyst" would conclude the firm is under-valued

2. Which of the following statements is true regarding the residual income valuation model?

a. The growth rate for the terminal value perpetuity must be negative as a firm cannot out-perform its cost of capital forever.

b. The growth rate for the terminal value perpetuity must be negative because net income will decay to zero in the "long-run"

c. The growth rate for the terminal value perpetuity must be positive because profits should increase by at least the rate of inflation.

d. Residual income should be equal to zero for any year as firms should always generate the level of income required by investors.

3. One problem with the trailing price-earnings ratios commonly reported is that

a. it divides share price, which reflects the present value of future earnings by historical earnings.

b. it divides share price, which reflects the present value of book value by historical earnings.

c. it does not take into consideration the present value of future earnings.

d. it’s based on analysts' expectations.

4. A company is expected to generate $175,000 in earnings next period and has a current market value of equity equal to $875,000. Assume that the geometric growth rate in expected future earnings is 4% per year. What is the earnings capitalization rate that is consistent with these facts?

5. Which of the following valuation multiples is consistent with economic theory and provides a basis for analyzing firms that have been classified as growth or value investments?

a. The market to book ratio

b. The trailing price to earnings multiple

c. The ratio of the terminal value perpetuity value to book value of equity

d. The degree of operating leverage ratio

Explanation / Answer

Based upon this information, which of the following must be true?

b. At the 12% discount rate, the seed value to the residual income perpetuity must have been positive

2. Which of the following statements is true regarding the residual income valuation model?

c. The growth rate for the terminal value perpetuity must be positive because profits should increase by at least the rate of inflation.

3. One problem with the trailing price-earnings ratios commonly reported is that

b. it divides share price, which reflects the present value of future earnings by historical earnings.

4. A company is expected to generate $175,000 in earnings next period and has a current market value of equity equal to $875,000. Assume that the geometric growth rate in expected future earnings is 4% per year. What is the earnings capitalization rate that is consistent with these facts?

Market value=Next year earnings/(capitalization rate-growth rate)

=>875000=175000/(r-4%)

=>r=24%

5. Which of the following valuation multiples is consistent with economic theory and provides a basis for analyzing firms that have been classified as growth or value investments?

a. The market to book ratio

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.