CSC Equity Securities Valuation 2 — Questions and Answers
Question 1: A stock trades at $50 with earnings per share of $4. What is its price-to-earnings (P/E) ratio?
- 10.5
- 12.5 (Correct answer)
- 14.0
- 15.5
Correct answer: 12.5
P/E = Price ÷ EPS = $50 ÷ $4 = 12.5.
Question 2: Which valuation approach estimates a stock's worth based on the present value of expected future dividends?
- Comparable company analysis
- Dividend discount model (Correct answer)
- Price-to-book ratio
- Enterprise value method
Correct answer: Dividend discount model
The dividend discount model (DDM) values a stock as the present value of all anticipated future dividends.
Question 3: In the Gordon Growth Model, if the required return is 10% and the dividend growth rate is 4%, what is the dividend yield implied?
- 4%
- 6% (Correct answer)
- 10%
- 14%
Correct answer: 6%
Dividend yield = Required return − Growth rate = 10% − 4% = 6%.
Question 4: A company has a book value per share of $25 and trades at $75. What is its price-to-book (P/B) ratio?
- 0.33
- 1.0
- 3.0 (Correct answer)
- 4.0
Correct answer: 3.0
P/B = Market price ÷ Book value per share = $75 ÷ $25 = 3.0.
Question 5: Which scenario would most likely lead an analyst to assign a higher P/E multiple to a stock?
- High financial leverage and cyclical revenues
- Strong earnings growth prospects and low risk (Correct answer)
- Declining profit margins and rising debt
- Mature industry with no reinvestment opportunities
Correct answer: Strong earnings growth prospects and low risk
Stocks with strong growth prospects and lower risk warrant higher P/E multiples because investors pay more for each dollar of earnings.
Question 6: What does a P/B ratio below 1.0 generally suggest about a company?
- The market values the company above its net assets
- The company may be undervalued or facing financial difficulties (Correct answer)
- The company has very high expected earnings growth
- The dividend yield exceeds the required rate of return
Correct answer: The company may be undervalued or facing financial difficulties
A P/B below 1.0 means the stock trades below book value, signalling potential undervaluation or fundamental problems.
Question 7: Which of the following best describes the 'intrinsic value' of a stock?
- The price at which the stock last traded on the exchange
- The par value stated on the share certificate
- The estimated true value based on fundamentals and expected cash flows (Correct answer)
- The average of the 52-week high and low prices
Correct answer: The estimated true value based on fundamentals and expected cash flows
Intrinsic value is the analyst's estimate of what a stock is really worth, derived from fundamental analysis of future cash flows.
CSC Equity Securities Valuation 2
A stock trades at $50 with earnings per share of $4.
What is its price-to-earnings (P/E) ratio?