Market-Based Valuation
1. Valuation using market multiples is popular because it simply multiplies a market multiple by what variable to determine value?
A) Stock price
B) Weighted average cost of capital
C) Summary performance measure
D) Working capital
Answer: C
Rationale: Using market multiples values the firm as the summary performance measure multiplied by the market multiple.
Topic: Market Multiples
LO: 1
2. Which of the following would not be used as a summary performance measure when using market multiples to determine value?
A) Stock price
B) Net operating assets
C) Net operating profit after tax
D) Book value
Answer: A
Rationale: Summary performance measures include earnings, book value, NOA, and NOPAT.
Topic: Market Multiples
LO: 1
3. Which of the following is an inconsistency of using market multiples to determine value?
A) Using a market multiple assumes that the target company is correctly priced, while comparable companies are mispriced.
B) Using a market multiple assumes that the target company is mispriced, while comparable companies are correctly priced.
C) Using a market multiple assumes that all companies are mispriced.
D) Using a market multiple assumes that the target company can be fully described by its summary performance measure.
Answer: B
Rationale: Using market multiples values the firm as the summary performance measure multiplied by the market multiple, which implicitly assumes that other firms from which the market multiple is obtained are correctly valued.
Topic: Balance Sheet Market Multiples
LO: 1
4. When considering the residual operating income model, a company-value-to-net-operating-assets ratio equal to 1 would suggest:
A) Future ROPI is equal to 0
B) Future ROPI is equal to 1
C) The expected present value of future ROPI is equal to 0
D) The expected present value of future ROPI is equal to 1
Answer: C
Rationale: When using market multiples and the residual operating income model if company value equals 1 then future ROPI must be zero.
Topic: Balance Sheet Market Multiples
LO: 1
5. Zhang Foods is a manufacturer and distributor of numerous food items. The company has a book value of $22.17 per share. Zhang Foods is part of the food processing industry which has an industry PB ratio of 2.17.
Using industry information, estimate the intrinsic value of Zhang Foods equity per share?
A) $10.22
B) $48.11
C) $37.71
D) $46.58
Answer: B
Rationale: Intrinsic value equals book value per share multiplied by the industry PB ratio.
Topic: Income Statement Market Multiples
LO: 2
6. Zhang Foods is a manufacturer and distributor numerous food items. The company recently reported earnings per share of $4.60. Based on its recent price of $75.42 the company has a PE ratio of 16.4. Zhang Foods is part of the food processing industry which has an industry P/E ratio of 20.25.
Using industry information, estimate the intrinsic value of Zhang Foods equity per share?
A) $ 4.60
B) $75.42
C) $93.15
D) $37.71
Answer: C
Rationale: Intrinsic value equals earnings per share multiplied by the industry PE ratio
Topic: Balance Sheet Market Multiples
LO: 1
7. Time Computers is a manufacturer of computer parts. The company has a book value of $1,054,704. In addition the company has 212,500 common shares issued and outstanding. Time Computers is part of the computing industry which has an industry PB ratio of 5.31.
Using industry information, estimate the intrinsic value of Time Computers equity per share?
A) $15.58
B) $ 4.96
C) $10.62
D) $26.36
Answer: D
Rationale: Intrinsic value equals book value multiplied by the industry PB ratio. Dividing the intrinsic value by the number of shares outstanding provides an intrinsic value per share.
Topic: Income Statement Market Multiples
LO: 2
8. Time Computers is a manufacturer of computer parts. The company recently reported earnings of $1,019,684. In addition, Time Computers has 212,500 shares issued and outstanding. The company has a PE ratio of 21.8. Time Computers is part of the computer parts industry which has an industry P/E ratio of 24.3.
Using industry information, estimate the intrinsic value of time Computers equity per share?
A) $ 4.80
B) $ 77.74
C) $116.60
D) $104.61
Answer: C
Rationale: Intrinsic value equals earnings multiplied by the industry PE ratio. Dividing the intrinsic value by the number of shares outstanding provides an intrinsic value per share.
Topic: Balance Sheet Market Multiples
LO: 1
9. Fairfield Learning is a retailer focused on education supplies. The company has a book value of $28.88 per share. Fairfield Learning has a PB ratio of 6.23 and the education supplies industry PB ratio is 5.31. Assuming that comparable industry companies are priced correctly the intrinsic value of Fairfield Learning’s equity per share is:
A) Undervalued $26.57 per share
B) Overvalued $26.57 per share
C) Priced correctly
D) Overvalued by $28.88 per share
Answer: B
Rationale: Intrinsic value equals book value per share multiplied by the industry PB ratio. To determine the amount of mispricing, the intrinsic value would be compared to the current price.
Topic: Income Statement Market Multiples
LO: 2
10. Fairfield Learning is a retailer focused on education supplies. The company recently reported earnings per share of $2.76. Based on its recent price of $32.71 the company has a PE ratio of 11.85. The educational supplies industry P/E ratio is 20.25.
Assuming that comparable industry companies are priced correctly the intrinsic value of Fairfield Learning’s equity per share is:
A) Undervalued $23.18 per share
B) Overvalued $23.18 per share
C) Priced correctly
D) Overvalued by $2.76 per share
Answer: A
Rationale: Intrinsic value equals earnings per share multiplied by the industry PE ratio. To determine the amount of mispricing the intrinsic value would be compared to the current price.
Topic: Selecting Comparables for Market Multiples
LO: 3
11. Which of the following factors should not be considered when choosing comparable companies and using net operating assets as the summary performance measure?
A) Expected future profitability
B) Expected future growth
C) Capital structure
D) Expected operating risk
Answer: C
Rationale: RNOA, growth in NOA and the variance of operating income are the three factors that need to be considered when choosing comparables when net operating assets is the summary performance measure.
Topic: Selecting Comparables for Market Multiples
LO: 3
12. Which of the following factors should not be considered when choosing comparable companies and using book value as the summary performance measure?
A) Expected future profitability
B) Expected future growth
C) Expected equity growth
D) Capital structure
Answer: C
Rationale: RNOA, growth in NOA and the variance of operating income and capital structure are the four factors that need to be considered when choosing comparable companies when book value is the summary performance measure.
Topic: Residual Operating Income Model
LO: 3
13. The correct version of the residual operating income model is:
A) ROPI = NOPAT – (NOABEG * re )
B) ROPI = NOPAT – (NOAEND * re )
C) ROPI = NOPAT + (NOABEG * rw )
D) ROPI = NOPAT – (NOABEG * rw )
Answer: D
Rationale: The residual operating income model is operating income in excess of a fair rate of return on beginning net operating assets.
Topic: Residual Operating Income Model
LO: 3
14. Under which circumstance will Company X not sell at a higher PB ratio than Company Y?
A) Company X has higher profitability than Company Y.
B) Company X has higher expected growth than Company Y.
C) Company X has a higher discount rate than Company Y.
D) Company X has higher leverage than Company Y.
Answer: C
Rationale: When deriving the PB ratio using the residual operating income model it can be shown that companies with lower discount rates will sell at a higher PB ratio.
Topic: PB Ratio
LO: 3
15. Given the following information for Malibu Corp. determine the corporation’s theoretically correct PB ratio:
| Net Operating Assets | = | $215 |
| Owners’ Equity | = | $215 |
| RNOA | = | 15% |
| ROE | = | 15% |
| WACC | = | 9% |
| Expected Growth rate in ROPI | = | 5% |
A) 1.0
B) 2.0
C) 2.2
D) 2.5
Answer: D
Rationale: In this circumstance we would obtain a value for equity of $537.5, resulting in a PB ratio of 2.5.
Topic: Balance Sheet Market Multiples
LO: 3
16. Given the following information for A Corp. and B Company determine the difference in the entities theoretically value of equity:
| A Corp. | B Company | |||
| Net Operating Assets | = | $215 | $215 | |
| Owners’ Equity | = | $215 | $215 | |
| RNOA | = | 15% | 12% | |
| ROE | = | 15% | 12% | |
| WACC | = | 9% | 9% | |
| Expected Growth rate in ROPI | = | 5% | 4% |
A) $0
B) $161.25
C) $129.00
D) $537.50
Answer: B
Rationale:
| A Corp | |
| ROPI | 12.9 |
| PV of ROPI | 322.5 |
| Value of Equity | 537.5 |
| PB ratio | 2.5 |
| B Company | |
| ROPI | 6.45 |
| PV of ROPI | 161.25 |
| Value of Equity | 376.25 |
| PB ratio | 1.75 |
| Difference | 161.25 |
Topic: Balance Sheet Market Multiples
LO: 3
17. Given the following information for A Corp. and B Company determine the difference in the entities theoretically correct PB ratio:
| A Corp. | B Company | |||
| Net Operating Assets | = | $215 | $215 | |
| Owners’ Equity | = | $215 | $215 | |
| RNOA | = | 15% | 12% | |
| ROE | = | 15% | 12% | |
| WACC | = | 9% | 9% | |
| Expected Growth rate in ROPI | = | 5% | 4% |
A) 2.5
B) 0.6
C) 0.75
D) There would be no expected difference
Answer: C
Rationale:
| A Corp | |
| ROPI | 12.9 |
| PV of ROPI | 322.5 |
| Value of Equity | 537.5 |
| PB ratio | 2.5 |
| B Company | |
| ROPI | 6.45 |
| PV of ROPI | 161.25 |
| Value of Equity | 376.25 |
| PB ratio | 1.75 |
| Difference | 0.75 |
Topic: Balance Sheet Market Multiples
LO: 3
18. Given the following information for C Corp. and D Company determine the difference in the entities theoretically value of equity:
| C Corp. | D Company | |||
| Net Operating Assets | = | $400 | $400 | |
| Owners’ Equity | = | $400 | $400 | |
| RNOA | = | 12% | 12% | |
| ROE | = | 12% | 12% | |
| WACC | = | 11% | 11% | |
| Expected Growth rate in ROPI | = | 8% | 6% |
A) $ 53.33
B) $133.33
C) $200.00
D) There would be no expected difference
