INVESTMENT MANAGEMENT EXAM 2 UPDATED ACTUAL
QUESTIONS AND CORRECT ANSWERS
Question:
1. The accounting measure of a firm's equity value generated by applying accounting principles to asset
and liability acquisitions is called __________.
1. book value
2. market value
3. liquidation value
4. Tobin's q
Answer:
1
Question:
2. The constant-growth dividend discount model (DDM) can be used only when the ___________.
1. growth rate is less than or equal to the required return
2. growth rate is greater than or equal to the required return
3. growth rate is less than the required return
4. growth rate is greater than the required return
Answer:
3
Question:
3. You want to earn a return of 10% on each of two stocks, A and B. Each of the stocks is expected to pay
a dividend of $4 in the upcoming year. The expected growth rate of dividends is 6% for stock A and 5%
for stock B. Using the constant-growth DDM, the intrinsic value of stock A __________.
1. will be higher than the intrinsic value of stock B
2. will be the same as the intrinsic value of stock B
3. will be less than the intrinsic value of stock B
4. The answer cannot be determined from the information given.
Answer:
1
Question:
4. A firm is planning on paying its first dividend of $2 three years from today. After that, dividends are
expected to grow at 6% per year indefinitely. The stock's required return is 14%. What is the intrinsic value
of a share today?
1. $25.00
2. $16.87
3. $19.24
4. $20.99 Review The Formulas in Quiz 9 Q4
Answer:
3
(V3 = ((D4 / (r − g)) = ((D3 × (1 + g)) / (r − g) = ($2.00 × (1.06) / (0.14 − 0.06) = $26.50
(V0 = (V3 + D3) / (1 + r)^3 = ($26.50 + $2.00) / (1.14)^3 = $19.24)
,Question:
5. You are considering acquiring a common share of Sahali Shopping Center Corporation that you would
like to hold for 1 year. You expect to receive both $1.20 in dividends and $30 from the sale of the share at
the end of the year. The maximum price you would pay for a share today is __________ if you wanted to
earn a 12% return.
1. $26.79
2. $27.86
3. $27.46
4. $35.45 Formula in Quiz 9 Q5
Answer:
2
(V0 = (P1 + D1) / (1 + r) = ($30 + $1.20) / 1.12 = $27.86)
Question:
6. Sanders, Incorporated, paid a $4 dividend per share last year and is expected to continue to pay out 60%
of its earnings as dividends for the foreseeable future. If the firm is expected to generate a 12% return on
equity in the future, and if you require a 14% return on the stock, the value of the stock is __________.
1. $22.30
2. $40.76
3. $45.57
4. $63.06 Formula in Quiz 9 Q6
Answer:
3
(g = (ROE × b) = (0.12 × (1 − 0.6)) = 0.048 = 4.8%)
(V0 = D1 / (k − g) = D0 × (1 + g) / (k − g) = ($4.00 × (1.048)) / (0.14 − 0.048) = $45.57)
Question:
7. A firm has current assets that could be sold for their book value of $10 million. The book value of its
fixed assets is $60 million, but they could be sold for $90 million today. The firm has total debt with a
book value of $40 million, but interest rate declines have caused the market value of the debt to increase to
$50 million. What is this firm's market-to-book ratio? (Round your answer to 2 decimal places.) (Formula /
Explanation in Q7 Quiz 9)
Answer:
1.67
(Market value of the firm = Market value of assets − Market value of debts = ($10 million + $90 million) −
$50 million = $50 million)
(Book value of the firm = Book value of assets − Book value of debts = ($10 million + $60 million) − $40
million = $30 million) (Market-to-book ratio = Market Value / Book Value $50 million/$30 million =
1.67)
Question:
8. Which one of the following is equal to the ratio of common shareholders' equity (from the balance sheet)
to common shares outstanding?
1. Book value per share
2. Liquidation value per share
3. Market value per share
4. Tobin's q
, Answer:
1
Question:
9. A firm has current assets that could be sold for their book value of $10 million. The book value of its
fixed assets is $60 million, but they could be sold for $95 million today. The firm has total debt at a book
value of $40 million, but interest rate changes have increased the value of the debt to a current market
value of $50 million. This firm's market-to-book ratio is __________.
1. 1.83
2. 1.50
3. 1.35
4. 1.46 (Explanation in Quiz 9 Q9)
Answer:
1
(Equity = Total Assets − Debt = (10+95) - 50 = 55 = (10+60) - 40 = 30 Market Value/Book Value of
Equity = $55/$30 =
1.833)
Question:
10. Bill, Jim, and Shelly are all interested in buying the same stock that pays dividends. Bill plans on
holding the stock for 1 year. Jim plans on holding the stock for 3 years. Shelly plans on holding the stock
until she retires in 10 years. Which one of the following statements is correct?
1. Bill will be willing to pay the most for the stock because he will get his money back in 1 year when he
sells.
2. Jim should be willing to pay three times as much for the stock as Bill will pay because his expected
holding period is three times as long as Bill's.
3. Shelly should be willing to pay the most for the stock because she will hold it the longest and hence will
get the most dividends.
4. All three should be willing to pay the same amount for the stock regardless of their holding period.
Answer:
4
Question:
11. A firm cuts its dividend payout ratio. As a result, you know that the firm's __________.
1. return on assets will increase
2. earnings retention ratio will increase
3. earnings growth rate will fall
4. stock price will fall
Answer:
2
QUESTIONS AND CORRECT ANSWERS
Question:
1. The accounting measure of a firm's equity value generated by applying accounting principles to asset
and liability acquisitions is called __________.
1. book value
2. market value
3. liquidation value
4. Tobin's q
Answer:
1
Question:
2. The constant-growth dividend discount model (DDM) can be used only when the ___________.
1. growth rate is less than or equal to the required return
2. growth rate is greater than or equal to the required return
3. growth rate is less than the required return
4. growth rate is greater than the required return
Answer:
3
Question:
3. You want to earn a return of 10% on each of two stocks, A and B. Each of the stocks is expected to pay
a dividend of $4 in the upcoming year. The expected growth rate of dividends is 6% for stock A and 5%
for stock B. Using the constant-growth DDM, the intrinsic value of stock A __________.
1. will be higher than the intrinsic value of stock B
2. will be the same as the intrinsic value of stock B
3. will be less than the intrinsic value of stock B
4. The answer cannot be determined from the information given.
Answer:
1
Question:
4. A firm is planning on paying its first dividend of $2 three years from today. After that, dividends are
expected to grow at 6% per year indefinitely. The stock's required return is 14%. What is the intrinsic value
of a share today?
1. $25.00
2. $16.87
3. $19.24
4. $20.99 Review The Formulas in Quiz 9 Q4
Answer:
3
(V3 = ((D4 / (r − g)) = ((D3 × (1 + g)) / (r − g) = ($2.00 × (1.06) / (0.14 − 0.06) = $26.50
(V0 = (V3 + D3) / (1 + r)^3 = ($26.50 + $2.00) / (1.14)^3 = $19.24)
,Question:
5. You are considering acquiring a common share of Sahali Shopping Center Corporation that you would
like to hold for 1 year. You expect to receive both $1.20 in dividends and $30 from the sale of the share at
the end of the year. The maximum price you would pay for a share today is __________ if you wanted to
earn a 12% return.
1. $26.79
2. $27.86
3. $27.46
4. $35.45 Formula in Quiz 9 Q5
Answer:
2
(V0 = (P1 + D1) / (1 + r) = ($30 + $1.20) / 1.12 = $27.86)
Question:
6. Sanders, Incorporated, paid a $4 dividend per share last year and is expected to continue to pay out 60%
of its earnings as dividends for the foreseeable future. If the firm is expected to generate a 12% return on
equity in the future, and if you require a 14% return on the stock, the value of the stock is __________.
1. $22.30
2. $40.76
3. $45.57
4. $63.06 Formula in Quiz 9 Q6
Answer:
3
(g = (ROE × b) = (0.12 × (1 − 0.6)) = 0.048 = 4.8%)
(V0 = D1 / (k − g) = D0 × (1 + g) / (k − g) = ($4.00 × (1.048)) / (0.14 − 0.048) = $45.57)
Question:
7. A firm has current assets that could be sold for their book value of $10 million. The book value of its
fixed assets is $60 million, but they could be sold for $90 million today. The firm has total debt with a
book value of $40 million, but interest rate declines have caused the market value of the debt to increase to
$50 million. What is this firm's market-to-book ratio? (Round your answer to 2 decimal places.) (Formula /
Explanation in Q7 Quiz 9)
Answer:
1.67
(Market value of the firm = Market value of assets − Market value of debts = ($10 million + $90 million) −
$50 million = $50 million)
(Book value of the firm = Book value of assets − Book value of debts = ($10 million + $60 million) − $40
million = $30 million) (Market-to-book ratio = Market Value / Book Value $50 million/$30 million =
1.67)
Question:
8. Which one of the following is equal to the ratio of common shareholders' equity (from the balance sheet)
to common shares outstanding?
1. Book value per share
2. Liquidation value per share
3. Market value per share
4. Tobin's q
, Answer:
1
Question:
9. A firm has current assets that could be sold for their book value of $10 million. The book value of its
fixed assets is $60 million, but they could be sold for $95 million today. The firm has total debt at a book
value of $40 million, but interest rate changes have increased the value of the debt to a current market
value of $50 million. This firm's market-to-book ratio is __________.
1. 1.83
2. 1.50
3. 1.35
4. 1.46 (Explanation in Quiz 9 Q9)
Answer:
1
(Equity = Total Assets − Debt = (10+95) - 50 = 55 = (10+60) - 40 = 30 Market Value/Book Value of
Equity = $55/$30 =
1.833)
Question:
10. Bill, Jim, and Shelly are all interested in buying the same stock that pays dividends. Bill plans on
holding the stock for 1 year. Jim plans on holding the stock for 3 years. Shelly plans on holding the stock
until she retires in 10 years. Which one of the following statements is correct?
1. Bill will be willing to pay the most for the stock because he will get his money back in 1 year when he
sells.
2. Jim should be willing to pay three times as much for the stock as Bill will pay because his expected
holding period is three times as long as Bill's.
3. Shelly should be willing to pay the most for the stock because she will hold it the longest and hence will
get the most dividends.
4. All three should be willing to pay the same amount for the stock regardless of their holding period.
Answer:
4
Question:
11. A firm cuts its dividend payout ratio. As a result, you know that the firm's __________.
1. return on assets will increase
2. earnings retention ratio will increase
3. earnings growth rate will fall
4. stock price will fall
Answer:
2
