Question 990 Multiples valuation, EV to EBITDA ratio, enterprise value
A firm has:
2 million shares;
$200 million EBITDA expected over the next year;
$100 million in cash (not included in EV);
1/3 market debt-to-assets ratio is (market assets = EV + cash);
4% pa expected dividend yield over the next year, paid annually with the next dividend expected in one year;
2% pa expected dividend growth rate;
40% expected payout ratio over the next year;10 times EV/EBITDA ratio.
30% corporate tax rate.
The stock can be valued using the EV/EBITDA multiple, dividend discount model, Gordon growth model or PE multiple. Which of the below statements is NOT correct based on an EV/EBITDA multiple valuation?
Question 935 real estate, NPV, perpetuity with growth, multi stage growth model, DDM
You're thinking of buying an investment property that costs $1,000,000. The property's rent revenue over the next year is expected to be $50,000 pa and rent expenses are $20,000 pa, so net rent cash flow is $30,000. Assume that net rent is paid annually in arrears, so this next expected net rent cash flow of $30,000 is paid one year from now.
The year after, net rent is expected to fall by 2% pa. So net rent at year 2 is expected to be $29,400 (=30,000*(1-0.02)^1).
The year after that, net rent is expected to rise by 1% pa. So net rent at year 3 is expected to be $29,694 (=30,000*(1-0.02)^1*(1+0.01)^1).
From year 3 onwards, net rent is expected to rise at 2.5% pa forever. So net rent at year 4 is expected to be $30,436.35 (=30,000*(1-0.02)^1*(1+0.01)^1*(1+0.025)^1).
Assume that the total required return on your investment property is 6% pa. Ignore taxes. All returns are given as effective annual rates.
What is the net present value (NPV) of buying the investment property?
Question 989 PE ratio, Multiples valuation, leverage, accounting ratio
A firm has 20 million stocks, earnings (or net income) of $100 million per annum and a 60% debt-to-equity ratio where both the debt and asset values are market values rather than book values. Similar firms have a PE ratio of 12.
Which of the below statements is NOT correct based on a PE multiples valuation?
A stock is expected to pay the following dividends:
| Cash Flows of a Stock | ||||||
| Time (yrs) | 0 | 1 | 2 | 3 | 4 | ... |
| Dividend ($) | 0.00 | 1.15 | 1.10 | 1.05 | 1.00 | ... |
After year 4, the annual dividend will grow in perpetuity at -5% pa. Note that this is a negative growth rate, so the dividend will actually shrink. So,
- the dividend at t=5 will be ##$1(1-0.05) = $0.95##,
- the dividend at t=6 will be ##$1(1-0.05)^2 = $0.9025##, and so on.
The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.
What will be the price of the stock in four and a half years (t = 4.5)?
A stock is expected to pay the following dividends:
| Cash Flows of a Stock | ||||||
| Time (yrs) | 0 | 1 | 2 | 3 | 4 | ... |
| Dividend ($) | 0.00 | 1.15 | 1.10 | 1.05 | 1.00 | ... |
After year 4, the annual dividend will grow in perpetuity at -5% pa. Note that this is a negative growth rate, so the dividend will actually shrink. So,
- the dividend at t=5 will be ##$1(1-0.05) = $0.95##,
- the dividend at t=6 will be ##$1(1-0.05)^2 = $0.9025##, and so on.
The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.
What is the current price of the stock?
Question 992 inflation, real and nominal returns and cash flows
You currently have $100 in the bank which pays a 10% pa interest rate.
Oranges currently cost $1 each at the shop and inflation is 5% pa which is the expected growth rate in the orange price.
This information is summarised in the table below, with some parts missing that correspond to the answer options. All rates are given as effective annual rates. Note that when payments are not specified as real, as in this question, they're conventionally assumed to be nominal.
| Wealth in Dollars and Oranges | ||||
| Time (year) | Bank account wealth ($) | Orange price ($) | Wealth in oranges | |
| 0 | 100 | 1 | 100 | |
| 1 | 110 | 1.05 | (a) | |
| 2 | (b) | (c) | (d) | |
Which of the following statements is NOT correct? Your:
Question 407 income and capital returns, inflation, real and nominal returns and cash flows
A stock has a real expected total return of 7% pa and a real expected capital return of 2% pa.
Inflation is expected to be 2% pa. All rates are given as effective annual rates.
What is the nominal expected total return, capital return and dividend yield? The answers below are given in the same order.
Question 526 real and nominal returns and cash flows, inflation, no explanation
How can a nominal cash flow be precisely converted into a real cash flow?
Question 574 inflation, real and nominal returns and cash flows, NPV
What is the present value of a nominal payment of $100 in 5 years? The real discount rate is 10% pa and the inflation rate is 3% pa.
Question 664 real and nominal returns and cash flows, inflation, no explanation
What is the present value of real payments of $100 every year forever, with the first payment in one year? The nominal discount rate is 7% pa and the inflation rate is 4% pa.
Question 728 inflation, real and nominal returns and cash flows, income and capital returns, no explanation
Which of the following statements about gold is NOT correct? Assume that the gold price increases by inflation. Gold has a:
Question 744 income and capital returns, real and nominal returns and cash flows, inflation
If someone says "my shares rose by 10% last year", what do you assume that they mean? The effective annual:
Question 1023 monetary policy, inflation, breakeven inflation rate
If the breakeven inflation rate was far above the US Fed's long term 2% average inflation target, the Fed would be expected to:
Meier and Tarhan (2006) conducted an interesting survey of corporate managers. The results are copied in Table 7 below. What proportion of managers are evaluating levered projects correctly?
| Table 7: Consistency between hurdle rate and the calculation of cash flows | |||||||
| Hurdle rate | Cash flow calculation (see below notes) | ||||||
|---|---|---|---|---|---|---|---|
| (i) | (ii) | (iii) | (iv) | (v) | Other | Total | |
| WACC | 11.3% | 34.8% | 1.7% | 3.5% | 18.3% | 1.7% | 71.3% |
| Equity levered | 0.0% | 2.6% | 0.9% | 0.0% | 0.9% | 0.9% | 6.1% |
| Equity unlevered | 1.7% | 1.7% | 0.9% | 0.9% | 1.7% | 0.9% | 7.8% |
| Other | 2.6% | 5.2% | 1.7% | 0.9% | 3.5% | 0.9% | 14.8% |
| Total | 16.5% | 44.4% | 5.2% | 5.2% | 24.4% | 4.4% | 100.0% |
The rows of the cross-tabulation indicate what the self-reported hurdle rate represents and the columns denote five different ways to calculate cash flows, (i) to (v), plus the “other” category. Each cell then displays the fraction of all 113 respondents for a given combination of what the hurdle rate represents and how the firm calculates its cash flows when evaluating a project.
The definitions of the cash flow calculations (i)-(v) are as follows:
(i) Earnings before interest and after taxes (EBIAT) + depreciation
(ii) Earnings before interest and after taxes (EBIAT) + depreciation – capital expenditures – net change in working capital
(iii) Earnings
(iv) Earnings + depreciation
(v) Earnings + depreciation – capital expenditures – net change in working capital
Assume that the WACC is after tax, the required return on unlevered equity is the WACC before tax, all projects are levered, the benefit of interest tax shields should be included in the valuation, earnings = net profit after tax (NPAT) and EBIAT = EBIT*(1-tc) which is often also called net operating profit after tax (NOPAT).
What proportion of managers are evaluating levered projects correctly?
Question 732 real and nominal returns and cash flows, inflation, income and capital returns
An investor bought a bond for $100 (at t=0) and one year later it paid its annual coupon of $1 (at t=1). Just after the coupon was paid, the bond price was $100.50 (at t=1). Inflation over the past year (from t=0 to t=1) was 3% pa, given as an effective annual rate.
Which of the following statements is NOT correct? The bond investment produced a:
Question 734 real and nominal returns and cash flows, inflation, DDM, no explanation
An equities analyst is using the dividend discount model to price a company's shares. The company operates domestically and has no plans to expand overseas. It is part of a mature industry with stable positive growth prospects.
The analyst has estimated the real required return (r) of the stock and the value of the dividend that the stock just paid a moment before ##(C_\text{0 before})##.
What is the highest perpetual real growth rate of dividends (g) that can be justified? Select the most correct statement from the following choices. The highest perpetual real expected growth rate of dividends that can be justified is the country's expected:
Question 739 real and nominal returns and cash flows, inflation
There are a number of different formulas involving real and nominal returns and cash flows. Which one of the following formulas is NOT correct? All returns are effective annual rates. Note that the symbol ##\approx## means 'approximately equal to'.
Question 740 real and nominal returns and cash flows, DDM, inflation
Taking inflation into account when using the DDM can be hard. Which of the following formulas will NOT give a company's current stock price ##(P_0)##? Assume that the annual dividend was just paid ##(C_0)##, and the next dividend will be paid in one year ##(C_1)##.
Question 745 real and nominal returns and cash flows, inflation, income and capital returns
If the nominal gold price is expected to increase at the same rate as inflation which is 3% pa, which of the following statements is NOT correct?
Question 882 Asian currency crisis, foreign exchange rate, original sin, no explanation
In the 1997 Asian currency crisis, the businesses most vulnerable to bankruptcy were those that:
Question 1038 fire sale, leverage, no explanation
Listen to 'Lessons and Questions from the GFC' on 6 December 2018 by RBA Deputy Governor Guy Debelle from 17:58 to 20:08 or read the below transcript:
Guy Debelle talks about the GFC and says that the Australian government’s guarantee of wholesale debt and deposits on 12 October 2008 was "introduced to facilitate the flow of credit to the real economy at a reasonable price and, in some cases, alleviate the need for asset fire sales, which have the capacity to tip markets and the economy into a worse equilibrium... The crisis very much demonstrated the critical importance of keeping the lending flowing. The lesson is that countries that did that fared better than countries that didn't. That lesson is relevant to the situation today in Australia, where there is a risk that a reduced appetite to lend will overly curtail borrowing with consequent effects for the Australian economy." (Debelle, 2019)
When assets are sold in a fire sale, there’s usually a large increase in the:
Question 1012 moral hazard, principal agent problem, asymmetric information
When does the ‘principal-agent problem’ occur? Is it when:
I. The principal has conflicting incentives (moral hazard);
II. The agent has conflicting incentives (moral hazard);
III. The principal has incomplete information about the agent (asymmetric information); or
IV. The agent has incomplete information about the principal (asymmetric information)?
The principal-agent problem occurs when the following statements are true:
Question 1010 lemons problem, asymmetric information, adverse selection, fungible
The ‘Lemons Problem’ is likely to more adversely affect the desirability of which type of investment?
Estimate the Chinese bank ICBC's share price using a backward-looking price earnings (PE) multiples approach with the following assumptions and figures only. Note that the renminbi (RMB) is the Chinese currency, also known as the yuan (CNY).
- The 4 major Chinese banks ICBC, China Construction Bank (CCB), Bank of China (BOC) and Agricultural Bank of China (ABC) are comparable companies;
- ICBC 's historical earnings per share (EPS) is RMB 0.74;
- CCB's backward-looking PE ratio is 4.59;
- BOC 's backward-looking PE ratio is 4.78;
- ABC's backward-looking PE ratio is also 4.78;
Note: Figures sourced from Google Finance on 25 March 2014. Share prices are from the Shanghai stock exchange.
Which firms tend to have high forward-looking price-earnings (PE) ratios?
Which firms tend to have low forward-looking price-earnings (PE) ratios? Only consider firms with positive PE ratios.