1 The valuation of stocks is more difficult than the valuati

1. The valuation of stocks is more difficult than the valuation of bonds because

a) The appropriate discount rate is more difficult to determine for stocks than it is for bonds

b) The future cash flows from stocks are more uncertain than the ones from bonds

c) The stock market is more volatile than the bond market

d) Stocks represent a residual claim on the firm’s assets whereas bonds have a senior claim on the assets

2.One main conclusion can be drawn if markets are efficient is that

a) There is no reason to believe that prices are too high or too low

b) It is possible to find positive NPV projects

c) Prices will react quickly to new information, but not always correctly

d) Historical price trends will provide a good idea of where prices are headed in the near future

3. What is the plowback ratio for a firm that has earnings per share (EPS) of $12 and pays out $8 dividend per share (DPS)?

a) 25.00%

b) 33.33%

c) 50.00%

d) 66.67%

Solution

1. B.

The valuation of stocks is more difficult than the valuation of bonds because stocks donot have finite maturity and the future cash flows. Cash flows are not known in advance. It means dividends are not specified.

Techniques for the valuation of stock are

Capital asset pricing model; Dividend discount model; Price Earning method and balance sheet valuation.

2. C.

If markets are EFFICIENT, the prices will react quickly to new information.

3. B

Plowback ratio =1 - DPS/EPS = 1 - 8/12 = 1-0.66666667 = 0.33333333 = 33.33%