1. The SML approach to valuing a stock has several advantages when compared to t
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Question
1. The SML approach to valuing a stock has several advantages when compared to the dividend cash flow model that include:A) adjusting for risk
B) SML can be used even if a firm does not pay a dividend
C) market risk premium is easier to estimate than dividends
D) A and B
E) all the above
2. The total return of a stock consists of:
a) Capital gains yield and growth rate
b) Capital gains yield and dividend yield
c) Dividend cash flows only
d) None of the above
3. Ultimately, the value of a firm is determined by:
a) Retained earnings
b) Earnings per share
c) Market investors
d) None of the above
4. The cost of capital is also equivalent to:
a) The required return
b) The discount rate
c) The opportunity cost
d) The hurdle rate
e) All the above
5. In making strategic capital budgeting decisions, which contingency is normally not considered as part of the planning process:
a) The option to expand
b) The option to abandon
c) The option to wait
d) None of the above, all are viable options 1. The SML approach to valuing a stock has several advantages when compared to the dividend cash flow model that include:
A) adjusting for risk
B) SML can be used even if a firm does not pay a dividend
C) market risk premium is easier to estimate than dividends
D) A and B
E) all the above
2. The total return of a stock consists of:
a) Capital gains yield and growth rate
b) Capital gains yield and dividend yield
c) Dividend cash flows only
d) None of the above
3. Ultimately, the value of a firm is determined by:
a) Retained earnings
b) Earnings per share
c) Market investors
d) None of the above
4. The cost of capital is also equivalent to:
a) The required return
b) The discount rate
c) The opportunity cost
d) The hurdle rate
e) All the above
5. In making strategic capital budgeting decisions, which contingency is normally not considered as part of the planning process:
a) The option to expand
b) The option to abandon
c) The option to wait
d) None of the above, all are viable options 1. The SML approach to valuing a stock has several advantages when compared to the dividend cash flow model that include:
A) adjusting for risk
B) SML can be used even if a firm does not pay a dividend
C) market risk premium is easier to estimate than dividends
D) A and B
E) all the above
2. The total return of a stock consists of:
a) Capital gains yield and growth rate
b) Capital gains yield and dividend yield
c) Dividend cash flows only
d) None of the above
3. Ultimately, the value of a firm is determined by:
a) Retained earnings
b) Earnings per share
c) Market investors
d) None of the above
4. The cost of capital is also equivalent to:
a) The required return
b) The discount rate
c) The opportunity cost
d) The hurdle rate
e) All the above
5. In making strategic capital budgeting decisions, which contingency is normally not considered as part of the planning process:
a) The option to expand
b) The option to abandon
c) The option to wait
d) None of the above, all are viable options
Explanation / Answer
1)
Option E: All the above
SML approach calculates the return of a security based on the systematic risk and thus it calculates the return adjusting for risk. The formula of Expected return =Rf+(Rf-Rm)*beta doesn’t involve the dividend term, thus it can be used to calculate the expected return even if the firm does not pay dividend. Also market risk premium, which is the difference between the market return and the risk free rate is easy to calculate as the data is readily available, where dividend estimate requires considering various factor like firm past dividend, expected growth etc.
2)
Option B: Capital gain yield and the dividend yield
Total return = (P1+Div)/P0=P1/P0+Div/P0=Price return+ Dividend yield= Capital gain yield + dividend yield
Where P1=Price at the end of the holding period, Div=Div at the end of the period,P0=initial price
3)
Option B: Earning per shares
Comparative valuation requires the EPS of the firm and compares with the EPS of the competing firm to determine the value of the firm
4)
Option E All of the above
Cost of capital is the opportunity cost of a firm i.e. the rate of return that can be earned by investing the capital into other investment with similar risk. Thus it is the required rate of return of the firm. The firm uses the cost of capital to discount the future cash flows.
5)
Option E None of the above, all are viable options
Capital budgeting business is the decision whether to undertake the project or not. Thus it requires the estimate of the profit for the project to decide whether to invest or not. It takes into account of all the possibilities like option to expand, option to wait and the option to abandon
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