CIM Equity Securities & Valuation 1 — Questions and Answers
Question 1: Which valuation model discounts future dividends to determine the intrinsic value of a stock?
- Capital Asset Pricing Model
- Dividend Discount Model (Correct answer)
- Price-to-Earnings Model
- Discounted Cash Flow to Firm Model
Correct answer: Dividend Discount Model
The Dividend Discount Model (DDM) values a stock by discounting expected future dividends at the required rate of return.
Question 2: A stock has an expected dividend of $2.50, a required return of 10%, and a constant growth rate of 4%. What is its intrinsic value using the Gordon Growth Model?
- $25.00
- $41.67 (Correct answer)
- $62.50
- $35.71
Correct answer: $41.67
Using Gordon Growth Model: V = D1 / (r - g) = $2.50 / (0.10 - 0.04) = $2.50 / 0.06 = $41.67.
Question 3: Which of the following best describes the Price-to-Book (P/B) ratio?
- Market price divided by annual earnings per share
- Market price divided by book value per share (Correct answer)
- Enterprise value divided by EBITDA
- Market price divided by free cash flow per share
Correct answer: Market price divided by book value per share
The P/B ratio compares a company's market price to its book value per share, indicating how much investors pay relative to net assets.
Question 4: What does a high Price-to-Earnings (P/E) ratio typically indicate about investor expectations?
- Investors expect low future earnings growth
- The stock is undervalued relative to peers
- Investors expect high future earnings growth (Correct answer)
- The company has a high dividend payout ratio
Correct answer: Investors expect high future earnings growth
A high P/E ratio generally indicates that investors are willing to pay a premium, expecting strong future earnings growth from the company.
Question 5: In a Discounted Cash Flow (DCF) analysis, which discount rate is most commonly used to value an entire firm?
- Cost of equity
- Risk-free rate
- Weighted Average Cost of Capital (WACC) (Correct answer)
- Dividend yield
Correct answer: Weighted Average Cost of Capital (WACC)
WACC reflects the blended cost of all capital sources (debt and equity) and is used to discount free cash flows to the firm in a DCF valuation.
Question 6: Which type of equity security gives holders a priority claim on assets and dividends over common shareholders, but typically lacks voting rights?
- Growth stock
- Preferred stock (Correct answer)
- Convertible bond
- Rights offering
Correct answer: Preferred stock
Preferred stock holders receive dividends before common shareholders and have priority in liquidation, but usually do not have voting rights.
Question 7: Which ratio is calculated as Enterprise Value divided by EBITDA and is used to compare companies regardless of their capital structure?
- P/E ratio
- EV/EBITDA multiple (Correct answer)
- Price-to-Sales ratio
- Dividend yield
Correct answer: EV/EBITDA multiple
EV/EBITDA is a capital-structure-neutral valuation multiple that allows comparison of companies with different levels of debt.
CIM Equity Securities & Valuation 1
Which valuation model discounts future dividends to determine the intrinsic value of a stock?