CFA Exam Question of the Day
Level I | Level II | Level III
2023-05-29
Question:
You are analyzing RechedXS, an energy trading firm.
RechedXS has a required rate of return of 7%, an earnings payout rate of 73%, and in 5 years you expect EPS to reach $5.05 per share.
The industry has an average ROE of 8.1% and P/E of 38.3.
Determine the terminal value of RechedXS stock in 5 years using the method of price multiples and the Gordon growth model.
Select an Answer:
$193.42; $79.27
$195.42; $79.27
$195.42; $78.27
$193.42; $78.27
Rationale:
Using the method of price multiples, we simply multiply the projected EPS by the industry P/E ratio: $5.05(38.3) = $193.42.
The Gordon growth model:
yields a P/E that we can use with the projected EPS.
We need to determine g, the growth rate. The growth rate will be equal to the retention rate multiplied by the ROE.
In this case, that will be 27%(8.1%) = 2.19%.
The P/E will then be 73%(1.0219)/(0.07 − 0.0219) = 15.5, so the projected terminal value will equal 15.5($5.05) = $78.27.
2023-05-28
Question:
You are analyzing RechedXS, an energy trading firm.
RechedXS has a required rate of return of 10%, an earnings payout rate of 83%, and in 5 years you expect EPS to reach $3.48 per share.
The industry has an average ROE of 9.6% and P/E of 21.0.
Determine the terminal value of RechedXS stock in 5 years using the method of price multiples and the Gordon growth model.
Select an Answer:
$72.08; $35.08
$73.08; $36.08
$72.08; $36.08
$73.08; $35.08
Rationale:
Using the method of price multiples, we simply multiply the projected EPS by the industry P/E ratio:
$3.48(21) = $73.08
The Gordon growth model:
yields a P/E that we can use with the projected EPS.
We need to determine g, the growth rate. The growth rate will be equal to the retention rate multiplied by the ROE.
In this case, that will be 17%(9.6%) = 1.63%.
The P/E will then be 83%(1.0163)/(0.10 − 0.0163) = 10.08; so, the projected terminal value will equal 10.08($3.48) = $35.08.
2023-05-27
Question:
Duhon Electronics has a return on equity of 13%, a required rate of return of 11%, and a 6% growth rate.
Find the justified price-to-book value ratio.
Select an Answer:
1.00
1.25
1.40
1.35
Rationale:
The justified price-to- book ratio is found by a variant of the Gordon growth model equation:
Therefore, we find:
(0.13 − 0.06) / (0.11 − 0.06) = 1.40
2023-05-26
Question:
You are analyzing a firm with the following characteristics:
- Current stock price: $35
- Current year estimated EPS: $1
- Current year dividends per share: $0.45
- Dividend growth rate: 1% per year
If the annual required rate of return is 5.8%, what is the justified leading price-to-earnings ratio?
Select an Answer:
12.47
35.00
9.47
11.26
9.38
Rationale:
The justified leading P/E ratio is given by the equation:
where 1 − b is the dividend payout ratio, r is the annual required return on equity, and g is the annual growth rate in dividends.
Here, we have the payout ratio equal to $0.45/$1.00 = 45%. Substituting the other values in the equation yields a justified leading P/E of 9.38.
2023-05-25
Question:
You are analyzing RechedXS, an energy trading firm.
RechedXS has a required rate of return of 11%, an earnings payout rate of 3%, and in 5 years you expect EPS to reach $6.57 per share.
The industry has an average ROE of 10.2% and P/E of 11.9.
Determine the terminal value of RechedXS stock in 5 years using the method of price multiples and the Gordon growth model.
Select an Answer:
$77.18; $18.58
$78.18; $18.58
$78.18; $19.51
$77.18; $19.58
Rationale:
Using the method of price multiples, we simply multiply the projected EPS by the industry P/E ratio:
$6.57(11.9) = $78.18
The Gordon growth model:
yields a P/E that we can use with the projected EPS.
We need to determine g, the growth rate. The growth rate will be equal to the retention rate multiplied by the ROE.
In this case, that will be 97%(10.2%) = 9.89%.
The P/E will then be 3%(1.0989)/(0.11 − 0.0989) = 2.97. Hence, the projected terminal value will equal 2.97($6.57) = $19.51.
