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Multiple Choice Quiz
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1
Your firm just announced earnings per share of $2. Suppose you believe that earnings will grow at 10% per year forever, the price of the stock today is $40, and you expect the forward P/E for your firm to stay constant at today’s level. According to the P/E heuristic, the price of the stock next year is
A)$40.
B)$44.
C)$46.
D)$48.
E)Cannot be calculated with the information provided.
2
In the situation above, according to the P/E heuristic, if you expect forward P/E to grow at 5% per year, the price of the stock next year will be
A)$40.00
B)$44.00
C)$46.20
D)$48.60
E)Cannot be calculated with the information provided.
3
The PEG heuristic
A)Assumes that stocks of high-growth firms should have higher P/E ratios than stocks of low-growth firms.
B)Is relatively intuitive.
C)Has no relation to economic reality.
D)All of the above.
E)None of the above.
4
The key variables that determine the P/E ratio of a company are
A)Its growth rate of sales and its required rate of return
B)Its required rate of return and the present value of growth opportunities
C)Its growth in EPS and its required rate of return
D)The P/E ratios of comparable firms in the industry
E)None of the above.
5
If a firm has positive growth opportunities
A)Its expected return on equity must exceed its required return.
B)Its expected return on sales must exceed its required return.
C)Its expected return on assets must exceed its required return.
D)Its expected return on assets must equal its required return.
E)None of the above.
6
Analysts tend to issue excessively optimistic forecasts. This is because
A)They tend to cover firms that they are enthusiastic about and drop firms they do not like
B)They have incentives to issue favorable forecasts to help generate investment banking deal flow.
C)Analysts are optimistic people by nature.
D)Both a and b.
E)None of the above
7
By focusing on crude heuristics, managers and analysts may end up with biased forecasts. To prevent this from happening, managers and analysts should
A)Verify that the sources of free cash flow equal the uses of free cash flow.
B)Apply valuation techniques that are grounded in finance theory, in addition to the heuristics.
C)Check that the assumptions made across the different heuristics are consistent.
D)All of the above
E)None of the above
8
Examples of biases in traditional discounted cash flow valuation include
A)Excessive optimism when computing the cash flows
B)Misframing cash flows by focusing only on the sources of cash flows
C)Making errors when computing the required rate of return
D)Both A and B
E)None of the above





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