ACCA FM · Chapter 13
Business valuations and market efficiency MCQs with Answers
9 multiple-choice questions on Business valuations and market efficiency for ACCA FM Financial Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
A company has total assets of $18m, including purchased goodwill of $2m, and total liabilities of $7m. There are 5 million shares in issue. What is the value per share using a net tangible asset basis?
- A) $1.40
- B) $1.80
- C) $2.20
- D) $3.20
Show answer & explanation
Answer: B) $1.80
Net tangible assets = total assets - intangible goodwill - liabilities = 18 - 2 - 7 = $9m. Value per share = $9m / 5m = $1.80. Including goodwill gives $2.20, and ignoring liabilities gives $3.20.
Question 2
An unlisted company has annual earnings of $2.4m. A similar listed company has a price/earnings ratio of 14. The acquirer believes a discount of 20% should be applied to the P/E ratio because the target is unlisted. What is the estimated value of the target's equity?
- A) $6.72m
- B) $26.88m
- C) $33.60m
- D) $40.32m
Show answer & explanation
Answer: B) $26.88m
Adjusted P/E = 14 x (1 - 0.2) = 11.2. Value = earnings x P/E = $2.4m x 11.2 = $26.88m. The discount reflects the lower marketability and higher risk of unlisted shares. Using the proxy P/E unadjusted gives $33.60m.
Question 3
A company has just paid a dividend of $0.25 per share. Dividends are expected to grow at 4% a year indefinitely and shareholders require a return of 11%. Using the dividend valuation model, what is the value of one share (to the nearest cent)?
- A) $1.73
- B) $2.36
- C) $3.57
- D) $3.71
Show answer & explanation
Answer: D) $3.71
P0 = D0(1 + g) / (Ke - g) = 0.25 x 1.04 / (0.11 - 0.04) = 0.26 / 0.07 = $3.71. Failing to grow the dividend to D1 gives $3.57.
Question 4
If a stock market is semi-strong form efficient, which of the following is correct?
- A) Share prices reflect only past price movements, so fundamental analysis can earn abnormal returns
- B) Share prices reflect all publicly available information, so analysing published financial statements will not consistently produce abnormal returns
- C) Share prices reflect all information, including information known only to insiders
- D) Share prices never change in response to new announcements
Show answer & explanation
Answer: B) Share prices reflect all publicly available information, so analysing published financial statements will not consistently produce abnormal returns
In a semi-strong form efficient market, share prices adjust quickly and accurately to all publicly available information, including past prices and new announcements. Neither technical nor fundamental analysis of public information can consistently beat the market, but investors with inside information could still earn abnormal returns.
Question 5
Which of the following would be true ONLY if a stock market were strong form efficient?
- A) Investors could not earn abnormal returns from analysing published accounts
- B) Investors could not earn abnormal returns by studying past share price patterns
- C) Share prices would react rapidly to the publication of annual results
- D) Directors trading on unpublished price-sensitive information would be unable to earn abnormal returns
Show answer & explanation
Answer: D) Directors trading on unpublished price-sensitive information would be unable to earn abnormal returns
Strong form efficiency means share prices reflect all information, public and private, so even insiders could not profit from their knowledge. The other statements are already true under weak form (past prices) or semi-strong form (published information) efficiency, which are implied by, but do not require, strong form efficiency.
Question 6
Research shows that a stock market is weak form efficient. What is the implication for investors?
- A) Fundamental analysis of published information cannot earn abnormal returns
- B) Insider dealing cannot earn abnormal returns
- C) Technical analysis of past share price movements cannot be used to earn consistent abnormal returns
- D) Share prices always equal the intrinsic value of the company
Show answer & explanation
Answer: C) Technical analysis of past share price movements cannot be used to earn consistent abnormal returns
Weak form efficiency means current share prices fully reflect all information contained in past price movements, so prices follow a random walk and chartism (technical analysis) cannot consistently earn abnormal returns. Weak form efficiency alone does not rule out profits from fundamental analysis or inside information.
Question 7
A company has annual earnings of $3m. Similar companies have an earnings yield of 12.5%. What is the estimated value of the company's equity using the earnings yield method?
- A) $0.375m
- B) $3.375m
- C) $24.0m
- D) $37.5m
Show answer & explanation
Answer: C) $24.0m
Value = earnings / earnings yield = $3m / 0.125 = $24.0m. The earnings yield is the reciprocal of the P/E ratio, so this is equivalent to using a P/E of 8. Multiplying earnings by 12.5 treats the yield as a P/E ratio.
Question 8
A company has 5% bonds ($100 nominal) that pay interest annually and will be redeemed at a 5% premium in four years' time. Investors require a pre-tax return of 7%. Using factors of 3.387 (4-year annuity at 7%) and 0.763 (year 4 at 7%), what is the market value of each bond?
- A) $71.43
- B) $93.23
- C) $97.05
- D) $104.14
Show answer & explanation
Answer: C) $97.05
Market value = PV of interest + PV of redemption = 5 x 3.387 + 105 x 0.763 = 16.935 + 80.115 = $97.05. The redemption amount is $105 because of the 5% premium; using $100 gives $93.23. Investors' pre-tax required return is used because tax relief on interest benefits the company, not the investor.
Question 9
A company expects to pay a dividend of $0.50 per share in one year's time. Dividends will then grow at 10% a year for the following two years (years 2 and 3), and at 4% a year indefinitely after that. The cost of equity is 12%. What is the value of a share today (to the nearest cent)?
- A) $6.25
- B) $6.91
- C) $9.18
- D) $25.00
Show answer & explanation
Answer: B) $6.91
Dividends: year 1 0.500; year 2 0.550; year 3 0.605. Value at the end of year 3 = D4 / (Ke - g) = 0.605 x 1.04 / 0.08 = 7.8650. PV = 0.500/1.12 + 0.550/1.12^2 + (0.605 + 7.8650)/1.12^3 = $6.91 (exact discounting, rounded to the nearest cent). Applying 10% growth in perpetuity gives $25.00, and forgetting to discount the year 3 value gives $9.18.