Q&A Hero

Q: Nogrowth Corporation expects their dividend to stay at $0.50 per share each year into the foreseeable future. Therefore A) the stock will be valued at $0.50 times the number of years an investor plans to keep it. B) the value of the stock can be estimated as $0.50 divided by an investor's required rate of return. C) the value of the stock cannot be determined using the dividend valuation model because the growth rate is zero. D) the value of the stock is positive only if the required return is negative.

Q: Using the constant growth dividend valuation model and assuming dividends will growth a constant rate forever, the increase in the value of the stock each year should be equal to the A) growth rate in dividends, g. B) required return on the stock, rcs. C) dividend yield plus the capital gains yield. D) dividend yield.

Q: A small company struggling to reach profitability just announced a major new government contract that will validate its technology and generate revenue for the next several years. The announcement of the contract will A) cause the stock price to increase because rcs (the required return) is likely to increase. B) cause the stock price to decrease because the government usually pays below market price for the goods and services it purchases. C) cause the stock price to increase because rcs (the required return) is likely to decrease and g (the growth rate in future dividends) is likely to increase. D) have no effect on the stock price because the company has not yet paid any dividends.

Q: A small biotechnology research corporation has been experiencing losses for the first three years of its existence, and thus has a negative balance in retained earnings. The corporation's stock price, however, is $1 per share. Which of the following statements is MOST correct? A) Investors are irrational to pay $1 per share when earnings per share have been negative for three years. B) Investors believe the stock is worth $1 per share because future earnings (and cash flows) are expected to be positive. C) The corporation's accountants must have made a mistake because retained earnings may not be negative. D) The required return on the stock will be small because the company has very few assets.

Q: Which of the following statements concerning the constant growth dividend valuation model is true? A) The required rate of return must exceed the growth rate. B) The dividend growth rate must be bigger than 8%. C) The growth rate must increase every year. D) The required rate of return must be equal to the growth rate for dividends.

Q: Which of the following statements concerning the required rate of return on stocks is true? A) The higher an investor's required rate of return, the higher the value of the stock. B) If risk is reduced, the required return will decrease because more investors are risk-averse. C) The required return on preferred stock is generally higher than the required return on common stock. D) The higher the risk, the higher the required return, other things being equal.

Q: You are considering the purchase of a common stock that paid a dividend of $2.00 yesterday. You expect this stock to have a growth rate of 15 percent for the next 3 years, resulting in dividends of D1 = $2.30, D2 = $2.645, and D3 = $3.04. The long-run normal growth rate after year 3 is expected to be 10 percent (that is, a constant growth rate after year 3 of 10% per year forever). If you require a 14 percent rate of return, how much should you be willing to pay for this stock? A) $89.75 B) $83.65 C) $56.46 D) $62.57

Q: If two firms have the same current dividend and the same expected growth rate, their stocks must sell at the same current price or else the market will not be in equilibrium. A) false, because the required return could be different B) true, because we are using a dividend valuation model C) true, if markets are semi-strong form efficient D) true, if investors are risk-averse

Q: Which of the following changes will make the value of a stock go up, other things being held constant? A) The required return decreases. B) The required return increases. C) In general, investors become more risk averse. D) The growth rate of dividends decreases.

Q: ACME, Inc. expects its current annual $2.50 per share common stock dividend to remain the same for the foreseeable future. Therefore, the value of the stock to an investor with a required return of 12% is A) $3.00. B) $18.33. C) $20.83. D) $30.00.

Q: Asymmetric Frames Corp. had a return on equity of 15%. The corporation's earnings per share was $6.00, its dividend payout ratio was 40% and its profit-retention rate was 60%. If these relationships continue, what will be United Financial Corp.'s internal growth rate? A) 6.0% B) 8.6% C) 9.0% D) 15.6%

Q: The common stock of a constant-growth firm is valued in the same manner as its preferred stock.

Q: Common stockholders demand a return on the price paid for their common stock, but since retained earnings on the balance sheet are merely "on paper" they do not require a return on earnings that have been retained.

Q: Historically, price appreciation, or capital gains yield, has accounted for a greater portion of returns on common stocks than dividend payments.

Q: The change in the value of a corporation's common stock as the result of growth is the same regardless of whether the growth is the result of internal growth or the infusion of new capital.

Q: Common stock valuation can be based on the present value of future dividends or alternatively on the present value of the firm's future quarterly net income.

Q: A firm can increase the growth rate of common stockholders' investment in the firm by retaining more earnings or increasing return on equity.

Q: The retention ratio is equal to 1 minus the dividend payout ratio.

Q: The stock valuation model D1/(rcs - g) requires the stock to grow at a rate greater than the required return; otherwise, the stock is worthless.

Q: In general, common stock and preferred stock are both valued by calculating the present value of all expected future cash flows, using the required return as the discount rate.

Q: A common stock with an expected dividend growth rate of zero would be valued in the same way as preferred stock, that is, the expected dividend divided by the required return.

Q: If the expected growth rate for dividends is zero, then the value of common stock will be equal to the current dividend.

Q: Because common stock represents a residual interest in the corporation, the value of common stock is equal to the total firm value less the firm's outstanding debt.

Q: The most relevant form of growth for valuing a firm's common stock is internal growth.

Q: Who bears the greatest risk of loss of value if a firm should fail?A) bondholdersB) preferred stockholdersC) common stockholdersD) All of the above bear equal risk of loss.

Q: Which of the following features, or benefits, belong to a firm's common stockholders? A) limited liability B) ownership of the firm C) voting rights D) all of the above

Q: What provision entitles the common shareholder to maintain a proportionate share of ownership in a firm? A) the cumulative feature B) the convertible feature C) the proportionality clause D) the preemptive right

Q: Assume that a firm had such serious financial problems that it was about to be liquidated after a bankruptcy. All of the firm's assets are about to be sold in order to pay the following claims against the firm: bondholders, preferred stockholders, common stockholders, and federal income taxes. Of the claims mentioned, what priority would common stockholders have? A) first B) second C) third D) fourth

Q: Consider the following four types of payments that could be made by a normal operating firm: interest, common dividends, income taxes, and preferred dividends. Compared to the other payments mentioned, where would you rank common dividend payments in terms of the order of payment if the firm is liquidating? A) first B) second C) third D) fourth

Q: Which of the following is NOT true regarding common stock? A) Dividends, unlike interest payments, are not tax deductible. B) Common stock, unlike bond principal, does not mature. C) Common stockholders are owners of the firm, whereas bondholders are creditors. D) Dividend payments, like interest payments, are fixed.

Q: Minority shareholders have a greater chance of electing a member to the board of directors if the company uses A) cumulative voting. B) majority voting. C) minority voting. D) proxy voting.

Q: If a shareholder cannot attend the corporation's annual meeting, the shares may still be voted using A) the preemptive right. B) a proxy. C) majority voting rules. D) the cumulative voting right.

Q: Limited liability for a corporation's common shareholders is a protective provision that aids the corporation in raising funds.

Q: In theory, shareholders select the board of directors, but in reality, management effectively selects the directors.

Q: Under majority voting, a majority (>50%) shareholder will be able to elect the entire board of directors.

Q: Under majority voting, a majority (>50%) shareholder will just be able to elect a simple majority of the board of directors.

Q: Under cumulative voting, a 10% shareholder will likely be able to elect 10% of the board of directors.

Q: If a common stockholder cannot personally attend the meeting of shareholders, then their votes are lost.

Q: Bondholders and preferred stockholders can be viewed as creditors, whereas the common stockholders are the true owners of the firm.

Q: Common stock does not mature.

Q: Convertibility is a common feature of common stock; it allows the common stockholders to convert their common shares into preferred shares or into bonds.

Q: Common stock cannot be worth less than its book value.

Q: Shareholders, as owners of the corporation, face unlimited liability for the corporation's debts, while bondholders, as creditors, may only lose the value of their investment if the company goes bankrupt.

Q: Cumulative voting is advantageous to minority shareholders because it may allow them to elect a member of the board of directors.

Q: The market price of a firm's common stock equals the sum of all equity accounts as reported in its balance sheet (common stock + paid-in capital + retained earnings) divided by the number of shares outstanding.

Q: If Neal O'Danny preferred stock pays an annual dividend of $2.80, and investors require a 9% return, what is the value of O'Danny's preferred stock today?

Q: Glacier Inc. preferred stock has a 5% stated dividend percentage, and a $100 par value. What is the value of the stock if your required rate of return is 6% per year? A) $83.33 B) $94.05 C) $100.00 D) $30.00

Q: Lithium Lakes Industries preferred stock has a par value of $100 and pays a dividend of $6.00 per share. It presently sells for $87 per share. What do investors require as a rate of return on this stock? Round off to the nearest .10%. A) 14.5% B) 9.3% C) 6.9% D) 6.0%

Q: Studio 55, Inc. has an issue of preferred stock that pays a dividend of $4.00. The preferred stockholders require a rate of return on this stock of 9%. At what price should the preferred stock sell for? Round off to the nearest $0.10. A) $36.00 B) $44.40 C) $62.50 D) $88.80

Q: LTM, Inc. has an issue of preferred stock whose par value is $1,000. The preferred stock pays a 4.5% dividend. If investors require a 5.5% rate of return for these shares, what price should the preferred stock sell for? A) $611.11 B) $508.33 C) $409.09 D) $818.18

Q: Bacon Signs Company preferred stock pays a perpetual annual dividend of 4.5% of its $100 par value. If investors' required rate of return on this stock is 12%, what is the value per share? A) $37.50 B) $31.82 C) $8.50 D) $45.00

Q: How is preferred stock affected by a decrease in the required rate of return? A) The value of a share of preferred stock increases. B) The dividend increases. C) The dividend decreases. D) The dividend yield increases.

Q: What is the value of a preferred stock that pays a $5.55 dividend to an investor with a required rate of return of 10%? A) $22.22 B) $27.83 C) $45 D) $55.50

Q: Whistle Corp. has a preferred stock that pays a dividend of $2.40. If you are willing to purchase the stock at $11, what is your required rate of return? (Round your answer to the nearest .1% and assume that there are no transaction costs.) A) 21.8% B) 11.0% C) 9.1% D) 20.1%

Q: Stimpson Inc. preferred stock pays a $.50 annual dividend. What is the value of the stock if your required rate of return is 10%? A) $.05 B) $.50 C) $5.00 D) $50.00

Q: Which of the following statements concerning preferred stock is MOST correct? A) Preferred stock is valued the same as zero coupon bonds because the cash flow patterns are similar. B) If a corporation issues 4% preferred stock with a par value of $100, the dividend will increase by 4% per year. C) Preferred stock dividends are typically the same each year, allowing a preferred stock to be valued as a perpetuity. D) Preferred stock dividends are calculated as a percentage of common stock dividends, although the preferred stock dividends must be paid first.

Q: Maynard Inc. preferred stock pays an annual dividend of $7 per share. Which of the following statements is true for an investor with a required return of 9%? A) The value of the preferred stock is $7 because the dividend is fixed at $7 each year . B) The value of the preferred stock is $63.00 per share. C) The value of the preferred stock is $77.78 per share. D) The value of the preferred stock is $6.30 per share because of the 9% required return.

Q: Public perception and reputation do not affect stock prices, which are strictly a function of dividends and required returns.

Q: A preferred stock that pays an annual dividend of $10, has a par value of $100, and has a required return of 5% will be valued at $200.

Q: The YTD% shown in Wall Street Journal stock quotes stands for the stock's dividend yield and is calculated by dividing the amount of the dividend by the stock's opening price on the first day of the year.

Q: ABC Corp. 5% preferred stock with a par value of $100 and a market price of $125 will pay an annual dividend this year of $12 per share.

Q: What provisions are available to protect a preferred stockholder?

Q: How is preferred stock similar to common stock? A) Preferred dividend payments usually have unlimited growth potential. B) Investors cannot sue a corporation for the non-payment of dividends. C) Both preferred and common stockholders have voting control of a firm. D) Preferred stock dividends and common stock dividends are fixed.

Q: Preferred stock differs from common stock in that A) preferred stock usually has a maturity date. B) preferred stock investors have a higher required return than common stock investors. C) preferred stock dividends are fixed. D) common stock investors have a required return and preferred stock investors do not.

Q: Many preferred stocks have a feature that requires a firm to periodically set aside an amount of money for the retirement of its preferred stock. What is the name of this feature? A) convertible B) callable C) cumulative D) sinking fund

Q: Many preferred stocks have a provision that entitles a company to repurchase its preferred stock from their holders at stated prices over a given time period. What is the name of this provision? A) cumulative B) putable C) callable D) convertible

Q: Most preferred stocks have a feature that requires all past unpaid preferred dividend payments be paid before any common stock dividends can be paid. What is the name of this feature? A) participating B) cumulative C) provisional D) convertible

Q: How is preferred stock similar to bonds? A) Dividend payments to preferred shareholders (much like bond interest payments to bondholders) are tax deductible. B) Investors can sue the firm if preferred dividend payments are not paid (much like bondholders can sue for non-payment of interest payments). C) Preferred stockholders receive a dividend payment (much like interest payments to bondholders) that is usually fixed. D) Preferred stock is not like bonds in any way.

Q: Cumulative preferred stock A) requires dividends in arrears to be carried over into the next period. B) has a right to vote cumulatively. C) has a claim to dividends before bonds. D) has a higher required return than common stock.

Q: Preferred stock is similar to a bond in the following way: A) Preferred stock always contains a maturity date. B) Both investments provide a stated income stream. C) Both contain a growth factor similar to common stock. D) Both provide interest payments.

Q: Preferred stock valuation usually treats the preferred stock as a A) capital asset. B) perpetuity. C) common stock. D) long-term bond.

Q: Preferred stock and common stock issued by the same firm will have the same required return because the riskiness of the firm's cash flows is the same for both securities.

Q: Preferred stock is less risky than common stock, but more risky than debt.

Q: A company's market capitalization is generally greater than its book value, in part due to its reputation for being able to deliver growth, attract top talent, and avoid ethical mistakes.

Q: Two approaches that allow for the retirement of preferred stock are call provisions and sinking fund provisions.

Q: A sinking-fund provision allows for the retirement of a portion of preferred stock each year.

Q: The upper limit on common stock dividends, which is set by the SEC, is generally equal to the sum of dividends paid on the company's preferred stock.

Q: The use of a call provision in addition to a sinking fund can effectively create a maturity date for preferred stock.

Q: If a firm does not have enough money to pay any common stock dividends, it is technically in default to the common shareholders.

Q: Although under normal operating conditions preferred shareholders do not have voting rights, protective provision generally allow for voting rights in the event of nonpayment of preferred dividends.