Question 1

Given no change in required returns, the price of a stock whose dividend is constant will:

Accepted Answer

Since the required return is not changing, the stock price is only influenced by the constant dividend payment. In this case, the stock price will remain unchanged.

Question 2

Fred Flintlock wants to earn a total of 10% on his investments. He recently purchased shares of ABC stock at a price of $20 a share. The stock pays a $1 a year dividend. The price of ABC stock needs
To _____ if Fred is to achieve his 10% rate of return.

Accepted Answer

To find out what price the stock needs to be at for Fred to achieve a 10% rate of return, we need to use the dividend discount model formula:

Price = Dividend / (Rate of return - Dividend growth rate)

We know that Fred wants a 10% rate of return, so the rate of return in this case is 0.10. We also know that the dividend is $1 a year, so the dividend growth rate can be calculated as:

Dividend growth rate = Dividend / Current price

Dividend growth rate = 1 / 20 = 0.05

Now we can plug in the values:

Price = 1 / (0.10 - 0.05) = $20

This means that if the price of the stock remains at $20, Fred will earn a rate of return of 5% instead of the desired 10%. To achieve a rate of return of 10%, the price of the stock needs to increase. The only choice that reflects an increase is C) increase by 5%. Therefore, the correct answer is C).

Question 3

Martin Industries pays a constant $2.50 a share annual dividend. The market price of this stock will:

Accepted Answer

The market price of a stock is determined by its dividends and the required rate of return. If the required rate of return increases, investors will demand a higher return on their investment, causing the price of the stock to decrease. Therefore, if the required return increases, the market price of Martin Industries stock will decrease, even if the dividend remains constant.

Question 4

A characteristic of public corporations is to allocate a portion of their earnings to shareholders through _______________.

Accepted Answer

Public corporations distribute a portion of their earnings to shareholders in the form of cash dividends. Stock splits and stock dividends do not involve actual distribution of earnings and net income is a measure of a company's profitability, not a distribution to shareholders. Stock liquidation is the process of selling off all the assets of a company and distributing the proceeds to its creditors and shareholders, and is not related to earnings distribution.

Question 5

You are considering investing in a ﬁrm and wish to place a value on the common stock. The
dividend on the ﬁrm's stock has not changed in the last ﬁve years. Absent any information
suggesting future changes in the dividend rate, the most appropriate stock valuation model would
be the ___________ model.

Accepted Answer

Since the dividend on the firm's stock has not changed in the last five years and there is no information indicating future changes in the dividend rate, the dividend growth rate can be assumed to be zero. Therefore, the most appropriate stock valuation model would be the zero growth model, which assumes a constant dividend payment over time.

Question 6

Dividend models suggest that ____________ determine the value of a ﬁnancial asset to which the owner is entitled while holding the asset.

Accepted Answer

Dividend models suggest that the value of a financial asset is determined by its future cash flows, as opposed to past or current cash flows. This is because investors are interested in the potential for future earnings and dividends, rather than just looking at what has happened in the past or what is currently happening.

Question 7

Cumulative voting is the procedure whereby a shareholder:

Accepted Answer

Cumulative voting allows a shareholder to concentrate all their votes on one candidate for the board of directors, rather than spreading them out among multiple candidates. This can be particularly beneficial in electing minority positions.

Question 8

The capital gain yield:

Accepted Answer

The capital gain yield is the rate at which the price of the stock grows or appreciates. It is calculated by dividing the increase in the price of the stock by the original price of the stock. The other options are incorrect. The dividend yield is the amount of dividends paid by the company divided by the current market price of the stock. The required rate of return is the return investors demand for investing in the stock. The capital gain yield can be a negative value if the stock price decreases. The current yield is the annual income generated by an investment, usually in the form of dividends or interest, divided by the current market price of the investment.

Question 9

ABC Co. is owned by a group of shareholders, all of whom vote independently and all of whom want personal control over the ﬁrm. If straight voting is used, a shareholder:

Accepted Answer

With straight voting, a shareholder must own enough shares to totally control the elections or have no control at all. Straight voting does not provide any proportional representation based on the number of shares owned. Therefore, if the shareholders all want personal control, they would need to own enough shares individually to have the power to control the elections.

Question 10

The capital gains yield as used in the dividend growth model is deﬁned as:

Accepted Answer

The capital gains yield in the dividend growth model is represented by the growth rate (g) of the dividends.

Question 11

If two stocks have the same earnings per share and required rate of return, differences in the ____________ of the two companies can account for different stock prices.

Accepted Answer

If two stocks have the same earnings per share and required rate of return, the growth opportunities of the two companies can account for differences in stock prices. This is because investors are willing to pay more for a stock that has a higher potential for future earnings growth. Factors such as market share, innovation, and expansion plans can all contribute to the perceived growth potential of a company.

Question 12

Which of the following is true of non-voting common stock?

Accepted Answer

Non-voting shares must receive dividends no lower than dividends on voting shares. This is often a condition to compensate for the lack of voting power, ensuring that non-voting shareholders receive at least equal (if not sometimes preferential) dividend payments compared to voting shareholders.

Question 13

Assume that you are using the dividend growth model to value stocks. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect the:

Accepted Answer

According to the dividend growth model, the market rate of return is used as the discount rate, which means that as the market rate of return increases, the present value of future dividends decreases, leading to a decrease in the market value of stocks.

Question 14

The primary reason for creating dual or multiple classes of stock has to do with:

Accepted Answer

The primary reason for creating dual or multiple classes of stock is to give control of the company to a specific group of shareholders or individuals. This is often done to prevent minority shareholders from having a significant say in the company's decision-making process. With multiple classes of stock, the group with the majority of voting rights can maintain control.

Question 15

D1 in the dividend growth model is associated with which of the following words when solving for P0?

Accepted Answer

D1, the first dividend payment, is associated with the expected or future dividend payment, rather than the past or recent dividend payments. Therefore, A is the best choice as it includes "next" and "expected" which align with the concept of D1.

Question 16

Jack owns 35 shares of stock in Beta, Inc. and wants to exercise as much control as possible over the company. Beta, Inc. has a total of 100 shares of stock outstanding. Each share receives one
Vote. Presently, the company is voting to elect two new directors. Which one of the following
Statements must be true given this information?

Accepted Answer

In cumulative voting, Jack can allocate all his votes (35 shares x 2 seats = 70 votes) to one candidate, ensuring he can elect at least one director.

Question 17

The James River Co. pays an annual dividend of $1.50 per share on its common stock. This dividend amount has been constant for the past 15 years and is expected to remain constant. Given
This, one share of James River Co. stock:

Accepted Answer

Since the dividend amount is constant and expected to remain constant, the stock is valued as if the dividend paid is a perpetuity. This means that the market value of the stock is calculated by dividing the annual dividend by the required rate of return.

Question 18

The owner of preferred stock:

Accepted Answer

Preferred stockholders have a higher claim on distributions of income than common shareholders, meaning they receive dividends before common shareholders.

Question 19

Given constant earnings per share, an increase in dividends will generally:

Accepted Answer

An increase in dividends, assuming constant earnings per share, typically means that a larger portion of the company's earnings is being paid out to shareholders rather than being reinvested in the company. This can lead to a decrease in the growth rate of the corporation since less money is being reinvested for future growth. It also increases the current yield (dividend yield) because the dividend payout is higher relative to the stock price.

Question 20

A supernormal growth stock generally:

Accepted Answer

A supernormal growth stock is a company that is experiencing high growth dividends for a limited number of years, typically 5-10 years. After this period, the company's growth rate will slow down to a more sustainable level. The other choices are incorrect, as they do not accurately describe a supernormal growth stock.

Quiz 8: Stock Valuation