Question 1

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.

Accepted Answer

Common stock valuation is typically based on the present value of future dividends or the present value of future cash flows to the firm, not directly on the present value of future quarterly net income. Net income is an important factor but is not directly used in the valuation models.

Question 2

Which of the following is not true regarding common stock?

Accepted Answer

Dividend payments for common stock are not fixed and can vary depending on the company's profitability and management decisions.

Question 3

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.

Accepted Answer

Both common stock and preferred stock are typically valued using discounted cash flow analysis, where future expected cash flows are discounted back to the present using a discount rate that reflects the riskiness of the investment. The resulting present value of cash flows represents the estimated intrinsic value of the stock.

Question 4

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?

Accepted Answer

In the event of liquidation, common shareholders are paid last, after all debts (including interest), taxes, and preferred dividends have been settled.

Question 5

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?

Accepted Answer

Common stockholders have the lowest priority in a firm's liquidation process. After bondholders, preferred stockholders, and federal income taxes are paid, whatever remains from the sale of assets will go to common stockholders, if anything is left.

Question 6

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

Accepted Answer

The value of common stock, when the expected growth rate for dividends is zero, is calculated by dividing the current dividend by the required rate of return, not equal to the current dividend alone.

Question 7

Who bears the greatest risk of loss of value if a firm should fail?

Accepted Answer

Common stockholders bear the greatest risk of loss of value if a firm should fail, as they are the last in line to receive any assets in the event of liquidation after bondholders and preferred stockholders have been paid off. Bondholders and preferred stockholders have higher priority in receiving assets and may even have contractual obligations for a fixed rate of return, while common stockholders do not have any guarantee of receiving anything if the company fails.

Question 8

Which of the following features,or benefits,belong to a firm's common stockholders?

Accepted Answer

Common stockholders have limited liability, as they are not personally liable for the debts of the company. They also own a part of the company and therefore have a say in the decision-making process and can exercise their voting rights. Therefore, all of the above features and benefits belong to a firm's common stockholders.

Question 9

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

Accepted Answer

The answer of The most relevant form of growth for...

Question 10

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.

Accepted Answer

If the expected dividend growth rate is zero, the dividend is expected to remain constant, similar to preferred stock. Therefore, it would be valued in the same way as preferred stock - by dividing the expected dividend by the required return.

Question 11

What provision entitles the common shareholder to maintain a proportionate share of ownership in a firm?

Accepted Answer

The provision that entitles the common shareholder to maintain a proportionate share of ownership in a firm is the preemptive right. This right allows shareholders to purchase additional shares of stock in proportion to their current ownership percentage, thus maintaining their proportional ownership in the company. The cumulative feature refers to the ability to withhold dividends and accumulate them for later payment, the convertible feature allows for conversion of one security to another, and the proportionality clause is not a commonly used term in corporate finance.

Question 12

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

Accepted Answer

The answer of The stock valuation model D₁/(r_cs- g)requires...

Question 13

Given the constant growth dividend valuation model,the expected percentage growth in value of a stock is equal to the capital gains yield for that stock.

Accepted Answer

According to the constant growth dividend valuation model, the expected percentage growth in value of a stock is equal to the capital gains yield plus the dividend yield for that stock. However, if the stock does not pay dividends, then the expected percentage growth in value is equal to the capital gains yield.

Question 14

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

Accepted Answer

The retention ratio, which indicates the proportion of earnings a company retains to reinvest in the business, is calculated as 1 minus the dividend payout ratio (the fraction of net income paid to shareholders as dividends).

Question 15

United Financial 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?

Accepted Answer

Internal growth rate can be calculated using the following formula:

Internal Growth Rate = Retention Rate × Return on Equity

Here, Retention rate = 60%, Return on Equity = 15%

Internal growth rate = 60% × 15% = 9%

However, since the corporation's dividend payout ratio is 40%, the actual growth rate will be lower than the internal growth rate.

Actual growth rate = Internal growth rate × (1 - Dividend Payout Ratio)

= 9% × (1 - 0.4)

= 5.4%

But the choices given do not include the option of 5.4%. The closest option is B) 8.6%.

Question 16

An investor's required rate of return for a common stock can be estimated by summing the stock's dividend yield and annual growth rate,assuming the growth rate is constant over time.

Accepted Answer

The required rate of return for a common stock can be estimated using the dividend yield and growth rate, but the assumption of a constant growth rate over time may not always hold true in reality.

Question 17

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.

Accepted Answer

Common stockholders are the owners of the company, but they have the lowest priority in terms of receiving payments in case of liquidation or bankruptcy. Thus, the value of common stock is derived from what's leftover after all other obligations are satisfied, which is the total firm value less the firm's outstanding debt.

Question 18

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

Accepted Answer

Retaining earnings rather than distributing them as dividends can lead to higher investment in the firm, and increasing return on equity can also lead to higher growth rate of common stockholders' investment.

Question 19

Baseheart,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:

Accepted Answer

To calculate the value of the stock, we can use the dividend discount model:

Value of stock = Annual dividend / Required return

Plugging in the given values, we get:

Value of stock = $2.50 / 0.12 = $20.83

Therefore, the value of the stock to an investor with a required return of 12% is $20.83. Choice C is the correct answer.

Question 20

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.

Accepted Answer

The change in the value of a corporation's common stock may differ depending on whether the growth is the result of internal growth or the infusion of new capital. If the growth is the result of internal growth, it may be viewed as a sign of the company's profitability and management effectiveness. On the other hand, if the growth is the result of an infusion of new capital, it may be viewed as a sign of investor confidence but may also dilute the value of existing shares.

Quiz 8: The Valuation and Characteristics of Stock