Question 1

A proxy is a document giving one party the authority to act for another party,including the power to vote shares of common stock.Proxies can be important tools relating to control of firms.

Accepted Answer

This statement accurately describes what a proxy is and how it can be used in corporate governance.

Question 2

Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the firm's total corporate value.

Accepted Answer

Discounting projected free cash flows at the firm's weighted average cost of capital is a commonly used method to calculate the present value of a firm, which represents its total corporate value.

Question 3

Two conditions are used to determine whether or not a stock is in equilibrium: (1)Does the stock's market price equal its intrinsic value as seen by the marginal investor,and (2)does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions,but not necessarily both,holds,then the stock is said to be in equilibrium.

Accepted Answer

For a stock to be in equilibrium, both conditions must hold: the stock's market price must equal its intrinsic value as seen by the marginal investor, and the expected return on the stock as seen by the marginal investor must equal this investor's required return.

Question 4

The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities.

Accepted Answer

This statement is true. The constant growth DCF (discounted cash flow) model is used to estimate the value of an asset based on its future cash flows, assuming those cash flows grow at a constant rate. This model can be used for common stock, perpetual preferred stock, or any other perpetual asset that generates cash flows. The formula for the constant growth DCF model is similar for all of these assets, with the main difference being the specific assumptions used for the growth rate and discount rate.

Question 5

If a firm's stockholders are given the preemptive right,this means that stockholders have the right to call for a meeting to vote to replace the management.Without the preemptive right,dissident stockholders would have to seek a change in management through a proxy fight.

Accepted Answer

The statement is incorrect. Preemptive right refers to a shareholder's right to maintain their proportion of ownership in the company by having the right to purchase newly issued shares before they are offered to the public. It does not give the stockholders the right to call for a meeting to vote to replace management.

Question 6

The preemptive right gives current stockholders the right to purchase,on a pro rata basis,any new shares issued by the firm.This right helps protect current stockholders against both dilution of control and dilution of value.

Accepted Answer

The preemptive right does give current stockholders the right to purchase new shares on a pro rata basis, which helps protect against dilution of control and value.

Question 7

From an investor's perspective,a firm's preferred stock is generally considered to be less risky than its common stock but more risky than its bonds.However,from a corporate issuer's standpoint,these risk relationships are reversed: bonds are the most risky for the firm,preferred is next,and common is least risky.

Accepted Answer

The answer of From an investor's perspective,a firm's preferred stock...

Question 8

The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold.

Accepted Answer

The total return on a share of stock refers to the sum of the dividend yield and any increase in the value of the stock, less any commissions or fees paid when the stock is purchased and sold.

Question 9

For a stock to be in equilibrium,two conditions are necessary: (1)The stock's market price must equal its intrinsic value as seen by the marginal investor and (2)the expected return as seen by the marginal investor must equal this investor's required return.

Accepted Answer

This is the definition of equilibrium in the stock market.

Question 10

If a stock's expected return as seen by the marginal investor exceeds this investor's required return,then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

Accepted Answer

This statement is based on the principle of equilibrium in finance, which states that asset prices will adjust until the expected return equals the required return of the marginal investor. When the expected return exceeds the required return, investors will buy the stock, which will drive up the price and consequently decrease the expected return. The process continues until the expected return matches the required return, achieving equilibrium. Therefore, the statement is true.

Question 11

The corporate valuation model can be used only when a company doesn't pay dividends.

Accepted Answer

The corporate valuation model can be used for companies that do pay dividends, but it requires making adjustments to reflect these payments.

Question 12

According to the nonconstant growth model discussed in the textbook,the discount rate used to find the present value of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash flows during the subsequent constant growth period.

Accepted Answer

According to the nonconstant growth model, the discount rate used to find the present value of cash flows during the initial growth period may be different from the discount rate used in the subsequent constant growth period. However, the model assumes that the discount rate remains constant during each period.

Question 13

If a stock's market price exceeds its intrinsic value as seen by the marginal investor,then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value.

Accepted Answer

This is because the marginal investor will consider the stock to be overpriced and therefore not a good investment. They will sell the stock, leading to a decrease in demand and eventually a decrease in price until it matches the investor's estimate of the intrinsic value.

Question 14

When a new issue of stock is brought to market,it is the marginal investor who determines the price at which the stock will trade.

Accepted Answer

The marginal investor is defined as the investor who is just willing to buy or sell the stock at the current price, and is therefore the final determinant of the stock price. As new shares are issued, the price is determined by the marginal investor's willingness to buy at that price.

Question 15

Classified stock differentiates various classes of common stock,and using it is one way companies can meet special needs such as when owners of a start-up firm need additional equity capital but don't want to relinquish voting control.

Accepted Answer

This statement is true. Classified stock is used to differentiate various classes of common stock, which can help companies meet special needs such as maintaining voting control while raising additional equity capital.

Question 16

According to the basic DCF stock valuation model,the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock.

Accepted Answer

The answer of According to the basic DCF stock valuation...

Question 17

The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

Accepted Answer

Common stock does not have a fixed or guaranteed return like bonds, so predicting future cash flows is inherently more uncertain. Stockholders bear more risk than bondholders as they have a residual claim on the company's assets, meaning they are last in line to receive any money if the company goes bankrupt or is liquidated. Bondholders have priority on receiving their contractual interest payments and principal repayment.

Question 18

The corporate valuation model cannot be used unless a company pays dividends.

Accepted Answer

The corporate valuation model (also known as the free cash flow to equity model) can be used for companies that do not pay dividends. It focuses on the cash flows available to shareholders, taking into account reinvestments in the business and changes in debt levels.

Question 19

Founders' shares are a type of classified stock where the shares are owned by the firm's founders,and they generally have more votes per share than the other classes of common stock.

Accepted Answer

Founders' shares typically have more voting rights per share than other classes of common stock, giving the founders more control over the company's decision-making.

Question 20

Preferred stock is a hybrid--a sort of cross between a common stock and a bond--in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.

Accepted Answer

Preferred stock dividends are not guaranteed in the same way bond interest payments are, and they do not typically increase annually like common stock dividends might. Preferred dividends are set at a fixed rate and can be suspended by the company in financial distress.

Quiz 9: Stocks and Their Valuation