Deck 5: Stocks

Question 1

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.

Answer 1

True

Question 2

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.

Answer 2

True

Question 3

a firm's expected growth rate increased then its required rate of return would

A) decrease.
B) fluctuate less than before.
C) fluctuate more than before.
D) possibly increase, possibly decrease, or possibly remain constant.
E) increase.

Answer 3

D

Question 4

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.

Question 5

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.

Question 6

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

Question 7

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.

Question 8

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.

Question 9

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.

Question 10

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.

Question 11

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.

Question 12

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.

Question 13

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

Question 14

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

Question 15

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.

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.

Question 17

Which of the following statements is CORRECT?

A) If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.
B) The stock valuation model, P0 = D1/(rs - g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.
C) The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
D) The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.
E) The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.

Question 18

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.

Question 19

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.

Question 20

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.

Question 21

Merrell Enterprises's stock has an expected return of 14% The stock's dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share Which of the following statements is CORRECT?

A) The stock's dividend yield is 8%.
B) The current dividend per share is $4.00.
C) The stock price is expected to be $54 a share one year from now.
D) The stock price is expected to be $57 a share one year from now.
E) The stock's dividend yield is 7%.

Question 22

Which of the following statements is CORRECT?

A) Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.
B) The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.
C) One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free.
D) One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.
E) A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.

Question 23

50 per share is the current price for Foster Farms' stockThe dividend is projected to increase at a constant rate of 5.50% per year The required rate of return on the stock, rs, is 9.00% What is the stock's expected price 3 years from today?

A) $37.86
B) $38.83
C) $39.83
D) $40.85
E) $41.69

Question 24

Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25) The stock sells for $32.50 per share, and its required rate of return is 10.5% The dividend is expected to grow at some constant rate, g, forever What is the equilibrium expected growth rate?

A) 6.01%
B) 6.17%
C) 6.33%
D) 6.49%
E) 6.65%

Question 25

Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return Which of the following statements is CORRECT?

A) Stock B must have a higher dividend yield than Stock A.
B) Stock A must have a higher dividend yield than Stock B.
C) If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's.
D) Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.
E) If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's.

Question 26

constant growth stocks are in equilibrium, have the same price, and have the same required rate of return Which of the following statements is CORRECT?

A) If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
B) If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
C) The two stocks must have the same dividend growth rate.
D) The two stocks must have the same dividend yield.
E) The two stocks must have the same dividend per share.

Question 27

Which of the following statements is CORRECT?

A) The preferred stock of a given firm is generally less risky to investors than the same firm's common stock.
B) Corporations cannot buy the preferred stocks of other corporations.
C) Preferred dividends are not generally cumulative.
D) A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.
E) Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.

Question 28

stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00 The dividend is expected to decline at a rate of 5% a year forever (g = -5%) If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

A) The company's dividend yield 5 years from now is expected to be 10%.
B) The constant growth model cannot be used because the growth rate is negative.
C) The company's expected capital gains yield is 5%.
D) The company's expected stock price at the beginning of next year is $9.50.
E) The company's current stock price is $20.

Question 29

preemptive right is important to shareholders because it

A) will result in higher dividends per share.
B) is included in every corporate charter.
C) protects the current shareholders against a dilution of their ownership interests.
D) protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.
E) allows managers to buy additional shares below the current market price.

Question 30

stock just paid a dividend of D0 = $1.50 The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0% What is the current stock price?

A) $23.11
B) $23.70
C) $24.31
D) $24.93
E) $25.57

Question 31

in analyzing a stock, find that its expected return exceeds its required returnThis suggests that you think

A) the stock should be sold.
B) the stock is a good buy.
C) management is probably not trying to maximize the price per share.
D) dividends are not likely to be declared.
E) the stock is experiencing supernormal growth.

Question 32

share of Lash Inc.'s common stock just paid a dividend of $1.00 If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 11.4%, what is the stock price?

A) $16.28
B) $16.70
C) $17.13
D) $17.57
E) $18.01

Question 33

markets are in equilibrium, which of the following conditions will exist?

A) Each stock's expected return should equal its required return as seen by the marginal investor.
B) All stocks should have the same expected return as seen by the marginal investor.
C) The expected and required returns on stocks and bonds should be equal.
D) All stocks should have the same realized return during the coming year.
E) Each stock's expected return should equal its realized return as seen by the marginal investor.

Question 34

Kelly Enterprises's stock currently sells for $35.25 per share The dividend is projected to increase at a constant rate of 4.75% per year The required rate of return on the stock, rs, is 11.50% What is the stock's expected price 5 years from now?

A) $40.17
B) $41.20
C) $42.26
D) $43.34
E) $44.46

Question 35

D1 = $1.25, g (which is constant) = 4.7%, and P0 = $26.00, what is the stock's expected dividend yield for the coming year?

A) 4.12%
B) 4.34%
C) 4.57%
D) 4.81%
E) 5.05%

Question 36

Which of the following statements is CORRECT?

A) Two firms with the same expected dividend and growth rates must also have the same stock price.
B) It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant.
C) If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.
D) The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
E) The constant growth model takes into consideration the capital gains investors expect to earn on a stock.

Question 37

a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.

A) The stock's dividend yield is 5%.
B) The price of the stock is expected to decline in the future.
C) The stock's required return must be equal to or less than 5%.
D) The stock's price one year from now is expected to be 5% above the current price.
E) The expected return on the stock is 5% a year.

Question 38

stock is expected to pay a dividend of $0.75 at the end of the year The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4% What is the stock's current price?

A) $17.39
B) $17.84
C) $18.29
D) $18.75
E) $19.22

Question 39

Which of the following statements is CORRECT, assuming stocks are in equilibrium?

A) Assume that the required return on a given stock is 13%. If the stock's dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.
B) A stock's dividend yield can never exceed its expected growth rate.
C) A required condition for one to use the constant growth model is that the stock's expected growth rate exceeds its required rate of return.
D) Other things held constant, the higher a company's beta coefficient, the lower its required rate of return.
E) The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.

Question 40

Companies can issue different classes of common stock Which of the following statements concerning stock classes is CORRECT?

A) All common stocks, regardless of class, must have the same voting rights.
B) All firms have several classes of common stock.
C) All common stock, regardless of class, must pay the same dividend.
D) Some class or classes of common stock are entitled to more votes per share than other classes.
E) All common stocks fall into one of three classes: A, B, and C.

Question 41

Jameson Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future The company's beta is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00% What is Jameson's current stock price, P0?

A) $18.62
B) $19.08
C) $19.56
D) $20.05
E) $20.55

Question 42

Carby Hardware has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?

A) $104.27
B) $106.95
C) $109.69
D) $112.50
E) $115.38

Question 43

D1 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock's expected capital gains yield for the coming year?

A) 6.50%
B) 6.83%
C) 7.17%
D) 7.52%
E) 7.90%

Question 44

Orwell building supplies' last dividend was $1.75 Its dividend growth rate is expected to be constant at 25% for 2 years, after which dividends are expected to grow at a rate of 6% forever Its required return (rs) is 12% What is the best estimate of the current stock price?

A) $41.58
B) $42.64
C) $43.71
D) $44.80
E) $45.92

Question 45

Alcott's preferred stock pays a dividend of $1.00 per quarter If the price of the stock is $45.00, what is its nominal (not effective) annual rate of return?

A) 8.03%
B) 8.24%
C) 8.45%
D) 8.67%
E) 8.89%

Question 46

D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock's expected dividend yield for the coming year?

A) 4.42%
B) 4.66%
C) 4.89%
D) 5.13%
E) 5.39%

Question 47

Hirshfeld Corporation's stock has a required rate of return of 10.25%, and it sells for $57.50 per share The dividend is expected to grow at a constant rate of 6.00% per year What is the expected year-end dividend, D1?

A) $2.20
B) $2.44
C) $2.69
D) $2.96
E) $3.25

Question 48

D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock's expected total return for the coming year?

A) 8.37%
B) 8.59%
C) 8.81%
D) 9.03%
E) 9.27%

Question 49

D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock's expected total return for the coming year?

A) 7.54%
B) 7.73%
C) 7.93%
D) 8.13%
E) 8.34%

Question 50

Kellner Motor Co.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per share Kellner's dividend is expected to grow at a constant rate of 7.00% What was the last dividend, D0?

A) $0.95
B) $1.05
C) $1.16
D) $1.27
E) $1.40

Question 51

Furniture is expected to pay a dividend of D1 = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future The company's beta is 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00% What is Dyer's current stock price?

A) $28.90
B) $29.62
C) $30.36
D) $31.12
E) $31.90

Question 52

last dividend paid by Coppard Incwas $1.25 The dividend growth rate is expected to be constant at 15% for 3 years, after which dividends are expected to grow at a rate of 6% forever If the firm's required return (rs) is 11%, what is its current stock price?

A) $30.57
B) $31.52
C) $32.49
D) $33.50
E) $34.50

Question 53

Connolly Co.'s expected year-end dividend is D1 = $1.60, its required return is rs = 11.00%, its dividend yield is 6.00%, and its growth rate is expected to be constant in the future What is Connolly's expected stock price in 7 years, i.e., what is?

A) $37.52
B) $39.40
C) $41.37
D) $43.44
E) $45.61

Question 54

last dividend paid by Wilden Corporation was $1.55 The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever The firm's required return (rs) is 12.0% What is the best estimate of the current stock price?

A) $37.05
B) $38.16
C) $39.30
D) $40.48
E) $41.70

Question 55

McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0 The company's last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00% What is the current price of the common stock?

A) $26.77
B) $27.89
C) $29.05
D) $30.21
E) $31.42

Question 56

Connor Publishing's preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share What is its effective annual (not nominal) rate of return?

A) 6.62%
B) 6.82%
C) 7.03%
D) 7.25%
E) 7.47%

Question 57

Burke Tires just paid a dividend of D0 = $1.32 Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter The required return on this low-risk stock is 9.00% What is the best estimate of the stock's current market value?

A) $41.59
B) $42.65
C) $43.75
D) $44.87
E) $45.99

Question 58

National Advertising just paid a dividend of D0 = $0.75 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future The company's beta is 1.25, the required return on the market is 10.50%, and the risk-free rate is 4.50% What is the company's current stock price?

A) $14.52
B) $14.89
C) $15.26
D) $15.64
E) $16.03