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

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

Accepted Answer

Over the long-term, capital gains have historically provided a larger portion of returns on common stocks than dividends. However, this can vary depending on the specific stock and market conditions.

Question 3

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.

Accepted Answer

The stock can still have value even if its growth rate is lower than the required return. The model assumes constant growth, but in reality, the growth rate can change over time. Additionally, the model does not take into account other factors that can affect a stock's value, such as dividends or market conditions.

Question 4

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 more earnings and increasing return on equity both contribute to a higher growth rate of common stockholders' investment in the firm. Retaining more earnings allows the firm to invest in new projects and expansion, leading to potential future profits and growth. Increasing return on equity means the firm is generating more profits with the same amount of equity, leading to higher earnings available for reinvestment and potentially higher stock prices.

Question 5

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 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

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

Accepted Answer

Common stockholders have all of the features and benefits listed, including limited liability, ownership of the firm, and voting rights.

Question 8

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.

Accepted Answer

Retained earnings represent a portion of the company's profit that has not been paid out as dividends to shareholders, but is instead reinvested in the business. Common stockholders, therefore, do have an interest in the return on retained earnings, as it contributes to the overall value of the company and can lead to potential future dividends or share price appreciation.

Question 9

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

A common stock with expected dividend growth rate of zero implies that the dividend payments will remain constant over time. In this scenario, the stock can be valued in the same way as preferred stock(using the expected dividend divided by the required return) since there is no growth in dividends to consider.

Question 10

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 terms of claims against a firm's assets in the event of liquidation. Bondholders, preferred stockholders, and federal income taxes would all have priority over common stockholders. Therefore, common stockholders would have the fourth priority.

Question 11

Which of the following changes will make the value of a stock go up,other things being held constant?

Accepted Answer

When the required return decreases, the stock becomes more attractive to investors because they can achieve their desired return with a lower level of risk. This increased demand for the stock will drive up its price. None of the other choices would cause the value of the stock to go up, as they would either increase the level of risk or decrease the expected return.

Question 12

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 have the lowest priority in receiving payment in case of liquidation or bankruptcy, and hence they are considered residual owners. The value of common stock, therefore, represents the amount left for shareholders after paying the firm's outstanding debts and obligations.

Question 13

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

Accepted Answer

Common stockholders bear the greatest risk of loss if a firm should fail because they are the last in line to receive payment in the event of bankruptcy or liquidation. Bondholders and preferred stockholders have priority over common stockholders in receiving payment from the company's assets.

Question 14

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

The present value of all expected future cash flows for both common stock and preferred stock is calculated using the required return as the discount rate. Therefore, the statement is true.

Question 15

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

Accepted Answer

To calculate the value of the stock to an investor with a required return of 12%, we can use the dividend discount model:

Value of Stock = Dividend / Required Return

Value of Stock = $2.50 / 0.12

Value of Stock = $20.83

Therefore, the best choice is C.

Question 16

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

Accepted Answer

Preemptive right is a provision that entitles common shareholders to maintain a proportionate share of ownership in a firm by giving them the right to purchase additional shares of stock before they are offered to the public. This helps to prevent dilution of their ownership stake.

Question 17

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?

Accepted Answer

The internal growth rate can be calculated using the formula:

Internal Growth Rate = Retention Rate × Return on Equity

Given that the retention rate is 60% and the return on equity is 15%, we can plug these values into the above formula to get:

Internal Growth Rate = 0.60 × 0.15 = 0.09 or 9%

Therefore, the best choice is B) 8.6% as it is the closest value to 9%.

Question 18

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

Accepted Answer

The common stock of a constant-growth firm is valued using the dividend discount model, while the preferred stock is valued using the constant dividend model. They are valued differently, therefore the statement is false.

Question 19

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 can be influenced by various factors aside from growth, such as market conditions, industry trends, and management decisions. Additionally, the infusion of new capital can dilute the value of existing shares, which can affect the overall growth of the stock. Therefore, the statement is false.

Question 20

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

Accepted Answer

Internal growth is the most relevant form of growth for valuing a firm's common stock because it is the growth that is generated from within the firm itself, rather than from external factors such as acquisitions or mergers. Internal growth is typically more sustainable and predictable than external growth, and it is therefore more likely to be reflected in the firm's future cash flows.

Quiz 8: The Valuation and Characteristics of Stock