Question 1

Which of the statements below is FALSE?

Accepted Answer

Preferred stock can be convertible or non-convertible, but convertible preferred stock can be converted to common shares. Therefore, statement C is false.

Question 2

Which of the statements below is TRUE?

Accepted Answer

The dividend growth model assumes that dividends will continue to grow at a constant rate, which may not always be the case. If a firm cuts its dividends, the model will produce a negative expected return because this goes against the assumption of constant growth. Therefore, statement B is true. Statements A, C, and D are false.

Question 3

Dividend models suggest that the value of a financial asset is determined by the ________ the owner is entitled to while holding the asset.

Accepted Answer

Dividend models, such as the Gordon Growth Model or the Dividend Discount Model, are based on the idea that the value of a financial asset, such as a stock, is determined by the future cash flows the owner is entitled to while holding the asset. The models estimate the present value of these future cash flows to arrive at the current value of the asset. Therefore, the best choice is C, future cash flows.

Question 4

The dividend models appeal to a fundamental concept of asset pricing--that the value of an asset is determined by the future cash flow to which the owner is entitled while holding the asset, and the required rate of return for the cash flow.

Accepted Answer

This statement is true. The dividend models are based on the concept of discounted cash flow analysis, which uses the expected future cash flows and the required rate of return to determine the present value of an asset. The value of a stock using dividend models is based on the investor's expectation of future dividends and the required rate of return for holding the stock.

Question 5

The dividend model requires that a firm has a cash dividend history and that the dividend history shows a ________.

Accepted Answer

The dividend model requires that the firm has a cash dividend history, which shows a either constant dividend or a positive growth in dividends (i.e., the firm consistently pays dividends or increases dividends over time). Therefore, choice C is the correct option. Choices A, B, and D are incorrect, as they do not meet the requirements of the dividend model.

Question 6

Which of the following statements is FALSE?

Accepted Answer

Preferred stock can actually be convertible, meaning it can be exchanged for a specified amount of common stock. Therefore, statement D is false.

Question 7

Willie's Western Corp. has outstanding nonconvertible preferred stock (cumulative) that pays a quarterly dividend of $1.25. If your required rate of return is 9.5%, what should you be willing to pay for 1000 shares of Willie's Western?

Accepted Answer

The price of preferred stock is calculated as the dividend divided by the required rate of return. The annual dividend is $1.25 * 4 = $5. The price per share is $5 / 0.095 = $52.63. For 1000 shares, it is $52,631.58.

Question 8

Which of the statements below is FALSE?

Accepted Answer

This statement is false because lack of a dividend pattern makes it difficult for dividend models to estimate expected returns accurately.

Question 9

The dividend growth model has a limitation due to the necessity to have a non-growing dividend pattern in order for it to work.

Accepted Answer

The dividend growth model actually requires an assumption of a constant growth rate in dividends per share, not a non-growing dividend pattern. It is designed to value stocks based on the assumption that dividends will grow at a constant rate indefinitely.

Question 10

Which of the following statements is TRUE?

Accepted Answer

This statement is true. Some preferred stocks are cumulative, meaning that if a company skips a cash dividend, it must pay it at some point in the future. A is incorrect because preferred stock does not have a maturity date, but the par value may still be repaid. B is incorrect because the par value of preferred stock may be repaid, unlike bonds. C is incorrect because a preferred stock's cash dividend is based on the stated dividend rate times the par value, not the market value.

Question 11

Which of the statements below is FALSE?

Accepted Answer

Statement D is false because the dividend growth model does not underestimate the expected return for all stocks. It is possible for the model to produce an overestimate or an estimate that is close to the actual return.

Question 12

Haven, Inc. has an 11.5% required rate of return. It does not expect to initiate dividends for 20 years, at which time it will pay $3.75 per share in dividends. At that time, Haven expects its dividends to grow at 6% forever. What is an estimate of Haven's price in 20 years (P₂₀) if its dividend at the end of year 20 is $3.75? What is its price in today's dollars if you desire a rate of return of 12%?

Accepted Answer

The answer of Haven, Inc. has an 11.5% required rate...

Question 13

Dividend models suggest that the value of a financial asset is determined by future cash flows. A problem arises, however, in that future cash flows may be difficult to predict as to ________ of these cash flows.

Accepted Answer

Dividend models suggest that future cash flows determine the value of a financial asset. However, predicting both the timing and amount of future cash flows can be difficult. Therefore, the best choice would be A) both the timing and the amount.

Question 14

Mantle Motors Co. pays a $2.15 dividend every quarter for its perpetual stock. If you expect an annual return of 8.75% on your investment, compute the stock price that you would be willing to pay, using quarterly data. Now compute the value using annual data. Explain your two answers. What would you be willing to pay for 100 preferred shares?

Accepted Answer

The answer of Mantle Motors Co. pays a $2.15 dividend...

Question 15

Shortcomings of the dividend pricing models suggest that we need a pricing model that is more inclusive than the dividend models and provides expected returns for companies based on aspects besides their historical dividend patterns. Which of the below is NOT one of these aspects?

Accepted Answer

Stable dividends is one of the aspects that is taken into consideration in dividend pricing models. The other aspects mentioned, such as the company's risk, the premium for taking on risk, and the reward for waiting, are all factors that can affect a company's expected returns and should be included in a comprehensive pricing model.

Question 16

Little River, Inc. has a 13% required rate of return. It does not expect to initiate dividends for 10 years, at which time it will pay $5 per share in dividends. At that time Little River expects its dividends to grow at 5% forever. What is an estimate of Little River's price in 10 years (P₁₀) if its dividend at the end of year 10 is $5.00? What is its price in today's dollars if you desire a rate of return of 13%? Repeat the problem, but replace the 10 years with 30 years and compare the two sets of prices. Describe the relationship between the number of years before you receive dividends and today's price.

Accepted Answer

The answer of Little River, Inc. has a 13% required...

Question 17

An application of the capital asset pricing model, called the security market line, is more inclusive than the dividend growth model for pricing stocks and provides expected returns for companies based on their risk, the premium for taking on risk, and the reward for waiting and not on their historical dividend
patterns.

Accepted Answer

The statement is true as the security market line, which is a graph that plots the expected return of a stock based on its beta (i.e., risk), is a more comprehensive approach for pricing stocks than the dividend growth model, which focuses solely on historical dividend patterns. The security market line incorporates the concepts of risk premium and time value of money, providing a more accurate estimation of expected returns.

Question 18

Jayhawk Corp. is selling for $30 a share. In looking at the stream of dividends over the past ten years, you find out that the first dividend was $1.00 and the last dividend was $2.00. What is its growth rate? What is its expected return?

Accepted Answer

The answer of Jayhawk Corp. is selling for $30 a...

Question 19

Preferred stock ________.

Accepted Answer

Preferred stock represents a preferential claim on dividends, meaning that holders of preferred stock will receive their dividends before common stockholders. Preferred stock does not reflect residual ownership of a company, as common stock does. Bondholders have a legal and specific claim to a fixed amount, but preferred stock does not always have this claim.

Question 20

The holder of preferred stock is entitled to a constant dividend ________.

Accepted Answer

The holder of preferred stock is entitled to a constant dividend every period, regardless of whether the company's earnings are positive or negative. Unlike common stockholders, preferred stockholders do not generally have voting rights and may have limited upside potential in terms of capital appreciation, but they do have priority over common stockholders when it comes to receiving dividend payments.

Quiz 7: Stocks and Stock Valuation

Which of the statements below is FALSE?

Which of the statements below is TRUE?

Dividend models suggest that the value of a financial asset is determined by the ________ the owner is entitled to while holding the asset.

The dividend models appeal to a fundamental concept of asset pricing--that the value of an asset is determined by the future cash flow to which the owner is entitled while holding the asset, and the required rate of return for the cash flow.

The dividend model requires that a firm has a cash dividend history and that the dividend history shows a ________.

Which of the following statements is FALSE?

Willie's Western Corp. has outstanding nonconvertible preferred stock (cumulative) that pays a quarterly dividend of $1.25. If your required rate of return is 9.5%, what should you be willing to pay for 1000 shares of Willie's Western?

Which of the statements below is FALSE?

The dividend growth model has a limitation due to the necessity to have a non-growing dividend pattern in order for it to work.

Which of the following statements is TRUE?

Which of the statements below is FALSE?

Dividend models suggest that the value of a financial asset is determined by future cash flows. A problem arises, however, in that future cash flows may be difficult to predict as to ________ of these cash flows.

Shortcomings of the dividend pricing models suggest that we need a pricing model that is more inclusive than the dividend models and provides expected returns for companies based on aspects besides their historical dividend patterns. Which of the below is NOT one of these aspects?

Jayhawk Corp. is selling for $30 a share. In looking at the stream of dividends over the past ten years, you find out that the first dividend was $1.00 and the last dividend was $2.00. What is its growth rate? What is its expected return?

Preferred stock ________.

The holder of preferred stock is entitled to a constant dividend ________.