Question 1

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

This statement is true because the cash flows associated with common stock are based on the company's profits and dividends, which are not guaranteed or contractually obligated like bond interest payments. The amount of dividend payments can vary depending on the company's financial performance, making it more difficult to estimate the cash flows associated with common stock.

Question 2

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 a basic principle of market behavior known as the law of one price. If the market price of a stock is higher than its intrinsic value, rational investors will sell the stock until its price falls back to the level of its intrinsic value.

Question 3

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 are typically given to the original founders of a company and have higher voting rights than other classes of common stock.

Question 4

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 the one who is willing to pay the highest price for the stock, and thus determines the price at which it will trade. This is known as the marginal price.

Question 5

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 true according to the principle of equilibrium in finance, which states that investor demand for a stock will cause its price to adjust until its expected return equals the required return of the marginal investor.

Question 6

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

This is correct, as discounting projected free cash flows at the weighted average cost of capital gives the firm's total corporate value.

Question 7

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 adjusting the model to account for the present value of future dividends.

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 includes both the dividend yield and the capital gains or losses from the change in the stock's price. It does not include any commissions paid when buying or selling the stock.

Question 9

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 10

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 can be used to create different classes of common stock with different voting rights, allowing companies to raise additional equity capital while still retaining control.

Question 11

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 12

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 is true. Proxies are legally binding documents that grant one party the power to act on behalf of another party in various business and legal matters, including voting shares of common stock. Proxies can play a crucial role in determining the control of a company, especially during shareholder meetings and other important decision-making events.

Question 13

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

Accepted Answer

The corporate valuation model can still be used even if a company does not pay dividends, as it considers the future cash flows of the company.

Question 14

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 allows current stockholders to maintain their proportional ownership in the company and prevent dilution of control and value.

Question 15

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 preemptive right allows stockholders to maintain their proportionate ownership of the company by having the right to purchase new shares issued by the company before they are offered to the public. It does not give them the right to call for a meeting to vote to replace management.

Question 16

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 17

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.

Question 18

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 19

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

The constant growth DCF model (also known as the Gordon model) is based on the assumption of constant growth in dividends, which is similar to the perpetuity formula that assumes a fixed and perpetual stream of cash flows. Therefore, the two models are conceptually similar and can be used to evaluate the prices of different types of securities, including common stocks and perpetual preferred stock.

Question 20

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

These are the two necessary conditions for a stock to be in equilibrium, as stated by the principle of efficient capital markets.

Quiz 9: Stocks and Their Valuation