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CHAPTER 8

Stock Valuation

True/False

1. When a call provision is exercised, preferred stock is usually repurchased at a discount.

DIFFICULTY: Moderate

KEYWORDS: call provision

2. The use of a sinking fund for preferred stock in effect establishes a maturity date for the stock.

DIFFICULTY: Easy

KEYWORDS: sinking fund

3. Stock valuation is more precise than bond valuation as stock cash flows are more certain.

DIFFICULTY: Moderate

KEYWORDS: stock valuation

4. Stock value is based entirely on historical cash flows.

DIFFICULTY: Easy

KEYWORDS: stock valuation

5. The stock valuation model D1/(Rc - g) requires Rc > G.

DIFFICULTY: Moderate

KEYWORDS: common stock value

6. Paid-in-kind preferred stock receives initial dividends of common stock.

DIFFICULTY: Moderate

KEYWORDS: paid-in-kind preferred stock

7. A call provision allows the issuer to buy its stock back from the investor.

DIFFICULTY: Moderate

KEYWORDS: call provision

8. When the firm decides to retain a portion of its earnings, the stockholders are indirectly investing in the firm.

DIFFICULTY: Moderate

KEYWORDS: retention of earnings

9. A company may issue multiple classes of preferred stock.

DIFFICULTY: Moderate

KEYWORDS: classes of preferred stock

10. Preferred stock, unlike bonds, cannot be converted into common stock.

DIFFICULTY: Moderate

KEYWORDS: convertible preferred

11. Common stockholders are essentially creditors of the firm.

DIFFICULTY: Moderate

KEYWORDS: common stockholders

12. Common stock represents a claim on residual income.

DIFFICULTY: Moderate

KEYWORDS: residual income

13. If you own shares of stock with a cumulative voting right, then you have the right of first refusal on any subsequent issues.

DIFFICULTY: Moderate

KEYWORDS: cumulative voting

14. The growth rate of future earnings is determined by return on equity and the profit-retention rate.

DIFFICULTY: Moderate

KEYWORDS: growth rate

15. The stockholder’s expected rate of return consists of a dividend yield and interest.

DIFFICULTY: Moderate

KEYWORDS: stockholder’s expected rate of return

16. In order to determine the value of a share of preferred stock, the discount rate used is the annual dividend percent.

DIFFICULTY: Moderate

KEYWORDS: discount rate

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

DIFFICULTY: Moderate

KEYWORDS: non-growth common stock

18. It is quite common for firms that issue preferred stock to issue more than one series.

DIFFICULTY: Moderate

KEYWORDS: series of preferred stock

19. In the event of bankruptcy, preferred stockholders and common stockholders have the same claim on the firm’s assets.

DIFFICULTY: Moderate

KEYWORDS: claim on assets, stockholders

20. Common stockholders bear more risk than debtholders but less risk than preferred stockholders.

DIFFICULTY: Moderate

KEYWORDS: risk and common stock

21. Protective provisions reduce the cost of preferred stock to the issuing firm.

DIFFICULTY: Moderate

KEYWORDS: protective provisions

22. Investors value the ability to convert preferred stock into common stock.

DIFFICULTY: Moderate

KEYWORDS: convertible feature

23. Although a participating feature is desirable from the investor’s perspective, it is infrequently found in preferred stock.

DIFFICULTY: Moderate

KEYWORDS: participating preferred

24. Preferred stock cannot be retired.

DIFFICULTY: Moderate

KEYWORDS: retiring preferred

25. The SEC discourages the issuance of preferred stock with a call provision.

DIFFICULTY: Moderate

KEYWORDS: call provision

26. When bankruptcy occurs, the claims of the common shareholders generally go unsatisfied.

DIFFICULTY: Moderate

KEYWORDS: bankruptcy

27. For minority shareholders, majority voting has an advantage over cumulative voting.

DIFFICULTY: Moderate

KEYWORDS: cumulative voting

28. The cumulative feature is necessary to protect the rights of preferred stockholders.

DIFFICULTY: Moderate

KEYWORDS: cumulative voting

29. Cumulative voting gives each share of stock a number of votes equal to the number of directors being elected to the board.

DIFFICULTY: Moderate

KEYWORDS: cumulative voting

30. The preemptive right helps existing common shareholders protect their proportionate share of ownership of the firm.

DIFFICULTY: Moderate

KEYWORDS: preemptive right

31. Internal growth, resulting in the growth of future earnings and the value of common stock, is the relevant growth for valuing a firm’s common stock.

DIFFICULTY: Moderate

KEYWORDS: growth rate

32. The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.

DIFFICULTY: Moderate

KEYWORDS: expected rate of return

Multiple Choice

33. UVP preferred stock pays $5.00 in annual dividends. If your required rate of return is 13%, how much will you be willing to pay for one share?

a. $38.46

b. $26.26

c. $65.46

d. $46.38

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

34. Green Corp.’s preferred stock is selling for $20.83. If the company pays $2.50 annual dividends, what is the expected rate of return on its stock?

a. 8.33%

b. 12.00%

c. 2.50%

d. 20.00%

DIFFICULTY: Moderate

KEYWORDS: expected rate of return

35. Sacramento Light & Power issued preferred stock in 1998 that had a par value of $85. The preferred stock pays a dividend of 5.75%. Investors require a rate of return of 6.50% today on this stock. What is the value of the preferred stock today? Round to the nearest $1.

a. $100

b. $85

c. $75

d. $16

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

36. Davis Gas & Electric issued preferred stock in 1985 that had a par value of $50. The stock pays a dividend of 7.875%. Assume that shares are currently selling for $62.50. What is the preferred stockholder’s expected rate of return? Round to the nearest 0.01%.

a. 6.30%

b. 7.88%

c. 10.25%

d. 5.02%

DIFFICULTY: Moderate

KEYWORDS: expected return

37. The quarterly dividends for adjustable rate preferred stock may be determined by:

a. the three-month Treasury bill rate.

b. the 10-year Treasury bond rate.

c. the 20-year Treasury bond rate.

d. all of the above.

DIFFICULTY: Moderate

KEYWORDS: preferred stock dividends

38. Preferred stock valuation usually treats the preferred stock as a:

a. capital asset.

b. perpetuity.

c. common stock.

d. long-term bond.

DIFFICULTY: Moderate

KEYWORDS: perpetuity

39. Which is not a feature of preferred stock?

a. Cumulative

b. Convertibility

c. Arbitrage

d. Participating

DIFFICULTY: Moderate

KEYWORDS: features of preferred stock

40. Which statement is true?

a. Investors can sue the corporation if it does not pay the agreed-upon preferred dividend.

b. Preferred stock of a given company is less risky to the investor than corporate bonds of the same corporation.

c. Most issues of preferred stock have a cumulative feature.

d. Preferred stock usually has a maturity that is less than the average maturity of bonds issued by the same company.

DIFFICULTY: Moderate

KEYWORDS: features of preferred stock

41. Which statement is true?

a. Preferred stock is similar to corporate bonds because dividends on preferred stock, like interest on bonds, are a tax-deductible expense to the corporation.

b. Preferred stock is similar to corporate bonds because the corporation usually pays the holders of the securities a fixed amount.

c. Preferred stockholders are considered to be the true owners of corporations.

d. Preferred stockholders have priority over bondholders when it comes to the payment of dividends.

DIFFICULTY: Moderate

KEYWORDS: features of preferred stock

42. The XYZ Company, whose common stock is currently selling for $40 per share, is expected to pay a $2.00 dividend in the coming year. If investors believe that the expected rate of return on XYZ is 14%, what growth rate in dividends must be expected?

a. 5%

b. 14%

c. 9%

d. 6%

DIFFICULTY: Moderate

KEYWORDS: dividends growth

43. The expected rate of return on a share of common stock whose dividends are growing at a constant rate (g) is which of the following?

a. (D1 + g)/Vc

b. D1/Vc

c. D1/g

d. None of the above

DIFFICULTY: Moderate

KEYWORDS: expected return

44. Green Company’s common stock is currently selling at $24.00 per share. The company recently paid dividends of $1.92 per share and projects growth at a rate of 4%. At this rate, what is the stock’s expected rate of return?

a. 4.08%

b. 8.00%

c. 12.00%

d. 8.80%

DIFFICULTY: Moderate

KEYWORDS: growth rate

45. Which of the following provisions is unique to preferred stockholders and usually not available to common stockholders?

a. Cumulative dividends feature

b. Voting rights

c. Fixed dividend

d. Both a & c

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

46. McMillen House of Books recently paid a $3 dividend on its preferred stock. Investors require a 6% return on the stock. The stock is currently selling for $45. Is the stock a good buy?

1. Yes, as it is undervalued $5.
2. Yes, as it is undervalued $10.
3. No, as it is overvalued $5.
4. No, as it is overvalued $10.

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

47. Common stockholders are essentially:

a. creditors of the firm.

b. managers of the firm.

c. owners of the firm.

d. all of the above.

DIFFICULTY: Moderate

KEYWORDS: common stock ownership

48. Preferred stock is similar to a bond because:

a. it has a maturity at which time the corporation repays par value.

b. it has a fixed amount to the investor.

c. it represents an ownership interest.

d. all of the above.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

49. What feature allows preferred stockholders the right to receive dividends over and above the stated dividend?

a. Cumulative

b. Convertible

c. Participating

d. Preemptive

DIFFICULTY: Moderate

KEYWORDS: participating preferred

50. Butler, Inc.’s return on equity is 17% and management retains 75% of earnings for investment purposes. Based on this information, what will be the firm’s growth rate?

a. 4.25%

b. 22.67%

c. 44.12%

d. 12.75%

DIFFICULTY: Moderate

KEYWORDS: growth rate

51. If a company has a return on equity of 25% and wants a growth rate of 10%, how much of ROE should be retained?

a. 40%

b. 50%

c. 60%

d. 70%

DIFFICULTY: Moderate

KEYWORDS: retention rate

52. Which of the following affect the value of a share of preferred stock?

a. Dividend amount

b. Investors’ required rate of return

c. Maturity date

d. Dividend amount and investors’ required rate of return

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

53. Style Corp. preferred stock pays $3.15. What is the value of the stock if your required rate of return is 8.5% (round your answer to the nearest $1, and assume no transaction costs)?

a. $33

b. $23

c. $27

d. $37

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

54. Solitron Manufacturing Company preferred stock is selling for $14. If it has a yearly dividend of $1, what is your expected rate of return if you purchase the stock at its market price (round your answer to the nearest .1%, and assume no transaction costs)?

a. 25.0%

b. 14.2%

c. 7.1%

d. 9.3%

DIFFICULTY: Moderate

KEYWORDS: expected return

55. Bell Corp. has a preferred stock that pays a dividend of $2.40. If you are willing to purchase the stock at $11 or below, what is your required rate of return (round your answer to the nearest .1%, and assume that there are no transaction costs)?

a. 21.8%

b. 11.0%

c. 9.1%

d. 20.1%

DIFFICULTY: Moderate

KEYWORDS: expected return

56. What is the value of a preferred stock that pays a $2.10 dividend to an investor with a required rate of return of 11% (round your answer to the nearest $1)?

a. $19

b. $23

c. $17

d. $21

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

57. How is preferred stock affected by a decrease in the required rate of return?

a. The value of a share of preferred stock decreases.

b. The dividend increases.

c. The dividend decreases.

d. None of the above.

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

58. _________ gives minority shareholders more power to elect board of directors.

1. Preemptive right
2. Majority voting
3. Proxy fights
4. Cumulative voting

DIFFICULTY: Easy

KEYWORDS: cumulative voting

59. Preferred stock is similar to a bond in the following way.

a. Preferred stock always contains a maturity date.

b. Both investments provide a constant income.

c. Both contain a growth factor similar to common stock.

d. None of the above.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

60. The common stockholders are most concerned with:

a. the percentage of profits retained.

b. the size of the firm’s beginning earnings per share.

c. the risk of the investment.

d. the spread between the return generated on new investments and the investor’s required rate of return.

DIFFICULTY: Moderate

KEYWORDS: common stockholder concerns

61. Tri State Pickle Company preferred stock pays a perpetual annual dividend of 2 1/2% of its par value. Par value of TSP preferred stock is $100 per share. If investors’ required rate of return on this stock is 15%, what is the value of per share?

a. $37.50

b. $15.00

c. $16.67

d. $6.00

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

62. Petrified Forest Skin Care, Inc. pays an annual perpetual dividend of $1.70 per share. If the stock is currently selling for $21.25 per share, what is the expected rate of return on this stock?

a. 36.13%

b. 12.5%

c. 8.0%

d. 13.6%

DIFFICULTY: Moderate

KEYWORDS: perpetuity return

63. You are evaluating the purchase of Cellars, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12% for the next three years. You plan to hold the stock for three years and then sell it. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected dividends. Round to the nearest $0.10.

a. $4.90

b. $11.50

c. $9.80

d. $6.10

DIFFICULTY: Moderate

KEYWORDS: common stock value

64. You are evaluating the purchase of Holdings, Inc. common stock that just paid a dividend of $1.80. You plan to hold the stock for three years and then sell it. You expect the price of the company’s stock to rise to $51.50 at the end of your three-year holding period. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected future stock price. Round to the nearest $.25.

a. $64.00

b. $55.25

c. $31.75

d. $103.00

DIFFICULTY: Moderate

KEYWORDS: common stock value

65. CEO naming friends to the board of directors and paying them more than the norm is an example of the:

1. agency problem.
2. preemptive right.
3. majority voting feature.
4. proxy fights.

DIFFICULTY: Easy

KEYWORDS: agency problem

66. Little Feet Shoe Co. just paid a dividend of $1.65 on its common stock. This company’s dividends are expected to grow at a constant rate of 3% indefinitely. If the required rate of return on this stock is 11%, compute the current value of per share of LFS stock.

a. $20.63

b. $21.24

c. $15.00

d. $55.00

DIFFICULTY: Moderate

KEYWORDS: common stock value

67. Moo Moo Land Dairy Co. has net income of $450,000 this year. The book value of MML common stock is $3 million dollars. The company’s dividend payout ratio is 60% and is expected to remain this way. What is MML’s sustainable growth rate?

a. 3%

b. 9%

c. 6%

d. 10%

DIFFICULTY: Moderate

KEYWORDS: growth rate

68. Marshall Manufacturing has common stock which paid a dividend of $1.00 a share last year. You expect the stock to grow at 5% per year. If the appropriate rate of return on this stock is 12%, how much are you willing to pay for the stock today?

1. $13.00
2. $15.00
3. $17.00

d. $19.00

DIFFICULTY: Moderate

KEYWORDS: common stock value

69. Marble Corporation’s ROE is 17%. Their dividend payout ratio is 20%. The last dividend, just paid, was $2.58. If dividends are expected to grow by the company’s sustainable growth rate indefinitely, what is the current value of Marble common stock if its required return is 18%?

a. $14.33

b. $18.27

c. $47.67

d. $66.61

DIFFICULTY: Moderate

KEYWORDS: common stock value

70. Fris B. Corporation stock is currently selling for $42.86. It is expected to pay a dividend of $3.00 at the end of the year. Dividends are expected to grow at a constant rate of 3% indefinitely. Compute the required rate of return on FBC stock.

a. 10%

b. 33%

c. 7%

d. 4.3%

DIFFICULTY: Moderate

KEYWORDS: expected return

71. You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today? Round to the nearest $.01.

a. $36.65

b. $91.23

c. $51.55

d. $74.82

DIFFICULTY: Moderate

KEYWORDS: common stock value

72. What does a sinking fund provision in a preferred stock require a firm to do?

a. Pay a dividend only when the firm experiences an overdraft.

b. Set aside an amount periodically for the retirement of the preferred stock.

c. Pay dividends to preferred shareholders only when the firm has funds to do so.

d. Convert the preferred shares to bonds.

DIFFICULTY: Moderate

KEYWORDS: sinking fund

73. Preferred stock is similar to common stock in that:

a. it has no fixed maturity date.

b. the nonpayment of dividends can bring on bankruptcy.

c. dividends are limited in amount.

d. all of the above.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

74. The expected rate of return for a common stock consists of:

1. growth.
2. current yield.
3. dividend yield.
4. both a and c.
5. all of the above.

DIFFICULTY: Moderate

KEYWORDS: expected rate of return, common stock

75. An increase in the _________________ will increase the value of preferred stock.

1. expected rate of return
2. life of the investment
3. dividend paid
4. both a and c

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

76. A stock currently sells for $63 per share, and the required return on the stock is 10%. Assuming a growth rate of 5%, calculate the stock's last dividend paid.

a. $1

b. $3

c. $5

d. $7

DIFFICULTY: Hard

KEYWORDS: last paid dividend

77. Valuing common stock relies on:

1. the risk-return trade-off.
2. the time value of money.
3. profits.
4. both a and b.
5. all of the above.

DIFFICULTY: Easy

KEYWORDS: principles for valuing common stock

78. A decrease in the _______________will cause an increase in common stock value.

a. growth rate

b. required rate of return

c. last paid dividend

d. both b and c

DIFFICULTY: Moderate

KEYWORDS: common stock value

79. Acme Consolidated has a return on equity of 12%. If Acme distributes 60% of earnings as dividends, then we would expect the common shareholders’ investment in the firm and the value of the common stock to grow by:

a. 4.80%.

b. 7.20%.

c. 12%.

d. 6%.

DIFFICULTY: Moderate

KEYWORDS: growth rate

80. Common stock value is primarily based on:

1. expected dividends.
2. book value.
3. total assets.
4. both a and b.

DIFFICULTY: Easy

KEYWORDS: common stock value

81. An investor is contemplating the purchase of common stock at the beginning of this year and to hold the stock for one year. The investor expects the year-end dividend to be $2.00 and expects a year-end price for the stock of $40. If this investor’s required rate of return is 10%, then the value of the stock to this investor is:

a. $36.36.

b. $38.18.

c. $33.06.

d. $34.88.

DIFFICULTY: Moderate

KEYWORDS: common stock value

82. A firm just paid $2.00 on its common stock and expects to continue paying dividends, which are expected to grow 5% each year, from now to infinity. If the required rate of return for this stock is 9%, then the value of the stock is:

a. $50.00.

b. $40.00.

c. $54.50.

d. $52.50.

DIFFICULTY: Moderate

KEYWORDS: common stock value

83. An issue of preferred stock currently sells for $52.50 per share and pays a constant annual expected dividend of $2.25 per share. The expected return on this security is:

a. 4.29%.

b. 0.04%.

c. 8.33%.

d. 13.33%.

DIFFICULTY: Moderate

KEYWORDS: expected return

84. Expected return for preferred stock consists of:

1. dividend yield.
2. growth.
3. interest income.
4. both a and b.
5. all of the above.

DIFFICULTY: Moderate

KEYWORDS: expected rate of return, preferred stock

85. An issue of common stock currently sells for $40.00 per share, has an expected dividend to be paid at the end of the year of $2.00 per share, and has an expected growth rate to infinity of 5% per year. The expected rate of return on this security is:

a. 5%.

b. 10.25%.

c. 13.11%.

d. 10%.

DIFFICULTY: Moderate

KEYWORDS: expected return

86. White Sink, Inc. just paid a dividend of $5.55 per share on its common stock, and the firm is expected to generate constant growth of 12.25% over the foreseeable future. The common stock is currently selling for $73.75 per share. The firm’s dividend payout ratio is 40%, and White’s marginal tax rate is 40%. What is the rate of return that common stockholders expect? Round to the nearest 0.1%.

a. 8.5%

b. 20.7%

c. 15.5%

d. 4.8%

DIFFICULTY: Moderate

KEYWORDS: expected return

87. KDP’s most recent dividend was $2.00 per share and is selling today in the market for $70. The dividend is expected to grow at a rate of 7% per year for the foreseeable future. If the market return is 10% on investments with comparable risk, should you purchase the stock?

a. No, because the stock is overpriced $1.33.

b. No, because the stock is overpriced $3.33.

c. Yes, because the stock is underpriced $1.33.

d. Yes, because the stock is underpriced $3.33.

DIFFICULTY: Moderate

KEYWORDS: common stock value

88. An issue of common stock currently sells for $50.00 per share, has an expected dividend to be paid at the end of the year of $2.50 per share, and has an expected growth rate to infinity of 5% per year. If investors’ required rate of return for this particular security is 12% per year, then this security is:

a. overvalued and offering an expected return higher than the required return.

b. undervalued and offering an expected return higher than the required return.

c. overvalued and offering an expected return lower than the required return.

d. undervalued and offering an expected return lower than the required return.

DIFFICULTY: Moderate

KEYWORDS: common stock value

89. You are considering the purchase of Miller Manufacturing, Inc.’s common stock. The stock paid a recent dividend of $2.00. The next dividend is expected to be $2.10. If the stock is returning 15%, calculate its dividend yield.

a. 3%

b. 5%

c. 8%

d. 10%

DIFFICULTY: Moderate

KEYWORDS: dividend yield

90. Which of the following statements is false?

a. Preferred stock is similar to bonds in that the dividend of a preferred stock is fixed much like the interest payment on a bond is fixed.

b. Preferred stockholders are entitled to dividends before common stockholders can receive dividends.

c. Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not pay back the investment.

d. Preferred dividend payments are a tax-deductible expenditure.

e. The market value of preferred stock, like bonds, will usually fluctuate in value primarily as the result of market rates of interest.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

91. Which of the following statements is true?

a. Preferred stock is similar to bonds in that the dividend of a preferred stock is fixed much like the interest payment on a bond is fixed.

b. Preferred stockholders are entitled to dividends before common stockholders can receive dividends.

c. Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not pay back the investment.

d. The market value of preferred stock, like bonds, will usually fluctuate in value primarily as the result of market rates of interest.

e. All of the above.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

92. Which of the following statements concerning preferred stock is correct?

a. Preferred stock generally is more costly to the firm than common stock.

b. Most issues of preferred stock have a cumulative feature.

c. Preferred stock cannot be convertible.

d. Preferred dividend payments are tax-deductible.

e. Preferred stock is a riskier form of capital to the firm than bonds.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

93. World Wide Interlink Corp. has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with an annual dividend of $5 per share. The stock will have a par value of $30. If investors’ required rate of return on this investment is currently 20%, what should the preferred stock’s market value be?

a. $5

b. $10

c. $15

d. $20

e. $25

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

94. Preferred stock is similar to a bond because:

a. investors always receive their investment back at maturity.

b. investors receive fixed payments.

c. it represents ownership of a firm.

d. all of the above.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

95. Which of the following statements is true?

a. Most preferred stock issues do not have a cumulative feature.

b. Preferred stock issues must have a call feature.

c. Preferred stock issues must have a sinking fund.

d. Preferred stock must have a par value.

e. None of the above.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

96. Preferred stockholders:

a. have a right to receive dividends before common stockholders.

b. normally have voting rights.

c. generally receive a dividend that varies with the financial performance of the firm.

d. are secured creditors.

e. bear greater risk than common stockholders.

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

97. Which of the following serves to protect preferred stockholders from not receiving dividends to which they are entitled?

a. The PIK feature

b. The participating feature

c. The cumulative feature

d. Convertibility

e. None of the above

DIFFICULTY: Moderate

KEYWORDS: preferred stock features

98. ABC, Inc. just paid a dividend of $2. ABC expects dividends to grow at 10%. The return on stocks like ABC, Inc. is typically around 12%. What is the most you would pay for a share of ABC stock?

1. $100
2. $110
3. $120
4. $130

DIFFICULTY: Moderate

KEYWORDS: common stock value

99. Marjen, Inc. just paid a dividend of $5. Marjen stock currently sells for $73.57. The return on stocks like Marjen, Inc. is typically around 10%. What is the dividend yield on the stock?

1. 1%
2. 3%
3. 5%
4. 7%

DIFFICULTY: Moderate

KEYWORDS: dividend yield

100. Which of the following statements is true?

a. Common stockholders are the true owners of a firm.

b. Capital obtained from the sale of common stock will ultimately be repaid by the corporation.

c. A corporation has a legal obligation to pay dividends on common stock.

d. Dividends on common stock usually do not grow.

e. Common stockholders have unlimited liability.

DIFFICULTY: Moderate

KEYWORDS: common stock features

101. Common stockholders are:

a. creditors of the firm.

b. managers of the firm.

c. owners of the firm.

d. debtors of the firm.

DIFFICULTY: Moderate

KEYWORDS: common stockholders

102. Which investor incurs the greatest risk?

a. Mortgage Bondholder

b. Preferred stockholder

c. Common stockholder

d. Debenture Bondholder

DIFFICULTY: Moderate

KEYWORDS: risk and common stock

103. What allows common stockholders the right to cast a number of votes equal to the number of directors being elected?

a. The majority voting provision

b. The casting feature

c. The cumulative voting provision

d. The proxy method

DIFFICULTY: Moderate

KEYWORDS: cumulative voting

104. What gives common stockholders the right to maintain a proportionate share of ownership in the firm when new shares are issued?

a. The participating right

b. The cumulative right

c. The preemptive right

d. The proxy right

DIFFICULTY: Moderate

KEYWORDS: preemptive right

105. The shareholder can cast all votes for a single candidate or split them among various candidates through:

1. proxy fights.
2. cumulative voting.
3. call provisions.
4. majority voting.

DIFFICULTY: Easy

KEYWORDS: cumulative voting

106. You are considering the purchase of common stock that just paid a dividend of $6.50 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 18%. How much should you expect to pay for this stock?

a. $86

b. $94

c. $108

d. $121

e. $242

DIFFICULTY: Moderate

KEYWORDS: common stock value

107. You are considering the purchase of Wahoo, Inc. The firm just paid a dividend of $4.20 per share. The stock is selling for $115 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 17.5%. If you were to purchase and hold the stock for three years, what would the expected dividends be worth today?

a. $12.60

b. $9.21

c. $17.12

d. $15.55

e. $11.46

DIFFICULTY: Moderate

KEYWORDS: common stock value

108. A share of common stock just paid a dividend of $3.25 per share. The expected long-run growth rate for this stock is 18%. If investors require a rate of return of 24%, what should the price of the stock be?

a. $57.51

b. $62.25

c. $71.86

d. $63.92

e. $44.94

DIFFICULTY: Moderate

KEYWORDS: common stock value

109. Common stockholders expect greater returns than bondholders because:

a. they have no legal right to receive dividends.

b. they bear greater risk.

c. in the event of liquidation, they are only entitled to receive any cash that is left after all creditors are paid.

d. all of the above.

e. none of the above.

DIFFICULTY: Moderate

KEYWORDS: common stock features

110. Rival groups compete for voting power through which feature of common stock?

a. Proxies

b. Cumulative voting

c. Call provision

d. Residual ownership

DIFFICULTY: Easy

KEYWORDS: proxy fights

Short-Answer Questions

111. Compare and contrast preferred stock and common stock valuation.

DIFFICULTY: Moderate

KEYWORDS: common stock valuation, preferred stock valuation

112. Discuss two reasons why preferred stock would be viewed as less risky than common stock to investors.

DIFFICULTY: Moderate

KEYWORDS: preferred stock versus common stock

113. Determine the rate of return on a preferred stock that costs $50 and pays a $6 per share dividend.

K = Div = 6 = 12%

Vg 50

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

114. Is the following common stock priced correctly? If no, what is the correct price?

Price = $26.25

Required rate of return = 13%

Dividend year 0 = $2.00

Dividend year 1 = $2.10

Growth rate = 2.10 - 2.00 = 5%

–––––––––––––

2.00

Vcs = 2.10 = $26.25

.13 - .05

The stock is priced correctly.

DIFFICULTY: Moderate

KEYWORDS: common stock value

115. Texon’s preferred stock sells for $85 and pays $11 each year in dividends. What is the expected rate of return?

Required rate of return = $11 = 0.129

$85

DIFFICULTY: Moderate

KEYWORDS: expected return

116. Draper Company’s common stock paid a dividend last year of $3.70. You believe that the long-term growth in the dividends of the firm will be 8% per year. If your required return for Draper is 14%, how much are you willing to pay for the stock?

P0 = $3.70(1+.08) = $3.996 = $66.60

–––––––––––––– –––––––

0.14 - 0.08 0.06

DIFFICULTY: Moderate

KEYWORDS: common stock value

117. Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1 and grows at a rate of 5%.

Kcs = 2.50 + 5% = 10% + 5% = 15%

25

DIFFICULTY: Moderate

KEYWORDS: expected return

118. You are considering the purchase of AMDEX Company stock. You anticipate that the company will pay dividends of $2.00 per share next year and $2.25 per share the following year. You believe that you can sell the stock for $17.50 per share two years from now. If your required rate of return is 12%, what is the maximum price that you would pay for a share of AMDEX Company stock?

Vc = $2.00 PVIF12%,1 + $19.75 PVIF12%,2

= ($2.00)(.893) + ($19.75)(.797)

= $17.53

DIFFICULTY: Moderate

KEYWORDS: common stock value

119. You can purchase one share of Sumter Company common stock for $80 today. You expect the price of the common stock to increase to $85 per share in one year. The company pays an annual dividend of $3.00 per share. What is your expected rate of return for Sumter stock?

$80.00 = $3.00 + $85.00

1 + R (1 + R)

$80.00 (1 + R) = $88.00

(1 + R) = $88.00 = $1.10

$80.00

R = .10

DIFFICULTY: Moderate

KEYWORDS: expected return

120. Dink and Company’s preferred stock pays an annual dividend of $2.80. The shares have no maturity date. You as an investor require a 7% return. What is the value of Dink’s preferred stock to you?

DIFFICULTY: Moderate

KEYWORDS: preferred stock value

121. Tannerly Worldwide’s common stock is currently selling for $48 a share. If the expected dividend at the end of the year is $2.40 and last year’s dividend was $2.00, what is the rate of return implicit in the current stock price?

Rc = 2.40/48 + (2.40 - 2.00)/2.00

= .05 + .20

= 25%

DIFFICULTY: Moderate

KEYWORDS: expected return

122. Miller/Hershey’s preferred stock is selling at $54 on the market and pays an annual dividend of $4.20 per share.

a. What is the expected rate of return on the stock?

b. If an investor’s required rate of return is 9%, what is the value

of the stock for that investor?

c. Considering the investor’s required rate of return, does this stock

seem to be a desirable investment?

a. R = D/V

R = $4.20/54

R = 7.78%

b. V = D/R

V = $4.20/.09

V = $46.66

c. No, it is not a desirable investment.

DIFFICULTY: Moderate

KEYWORDS: expected return

123. The common stock of Cranberry, Inc. is selling for $26.75 on the open market. A dividend of $3.68 is expected to be distributed, and the growth rate of this company is estimated to be 5.5%. If Richard Dean, an average investor, is considering purchasing this stock at the market price, what is his expected rate of return?

R = (D/V) + g

R = ($3.68/$26.75) + .055

R = 19.26%

DIFFICULTY: Moderate

KEYWORDS: expected return