Deck 7: Socks Equity Characteristics and Valuation

Question 1

Founders' shares is a type of classified stock where the shares are owned by the firm's founders and they retain the sole voting rights to those shares but have restricted dividends for a specified time period.

Answer 1

True

Question 2

A publicly owned corporation is simply a company whose shares are held by the investing public, which may include other corporations and institutions.

Answer 2

True

Question 3

According to the basic stock valuation model, the value an investor assigns to a share of stock is dependent upon the length of time the investor plans to hold the stock.

Answer 3

False

Question 4

One advantage of using common stock as a source of funds is that common stock does not legally obligate the firm to make payments to stockholders.

Question 5

When management controls more than 50% of the shares of the firm, they must be concerned with the potential of a proxy fights than can lead to takeovers of the firm and the replacement of management.

Question 6

Other things held constant, P/E ratios are higher for firms with high growth prospects.At the same time, P/E's are lower for riskier firms, other things held constant.These two factors, growth prospects and riskiness, may either be offsetting or reinforcing as P/E determinants.

Question 7

The constant growth model used for evaluating the price of a share of common stock can also be used to find the price of perpetual preferred stock or any other perpetuity.

Question 8

When a firm issues new equity, market pressure applies first to the new shares issued and then to existing shares.
Subsequent to the new issue, the value of the new shares will rise to the equilibrium price of the old shares.

Question 9

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

Question 10

American depository receipts (ADRs) are foreign stocks listed on a domestic exchange.

Question 11

According to the textbook model, under conditions of nonconstant growth, the discount rate utilized to find the present value of the expected cash flows will be the same for the initial growth period as for the normal growth period.

Question 12

The book value per share is computed by taking the sum of common stock, additional paid in capital, and retained earnings and dividing the number by the number of shares outstanding.

Question 13

A stock's par value is equal to the market value of the stock on the last day of the fiscal year for a firm.

Question 14

The net income that firm earns can either be paid out to shareholders as as ____.

A)interest; additional paid-in capital
B)dividends; retained earnings
C)shares; capital stock.
D)capital gains; additional paid-in capital
E)interest; retained earnings

Question 15

A proxy fight is an attempt by a group to gain control of a firm by convincing its stockholders to give the group the authority to vote their shares in order to elect a new management team.

Question 16

From a social welfare perspective, common stock is a desirable form of financing in part because it involves no fixed charge payments.Its inclusion in a firm's capital structure makes the firm less vulnerable to the consequences of unanticipated declines in sales and earnings than if only debt were available.

Question 17

One advantage of common stock as a source of funds is that the underwriting and distribution costs of common stock are usually much lower than those for debt.

Question 18

A preemptive right is a provision in the corporate charter or by laws that gives common stockholders the right to purchase on a pro rata basis new issues of common stock.

Question 19

Preemptive rights are important to stockholders because they provide protection against a dilution of value when new shares are issued.

Question 20

In international markets, excluding stocks sold in the United States, what is any stock that is traded in a country other than the issuing company's home country called?

A)ADRs
B)Yankee stock
C)Euro stock
D)Class A stock
E)Preferred stock

Question 21

Shareholders exert control of the management of the firm by

A)electing board members who can replace management.
B)directly replacing management with themselves.
C)buying shares in an IPO at a discounted price.
D)running the daily operations of the firm.
E)None of the above.

Question 22

A share of perpetual preferred stock pays an annual dividend of $6 per share.If investors require a 12 percent rate of return, what should be the price of this preferred stock?

A)$57.25
B)$50.00
C)$62.38
D)$46.75
E)$41.64

Question 23

Nahanni Treasures Corporation is planning a new common stock issue of five million shares to fund a new project. The increase in shares will bring to 25 million the number of shares outstanding.Nahanni's long-term growth rate is 6 percent, and its current required rate of return is 12.6 percent.The firm just paid a $1.00 dividend and the stock sells for $16.06 in the market.On the announcement of the new equity issue, the firm's stock price dropped.Nahanni estimates that the company's growth rate will increase to 6.5 percent with the new project, but since the project is riskier than average, the firm's cost of capital will increase to 13.5 percent.Using the DDM constant growth model, what is the change in the equilibrium stock price?

A)−$1.77
B)−$1.06
C)−$0.85
D)−$0.66
E)−$0.08

Question 24

Ms.Manners Catering (MMC) has paid a constant $1.50 per share dividend to its common stockholders for the past 25 years.MMC expects to continue this policy for the next two years, and then begin to increase the dividend at a constant rate equal to 2 percent per year into perpetuity.Investors require a 12 percent rate of return to purchase MMC's common stock.What is the market value of MMC's common stock?

A)$14.73
B)$15.00
C)$15.58
D)$15.30
E)$12.20

Question 25

The last dividend on Spirex Corporation's common stock was $4.00, and the expected growth rate is 10 percent.If you require a rate of return of 20 percent, what is the highest price you should be willing to pay for this stock?

A)$44.00
B)$38.50
C)$40.00
D)$45.69
E)$50.00

Question 26

If the expected rate of return on a stock exceeds the required rate,

A)The stock is experiencing supernormal growth.
B)The stock should be sold.
C)The company is probably not trying to maximize price per share.
D)The stock is a good buy.
E)Dividends are not being declared.

Question 27

A share of preferred stock pays a quarterly dividend of $2.50.If the price of this preferred stock is currently $50, what is the simple annual rate of return?

A)12%
B)18%
C)20%
D)23%
E)28%

Question 28

Mesmer Analytic, a biotechnology firm, floated an initial public offering of 2,000,000 shares at a price of $5.00 per share.The firm's owner/managers held 60 percent of the company's $1.00 par value authorized and issued stock following the public offering.One month after the IPO, the firm's board of directors declared a one-time dividend of $0.50 per share payable to all stockholders, meaning that the owner/managers would receive an immediate dividend, in part out of the pockets of the new public stockholders.What was the book value per share of the firm before and after the special dividend was paid?

A)$2.60; $2.10
B)$2.60; $2.60
C)$2.60; $2.30
D)$1.60; $1.10
E)$1.60; $1.00

Question 29

Alpha's preferred stock currently has a market price equal to $80 per share.If the dividend paid on this stock is $6 per share, what is the required rate of return investors are demanding from Alpha's preferred stock?

A)7.5%
B)13.3%
C)6.0%
D)$6.00
E)None of the above is a correct answer.

Question 30

A share of preferred stock pays a dividend of $0.50 each quarter.If you are willing to pay $20.00 for this preferred stock, what is your simple (not effective) annual rate of return?

A)10%
B)8%
C)6%
D)12%
E)14%

Question 31

Velcraft Company has 20,000,000 shares of common stock authorized, but to date, has only 12,000,000 shares outstanding, each with a $1.00 par value.The company has $24,000,000 in additional paid-in capital and retained earnings are $96,000,000.What is Velcraft's current book value per share?

A)$1.00
B)$3.00
C)$11.00
D)$6.60
E)$9.00

Question 32

The last dividend paid by Klein Company was $1.00.Klein's growth rate is expected to be a constant 5 percent for 2 years, after which dividends are expected to grow at a rate of 10 percent forever.Klein's required rate of return on equity (rs) is 12 percent.What is the current price of Klein's common stock?

A)$21.00
B)$33.33
C)$42.25
D)$50.16
E)$58.75

Question 33

You are given the following data: (1) The risk-free rate is 5 percent.
(2) The required return on the market is 8 percent.
(3) The expected growth rate for the firm is 4 percent.(4) The last dividend paid was $0.80 per share.
(5) Beta is 1.3.
Now assume the following changes occur:
(1) The inflation premium drops by 1 percent.
(2) An increased degree of risk aversion causes the required return on the market to go to 10 percent after adjusting for the changed inflation premium.
(3) The expected growth rate increases to 6 percent.(4) Beta rises to 1.5.
What will be the change in price per share, assuming the stock was in equilibrium before the changes?

A)+$12.11
B)−$4.87
C)+$6.28
D)−$16.97
E)+$2.78

Question 34

Stock owned by the organizers of the firm who have sole voting rights is

A)preferred stock.
B)common equity.
C)founders' shares.
D)convertible equity.
E)retained earnings.

Question 35

You are trying to determine the appropriate price to pay for a share of common stock.If you purchase this stock, you plan to hold it for 1 year.At the end of the year you expect to receive a dividend of $5.50 and to sell the stock for $154.The appropriate rate of return for this stock is 16 percent.What should be the current price of this stock?

A)$137.50
B)$150.22
C)$162.18
D)$98.25
E)$175.83

Question 36

Certificates representing ownership in stocks of foreign companies, which are held in a trust bank located in the country the stock is traded are called .

A)Certificates of Ownership
B)Foreign Stock Funds
C)Mutual Funds
D)American Depository Receipts
E)Investment Bankers

Question 37

A share of common stock has a current price of $82.50 and is expected to grow at a constant rate of 10 percent.If you require a 14 percent rate of return, what is the current dividend on this stock?

A)$3.00
B)$3.81
C)$4.29
D)$4.75
E)$6.13

Question 38

Blow Glass Corporation has 100,000 shares of stock outstanding, each with a par value of $2.50 per share.Blow Glass also has another 400,000 shares of stock that are shelf registered.Blow Glass has retained earnings of
$9,000,000 and additional paid-in capital of $1,000,000.What is Blow Glass's book value per share?

A)$90.00
B)$100.00
C)$27.50
D)$102.50
E)$92.50

Question 39

Micromain Company has 10,000,000 shares of common stock authorized and 8,000,000 shares outstanding, each with a $1.00 par value.The firm's additional paid-in capital account has a balance of $18,000,000.The previous year's retained earnings account was $124,000,000.In the year just ended, Micromain generated net income of $16,000,000 and the firm has a dividend payout ratio of 40 percent.What will Micromain's book value per share be when based on the final year-end balance sheet?

A)$20.75
B)$15.00
C)$15.96
D)$19.95
E)$18.75

Question 40

When using the Dividend Discount Model, assuming that growth (g) will remain constant, the dividend yield is a good measure of the required return on a common stock under which of the following circumstances?

A)g = 0
B)g > 0
C)g < 0
D)Under no circumstances.
E)Answers a and b are both correct.

Question 41

Hard Hat Construction's stock is currently selling at an equilibrium price of $30 per share.The firm has been experiencing a 6 percent annual growth rate.Last year's earnings per share, E0, were $4.00, and the dividend payout ratio is 40 percent.The risk-free rate is 8 percent, and the market risk premium is 5 percent.If systematic risk (beta) increases by 50 percent, and all other factors remain constant, by how much will the stock price change? (Hint: Use four decimal places in your calculations.)

A)−$7.33
B)+$7.14
C)−$15.00
D)−$15.22
E)+$22.63

Question 42

Laserclok Corporation paid a dividend for 50 years until it experienced financial difficulty three years ago, at which ti dividend payment was suspended (that is, a dividend has not been paid during the past three years).The company is much stronger financially, but Laserclok does not expect to pay a dividend for the next five years.Beginning six year today, the company will pay a dividend equal to $2.10, which is 5 percent greater than the last dividend paid three yea After the dividend payments start again, Laserclok expects the dividend to continue to be paid and to grow at a const of 5 percent.If the appropriate market rate for investments similar to Laserclok's stock is 15 percent, at what price sh the stock currently be selling in the financial markets?

A)$21.00
B)$10.44
C)$14.00
D)There is not enough information to answer the question.
E)None of the above.

Question 43

Garcia Inc.has a current dividend of $3.00 per share (D0 = $3.00).Analysts expect that the dividend will grow at a rate of 25 percent a year for the next three years, and thereafter it will grow at a constant rate of 10 percent a year.The company's cost of equity capital is estimated to be 15 percent.What is the current stock price of Garcia Inc.?

A)$75.00
B)$88.55
C)$95.42
D)$103.25
E)$110.00

Question 44

You have a chance to purchase a perpetual security that has a stated annual payment (cash flow) of $50.However, this is an unusual security in that the payment will increase at an annual rate of 5 percent per year; this increase is designed to help you keep up with inflation.The next payment to be received (your first payment, due in 1 year) will be $52.50.If your required rate of return is 15 percent, how much should you be willing to pay for this security?

A)$350
B)$482
C)$525
D)$556
E)$610

Question 45

Your company paid a dividend of $2.00 last year.The growth rate is expected to be 4 percent for 1 year, 5 percent the next year, then 6 percent for the following year, and then the growth rate is expected to be a constant 7 percent thereafter.The required rate of return on equity (ks) is 10 percent.What is the current price of the common stock?

A)$53.45
B)$60.98
C)$64.49
D)$67.47
E)$69.21

Question 46

A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50, and $3.50.If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock?

A)$67.81
B)$22.49
C)$58.15
D)$31.00
E)$43.97

Question 47

NYC Company has decided to make a major investment.The investment will require a substantial early cash outflow, and inflows will be relatively late.As a result, it is expected that the impact on the firm's earnings for the first 2 years will cause a negative growth of 5 percent annually.Further, it is anticipated that the firm will then experience 2 years of zero growth, after which it will begin a positive annual sustainable growth of 6 percent.If the firm's required return is 10 percent and its last dividend, D0, was $2 per share, what should be the current price per share?

A)$32.66
B)$47.83
C)$53.64
D)$38.47
E)$42.49

Question 48

Modular Systems Inc.just paid dividend D0, and it is expecting both earnings and dividends to grow by 0 percent in Year 2, by 5 percent in Year 3, and at a rate of 10 percent in Year 4 and thereafter.The required return on Modular is 15 percent, and it sells at its equilibrium price, P0 = $49.87.What is the expected value of the next dividend? (Hint: Set up and solve an equation with the unknown.)

A)It cannot be estimated without more data.
B)$1.35
C)$1.85
D)$2.35
E)$2.85

Question 49

Yesterday BrandMart Supplies paid its common stockholders a dividend equal to $3 per share.BrandMart expects to pay a $5 per share one year from today.After the $5 dividend is paid, the company expects its growth rate will remain constant at 4 percent per year forever.If BrandMart's investors demand a 12 percent rate of return, what should be the current market price of the company's stock?

A)$62.50
B)$65.00
C)$62.27
D)$37.50
E)None of the above is correct.

Question 50

Berg Inc.has just paid a dividend of $2.00.Its stock is now selling for $48 per share.The firm is half as risky as the market.The expected return on the market is 14 percent, and the yield on U.S.Treasury bonds is 11 percent.If the market is in equilibrium, what rate of growth is expected?

A)13%
B)10%
C)4%
D)8%
E)−2%

Question 51

A share of stock has a dividend of D0 = $5.The dividend is expected to grow at a 20 percent annual rate for the next 10 years, then at a 15 percent rate for 10 more years, and then at a long-run normal growth rate of 10 percent forever.If investors require a 10 percent return on this stock, what is its current price?

A)$100.00
B)$82.35
C)$195.50
D)$212.62
E)The data given in the problem are internally inconsistent, i.e., the situation described is impossible in that no equilibrium price can be produced.

Question 52

Eastern Auto Parts' last dividend was D0 = $0.50, and the company expects to experience no growth for the next 2 years.However, Eastern will grow at an annual rate of 5 percent in the third and fourth years, and, beginning with the fifth year, it should attain a 10 percent growth rate which it should sustain thereafter.Eastern has a required rate of return of 12 percent.What should be the present price per share of Eastern common stock?

A)$19.26
B)$31.87
C)$30.30
D)$20.83
E)$19.95

Question 53

Given the following information, calculate the expected capital gains yield for Chicago Bears Inc.: beta = 0.6; rM = 15%; rRF = 8%; = $2.00; P0 = $25.00.Assume the stock is in equilibrium and exhibits constant growth.

A)3.8%
B)0%
C)8.0%
D)4.2%
E)None of the above.

Question 54

DAA's stock is selling for $15 per share.The firm's income, assets, and stock price have been growing at an annual 15 percent rate and are expected to continue to grow at this rate for 3 more years.No dividends have been declared as yet, but the firm intends to declare a dividend of D3 = $2.00 at the end of the last year of its supernormal growth.After that, dividends are expected to grow at the firm's normal growth rate of 6 percent.The firm's required rate of return is 18 percent.The stock is

A)Undervalued by $3.03.
B)Overvalued by $3.03.
C)Correctly valued.
D)Overvalued by $2.25.
E)Undervalued by $2.25.

Question 55

Suppose you are willing to pay $30 today for a share of stock which you expect to sell at the end of one year for $32.If you require an annual rate of return of 12 percent, what must be the amount of the annual dividend which you expect to receive at the end of Year 1?

A)$2.25
B)$1.00
C)$1.60
D)$3.00
E)$1.95

Question 56

You are considering the purchase of a common stock that just paid a dividend of $2.00.You expect this stock to have a growth rate of 30 percent for the next 3 years, then to have a long-run normal growth rate of 10 percent thereafter.If you require a 15 percent rate of return, how much should you be willing to pay for this stock?

A)$71.26
B)$97.50
C)$82.46
D)$79.15
E)$62.68

Question 57

Club Auto Parts' last dividend, D0, was $0.50, and the company expects to experience no growth for the next 2 years.However, Club will grow at an annual rate of 5 percent in the third and fourth years, and, beginning with the fifth year, it should attain a 10 percent growth rate which it will sustain thereafter.Club has a required rate of return of 12 percent.What should be the price per share of Club stock at the beginning of the third year, P2?

A)$19.98
B)$25.06
C)$31.21
D)$19.48
E)$27.55

Question 58

Carlson Products, a constant growth company, has a current market (and equilibrium) stock price of $20.00. Carlson's next dividend, D1, is forecasted to be $2.00, and Carlson is growing at an annual rate of 6 percent.Carlson has a beta coefficient of 1.2, and a required rate of return on the market is 15 percent.As Carlson's financial manager, you have access to insider information concerning a switch in product lines which would not change the growth rate, but would cut Carlson's beta which would not change the growth rate, but would cut Carlson's beta coefficient in half.If you buy the stock at the current market price, what is your expected percentage capital gain?

A)23%
B)33%
C)43%
D)53%
E)There would be a capital loss.

Question 59

Philadelphia Corporation's stock recently paid a dividend of $2.00 per share (D0 = $2), and the stock is in equilibrium. The company has a constant growth rate of 5 percent and a beta equal to 1.5.The required rate of return on the market is 15 percent, and the risk-free rate is 7 percent.Philadelphia is considering a change in policy which will increase its beta coefficient to 1.75.If market conditions remain unchanged, what new constant growth rate will cause the common stock price of Philadelphia to remain unchanged?

A)8.85%
B)18.53%
C)6.77%
D)5.88%
E)13.52%

Question 60

The Satellite Building Company has fallen on hard times.Its management expects to pay no dividends for the next 2 years.However, the dividend for Year 3, D3, will be $1.00 per share, and the dividend is expected to grow at a rate of 3 percent in Year 4, 6 percent in Year 5, and 10 percent in Year 6 and thereafter.If the required return for Satellite is 20 percent, what is the current equilibrium price of the stock?

A)$0
B)$5.26
C)$6.34
D)$12.00
E)$13.09

Question 61

Assume an all equity firm has been growing at a 15 percent annual rate and is expected to continue to do so for 3 more years.At that time, growth is expected to slow to a constant 4 percent rate.The firm maintains a 30 percent payout ratio, and this year's retained earnings net of dividends were $1.4 million.The firm's beta is 1.25, the risk-free rate is 8 percent, and the market risk premium is 4 percent.If the market is in equilibrium, what is the market value of the firm's common equity (1 million shares outstanding)?

A)$6.41 million
B)$12.96 million
C)$9.18 million
D)$10.56 million
E)$7.32 million

Question 62

Worldwide Inc., a large conglomerate, has decided to acquire another firm.Analysts are forecasting a period (2 years) of extraordinary growth (20 percent), followed by another 2 years of unusual growth (10 percent), and finally a normal (sustainable) growth rate of 6 percent annually.If the last dividend was D0 = $1.00 per share and the required return is 8 percent, what should the market price be today?

A)$93.70
B)$72.76
C)$99.66
D)$98.57
E)$68.87

Question 63

A financial analyst has been following Fast Start Inc., a new high-growth company.She estimates that the current risk-free rate is 6.25 percent, the market risk premium is 5 percent, and that Fast Start's beta is 1.75.The current earnings per share (EPS0) is $2.50.The company has a 40 percent payout ratio.The analyst estimates that the company's dividend will grow at a rate of 25 percent this year, 20 percent next year, and 15 percent the following year.After three years the dividend is expected to grow at a constant rate of 7 percent a year.The company is expected to maintain its current payout ratio.The analyst believes that the stock is fairly priced.What is the current price of the stock?

A)$16.51
B)$17.33
C)$18.53
D)$19.25
E)$19.89