Deck 7: Stocks Equity Characteristics and Valuation

Question 1

If the price of a firm's stock is overvalued, then the company may repurchase shares of their common stock.

Answer 1

False

Question 2

According to the convertibility provision, a common stock can be converted to a certain number of shares of preferred stock at the conversion price.

Answer 2

False

Question 3

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.

Answer 3

True

Question 4

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 5

A call provision with a sinking fund will add a maturity option to a preferred stock issue.

Question 6

The amount in excess of par value that a company must pay when it repurchases a security is known as the _____.

A) call premium
B) preemptive price
C) cumulative dividend
D) participating dividend
E) growth stock

Question 7

When do firms get the right to redeem a preferred stock?

A) By paying accumulated dividends
B) By issuing the stock at par value
C) By incorporating a call provision
D) By providing voting rights
E) By including a preemptive right

Question 8

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

Question 9

Which of the following securities have the highest priority with regard to earnings and assets of a firm?

A) Corporate bonds
B) Preferred stock
C) Common stock
D) American depository receipts (ADRs)
E) Foreign stocks

Question 10

If we view P/E ratios as measures of payback, all else equal, higher earnings multipliers are better.

Question 11

Which of the following securities is eligible for a cumulative dividend?

A) Growth stock
B) Preferred stock
C) Classified stock
D) Income stock
E) Founders' stock

Question 12

Stock prices move opposite changes in cash flows expected from the stock in the future, but they move in the same direction as changes in rates of return.

Question 13

A convertibility provision gives the issuing corporation the right to call in the preferred stock for redemption.

Question 14

Which of the following provisions will call for the repurchase and retirement of a given percentage of the preferred stock each year?

A) Participation
B) Cumulative dividends
C) Sinking fund
D) Preemptive right
E) Call provision

Question 15

A common stock of a firm will have a maturity period of 10 years.

Question 16

Which of the following is included in the call provision of a preferred stock?

A) Preferred stockholders can elect the members of the board of directors and also vote on corporate issues.
B) Preferred stockholders have priority over common stockholders with regard to assets of the firm.
C) Preferred stockholders have the right to receive preferred dividends previously not paid, to be disbursed before any common stock dividends can be paid.
D) Preferred stock can be redeemed by incorporating a maturity option to a preferred stock issue.
E) Preferred stock can participate with the common stock in sharing the firm's earnings.

Question 17

According to the convertibility provision, a preferred stock can be converted into a _____.

A) common stock
B) corporate bond
C) nonvoting stock
D) cumulative stock
E) participating stock

Question 18

Which of the following is considered a hybrid security?

A) Corporate bonds
B) Preferred stock
C) Founders' shares
D) Foreign equity
E) Growth stock

Question 19

Which of the following is a feature of a preferred stock?

A) Preferred stockholders have priority over debt holders, with regard to earnings and assets of the firm.
B) Preferred stockholders can elect the members of the board of directors and also vote on corporate issues.
C) The firm has no obligation, contractual or implied, to pay preferred stock dividends.
D) Preferred stockholders have the right to receive shares of new stock issue in proportion to their current ownership holdings.
E) Preferred stockholders have a higher priority claim to distributions made by the firm than common stockholders.

Question 20

Changes in stock prices occur because investors change the rates of return they require to invest in stocks and/or the expectations about the cash flows associated with stocks change.

Question 21

Which of the following is true about a growth stock?

A) It pays a fixed amount of dividends every year.
B) It has sole voting rights but generally pays out only restricted dividends (if any) for a specified number of years.
C) It pays pay large and relatively constant dividends each year.
D) It pays cumulative dividends at the time of maturity.
E) It generally pays little or no dividends so as to retain earnings to help fund developmental opportunities.

Question 22

How can a preferred stock incorporate a maturity proviso with the preferred stock issue?

A) By including a call provision
B) By including a cumulative dividends provision
C) By including a preemptive right
D) By including a participating provision
E) By including a convertibility provision

Question 23

Which of the following is true about the payment of dividends by a firm?

A) Dividends are paid only to the bondholders of the firm
B) Common stockholders have priority over preferred stockholders with regard to dividends
C) Preferred stocks will pay accumulated dividends only once i.e. at the time of maturity
D) Growth stocks pay little or no dividends and instead retain most of their earnings each year
E) Common stockholders will receive a fixed amount of dividend every year

Question 24

Shareholders exert control of the management of the firm by:

A) running the daily operations of the firm.
B) directly replacing management with themselves.
C) buying shares in an IPO at a discounted price.
D) electing board members who can replace the management.
E) buying shares in a second firm at a substantially reduced price.

Question 25

The preferred dividend is generally stated as a percentage of the _____.

A) market value of the share
B) net sales
C) call premium
D) par value
E) sinking fund

Question 26

The common stockholders have the right to _____.

A) vote for the changes in the firm's charter
B) convert their stock into a bond
C) receive the cash distributions before the preferred stockholders
D) determine the market value of their share
E) receive cumulative dividends

Question 27

Which of the following securities can be converted into common stock?

A) Income stocks
B) Growth stocks
C) Preemptive stocks
D) Founders' shares
E) Preferred stocks

Question 28

Stock owned by the organizers of the firm who will have full voting rights is:

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

Question 29

A preferred stock can be exchanged for a certain number of shares of common stock at the _____.

A) par value
B) conversion price
C) discount rate
D) capital gain rate
E) premium price

Question 30

When will a company repurchase shares of its common stock in the financial markets?

A) The price of a firm's stock is overvalued
B) The management wants to reduce the ownership control of the firm
C) The firm has excess cash but no good investment opportunities
D) The firm has very less cash
E) The returns on the firm's stocks are generated by capital gains

Question 31

What action would the management take if it wants to gain more ownership control of the firm?

A) Issue more growth stocks
B) Solicit and get stockholders' proxies
C) Repay a portion of the loan
D) Repurchase shares of common stock
E) Pay cumulative dividends to preferred stocks

Question 32

Which of the following type of security holders are entitled to a fixed amount of dividends?

A) Income stocks
B) Growth stocks
C) Common stocks
D) Preferred stocks
E) Founders' shares

Question 33

A shareholder can transfer the right to vote to a second party, by means of an instrument known as _____.

A) arbitrage
B) allotment
C) consortium
D) rationing
E) proxy

Question 34

A protective feature on a preferred stock that requires preferred dividends previously not paid to be disbursed before any common stock dividends can be paid is called _____.

A) par value
B) voting rights
C) cumulative dividends
D) sinking fund
E) preemptive right

Question 35

What is the stockholder's minimum financial obligation in the event the corporation is liquidated and its debts are repaid?

A) Assets of the firm
B) Par value of the firm's stock
C) Earnings of the firm
D) Total liabilities of the firm
E) Market value of the firm's stock

Question 36

Scubapro Corporation currently has 500,000 shares outstanding and plans to issue 200,000 more shares in a seasoned equity offering. The current shareholders have preemptive rights on any new issue of stock by Scubapro Corporation. How many stocks would an investor with 20,000 shares, who exercises his preemptive rights on the new stock issue, have the right to buy?

A) 200,000 shares
B) 120,000 shares
C) 20,000 shares
D) 12,000 shares
E) 8,000 shares

Question 37

Which of the following is a nonvoting stock?

A) Common stock
B) Preferred stock
C) Founders' shares
D) Preemptive stock
E) Growth stock

Question 38

Stocks that produce returns that are based primarily on dividends are traditionally called _____.

A) preferred stocks
B) income stocks
C) growth stocks
D) founders' stocks
E) classified stocks

Question 39

What is the other name for par value of a preferred stock?

A) Liquidation value
B) Interest
C) Preference value
D) Cumulative value
E) Hybrid value

Question 40

The par value of common stock of a firm is $15 per share. Based on this information, determine the true statement.

A) If the share is purchased for $8, then the firm has to pay $7 per share to the stockholder, at the time of liquidation.
B) If the share is purchased for $20, then the firm has to pay an interest of $5 per share.
C) The stockholder has to pay $15 per share to the firm every year.
D) The firm pays a fixed dividend of $15 every year.
E) If the share is purchased for $10, then the stockholder has to pay $5, in case of bankruptcy.

Question 41

If the expected rate of return on a stock exceeds the required rate, it means that _____

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

Question 42

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

A) g = 0
B) g > 0
C) g < 0
D) g = rs
E) g > rs

Question 43

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 the number of shares outstanding to 25 million. 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 44

The constant growth Dividend Discount Model (DDM) may be written as _____.

A) r0 = D0/(P0 + g)
B) P0 = D0/(rs + g)
C) P0 = D0/(rs − g)
D) P0 = D1/(rs - g)
E) r0 = D0/(P0 - g)

Question 45

The P/E ratio gives an indication of _____.

A) a firm's earnings per share
B) a stock's dividend yield
C) the payback period of a stock
D) market price of a stock
E) the intrinsic value of a stock

Question 46

A share of a 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 47

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 48

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 49

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

Question 50

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) $13.33

Question 51

What is the risk of investing money in American depository receipts (ADRs)?

A) Risks associated with the corporations in which the investments are made
B) ADRs are not foreign stocks
C) Inability to take funds such as dividends out of the country
D) Risk of translation of value into domestic terms
E) Risk of translation of information into domestic terms

Question 52

Which of the following is considered as a Euro stock?

A) A German company selling stock in the United States
B) A Japanese company selling stock in Japan
C) A U.S. company selling stock in Germany
D) A German company selling stock in Japan
E) A Japanese company selling stock in the United States

Question 53

On January 1, 2016, the price of a stock is 42.50, whereas on December 31, 2016, the price of the stock is 48.78. Determine the capital gain yield of the stock.

A) 13.25%
B) 14.78%
C) 15.14%
D) 16.33%
E) 17.49%

Question 54

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) $2.81
B) $3.00
C) $4.29
D) $4.75
E) $6.13

Question 55

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

A) American depository receipts
B) Yankee stock
C) Euro stock
D) Class A stock
E) Preferred stock

Question 56

If a German company sells its stock in the United States, it is termed as _____.

A) founders' stock
B) Yankee stock
C) income stock
D) growth stock
E) Euro stock

Question 57

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

Question 58

What is the formula to calculate P/E ratio?

A) Market price per share ÷ Book value per share
B) Earnings available to common stockholders (EAC) ÷ Number of shares
C) Common dividends ÷ Number of shares
D) Market price per share ÷ Earnings per share
E) Average cost of funds × Invested capital

Question 59

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 60

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 the current price of this stock be?

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

Question 61

On January 3, 2016, the stock price of a firm was $25 and on January 4, 2016, it reduced to $19. Which of the following is a probable reason for the decrease in the stock price?

A) A boom in the economy
B) Reduction in the cost of debt
C) Increased rate of return
D) Higher future cash flows
E) Increased company's growth rate

Question 62

Which of the following is true about the P/E ratio of a firm?

A) The higher the P/E ratio, the less investors are willing to pay for each dollar earned by the firm.
B) If a firm's P/E ratio is 8, then, it would take 8 years for an investor to double his or her initial investment.
C) The appropriate value of P/E ratio is multiplied with EPS to estimate the stock price.
D) If a company's P/E ratio is too high relative to that of similar firms, its earnings have not been fully captured in the existing stock value.
E) If the firm's P/E ratio is too low relative to that of similar firms, it means that the market has overvalued its current earnings.

Question 63

Which of the following is true about the change in a stock price?

A) If investors demand higher returns to invest in stocks, then prices should increase.
B) If investors demand lower returns to invest in stocks, then prices should fall.
C) If investors demand higher returns to invest in stocks, then prices should fall.
D) If investors expect their investments to generate lower future cash flows, then prices should increase.
E) If investors expect their investments to generate higher future cash flows, then prices should fall.

Question 64

The EVA of a firm is $6.25 million and the firm has 2.78 million outstanding shares. What is the maximum amount of dividend that can be paid to shareholders?

A) $1.65
B) $2.25
C) $3.12
D) $3.89
E) $4.41

Question 65

What does a P/E ratio of 10 indicate?

A) It would take 10 years for an investor to recover his or her initial investment.
B) The firm will pay a dividend of $10 per share.
C) The value of the stock will be 10 times the initial investment at the time of maturity.
D) A stock's value will increase by 10 percent every year.
E) An investor would receive 10 percent of the total earnings of the firm, at the time of liquidation.

Question 66

In the EVA equation, the _____ is subtracted from the after-tax operating income to determine the economic value added.

A) marginal tax
B) operating cash flows
C) current intrinsic value
D) average cost of funds
E) total capital invested

Question 67

The current expected value of a stock is $32. If investors demand a higher rate of return of 10% instead of the 8% rate of return, what will the impact on the stock price of the firm be?

A) The stock price will increase by 10%.
B) The stock price will not be affected by the change in the rate of return.
C) The stock price will increase to $35.
D) The stock price will reduce to zero.
E) The stock price will decrease.

Question 68

What does a decrease in the value of a firm's after-tax operating income by the costs associated with both its debt and its equity indicate?

A) Price earnings ratio of the firm
B) Expected capital gains yield of the firm
C) Intrinsic value of stock of the firm
D) Nonconstant growth of stock of the firm
E) Change in the firm's economic value

Question 69

Considering the economic value added (EVA) of a firm, which of the following should increase the firm's value?

A) EVA = 0
B) EVA > 0
C) EVA < 0
D) EVA > EPS
E) P/E ratio > EVA

Question 70

A firm has an EBIT of $22 million, total invested capital of $74 million, and the average cost of funds of 12%. The firm has a marginal tax rate of 35% and 4.2 million shares of the firm are outstanding. What is the EVA of the firm?

A) $4.83 million
B) $5.42 million
C) $6.33 million
D) 3.61 million
E) $7.97 million