Deck 7: Stocks Equity Characteristics and Valuation

Question 1

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

A)Debenture bonds
B)Preferred stock
C)Classified stock
D)Common stock
E)Founders' stock

Answer 1

  B

Question 2

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

Answer 2

  A

Question 3

If a firm wants to be able to redeem some of its preferred stock at some date after issue, it must _____. 

A)pay accumulated dividends to the common stockholders
B)issue the stock at par value at the time of issue
C)incorporate a call provision in the preferred stock issue
D)provide voting rights to preferred stockholders
E)include a preemptive right in the preferred stock issue

Answer 3

  C

Question 4

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

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

Question 5

Which of the following provisions/features allows the firm to repurchase and retire a given percentage of its preferred stock each year?

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

Question 6

A convertible 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 7

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

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

Question 8

If a preferred stock issue has a conversion feature, the stock can be converted into _____. 

A)common stock
B)corporate bonds
C)bonds with voting rights
D)cumulative stock
E)founders stock

Question 9

Which of the following types of stock generally pays a fixed amount of dividends each year?

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

Question 10

Which of the following is true of the call provision found in preferred stocks?

A)The call provision gives preferred stockholders the right to both elect the members of the board of directors and call for votes on corporate issues.
B)The call provision gives preferred stockholders priority over common stockholders with regard to ownership of the assets of the firm.
C)The call provision gives preferred stockholders the right to receive preferred dividends that were not paid in previous years before any common stock dividends can be paid.
D)The call provision gives the issuing firm right to redeem its preferred stock by incorporating a maturity option in the issue.
E)The call provision gives preferred stock the right to participate with the common stock in a firm's earnings.

Question 11

Which of the following securities has the highest priority with regard to the distribution of both earnings and proceeds from the liquidation of assets of a firm?

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

Question 12

Which of the following types of securities is referred to as a hybrid security?

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

Question 13

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

A)Issue more growth stocks
B)Issue more common stock to the public
C)Repay portions of its loans
D)Repurchase shares of common stock
E)Pay cumulative dividends to preferred stocks

Question 14

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

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

Question 15

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

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

Question 16

Which of the following is true about a growth stock?

A)It pays a fixed amount of dividends every year.
B)It has voting rights and generally pays a fixed amount of interest each year until maturity.
C)It pays 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 because the firm retains most of its earnings to fund developmental opportunities.

Question 17

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 dividend payments.
C)Preferred stocks pay accumulated dividends only once i.e. at the time of maturity.
D)Growth stocks pay little or no dividends; rather, the firms retain most of their earnings each year to reinvest in assets.
E)Common stockholders generally receive a fixed amount of dividend every year.

Question 18

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

A)Preferred stockholders have priority over debt holders, with regard to the distribution of 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 generally pays different amounts of preferred stock dividends each year.
D)Preferred stockholders have the right to receive shares of any new common stock issues 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 19

A firm most likely will repurchase shares of its common stock in the financial markets when _______. 

A)the price of the firm's stock is overvalued
B)management wants to increase the ownership control of the outside investors
C)the firm has a large amount of cash and a number of good investment opportunities that will grow the firm
D)common stockholders are the last to receive proceeds from liquidation
E)the returns on the firm's stock is generated by solely by capital gains

Question 20

How can a firm effectively incorporate a maturity provision within a 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 voting provision

Question 21

A firm has 1,000 shares of common stock outstanding with a par value of $15 per share. Upon liquidation, the firm has insufficient funds and requires an additional $5,000 to repay its creditors. Which of the following statements is true about the common shareholders' financial obligation?

A)If the share is purchased for $8, the stockholders are obligated to pay $2 per share to the creditors.
B)If the share is purchased for $20, the stockholders are obligated to pay interest equal to $15 per share to the firm.
C)If the share is purchased for $15, the stockholders are obligated to pay $15 per share to the bondholders.
D)If the share is purchased for $18, the stockholders are obligated to pay a dividend of $3 per share to the firm.
E)If the share is purchased for $10, the stockholders are obligated to contribute $5 per share to the firm.

Question 22

Which of the following represents the minimum legal financial obligation of a common stockholder if a firm is liquidated and additional funds are needed to repay its debt?

A)The redemption value of the common stock
B)The par value of the common stock
C)The earnings per share of the common stock
D)The interest obligation per share of the common stock
E)The market value per share of the common stock

Question 23

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

A)market value per share
B)earnings per share
C)call premium per share
D)per share par value
E)sinking fund

Question 24

Excluding stocks traded in the United States, a stock that is traded in a country other than the issuing company's home country is called a ________. 

A)Class B stock
B)Yankee stock
C)Euro stock
D)Global classified equity
E)Preferred stock

Question 25

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

Question 26

Which of the following stocks is a nonvoting stock and is referred to as hybrid stock?

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

Question 27

_____ have sole voting rights, are owned by the persons who started the company, and generally pay only restricted dividends (if any) for a specified number of years. 

A)Preferred shares
B)Ordinary common shares
C)Founders' shares
D)Convertible shares
E)Retained shares

Question 28

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

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

Question 29

A shareholder can transfer the right to vote to another person by means of an instrument known as _____. 

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

Question 30

Certificates that represent ownership in stocks of foreign companies and are held in trusts at banks located in the countries where the stocks are traded are called _____. 

A)certificates of ownership
B)foreign stock funds
C)Samurai mutual funds
D)American depository receipts
E)Euro stocks

Question 31

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)3.7%
D)4.2%
E)13.3%

Question 32

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 as the project is riskier than average, the firm's required return on stock will increase to 13.5 percent. Using the constant growth dividend discount 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 33

Which of the following is true of founders' shares?

A)Founders' shares are certificates that represent ownership in stocks of foreign companies held in trust by the bank that created the founders' shares.
B)The terms founders' shares and Euro stocks are used interchangeably.
C)Founders' shares are stocks owned by the creators of a company that have sole voting rights but generally pay out only restricted (if any) dividends for a specified number of years.
D)Founders' shares are issued by foreign companies and traded in the United States.
E)With the exception of shares traded in the United States, any shares that are traded in a country other than the issuing company's home country are called founders' shares.

Question 34

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

A)the stock is experiencing an abnormal growth pattern.
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 35

Which of the following is true of common stock?

A)Common stock is often referred to as a hybrid security.
B)Common stock often contains some of the same characteristics as bonds.
C)Most common stock traditionally pays a constant income called interest.
D)A firm can be forced into bankruptcy if it misses common stock dividend payments.
E)Dividends must be paid on preferred stock before they can be paid on common stock.

Question 36

Common shareholders can exert control of the management of the firm by:

A)requiring the firm to unionize.
B)directly replacing management with themselves.
C)buying shares in an initial public offering (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 37

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 38

Common stockholders have the right to _____. 

A)vote for the changes in a firm's charter
B)convert their stock into bonds
C)receive the cash distributions before preferred stockholders
D)receive the par value of shares on liquidation
E)receive cumulative dividends

Question 39

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

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

Question 40

Which of the following is true of American depository receipts?

A)With the exception of stocks traded in the United States, stocks that are traded in a country other than the issuing company's home country are called American depository receipts.
B)American depository receipts are pools of stocks of different American companies issued by foreign companies that are traded in international stock markets.
C)An American depository receipt is the stock of an American company that is traded in foreign countries.
D)If a Japanese company sells its stocks in the United States, the transaction is termed an American depository receipt.
E)American depository receipts provide U.S. investors with the ability to invest in foreign companies with less complexity and difficulty than might otherwise be possible.

Question 41

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? (Round intermediate calculations to two decimal places.)

A)$39.38
B)$22.49
C)$58.15
D)$63.00
E)$43.96

Question 42

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 (D0) on this stock?

A)$2.00
B)$3.00
C)$4.00
D)$3.30
E)$6.00

Question 43

The price-earnings (P/E) ratio gives an indication of _____. 

A)a firm's debt position
B)a stock's dividend yield
C)the payback period of a stock
D)the par value of a stock
E)the maturity value of a stock

Question 44

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

A)The stock price will increase by 10 percent.
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 as a result of the higher rate of return demanded by investors.

Question 45

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 46

On January 1 of the current year, the price of a stock is $42.50, whereas on December 31 of the current year, 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 47

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

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

Question 48

The constant growth dividend discount model (DDM) may be written as _____. 

A) $\hat { \mathrm { r } } _ { 0 } = \mathrm { \hat D } _ { 0 } / \left( \mathrm { P } _ { 0 } + \mathrm { g } \right)$
B) $\hat { \mathrm { P } } _ { 0 } = \hat { \mathrm { D } } _ { 0 } / \left( \mathrm { r } _ { \mathrm { s } } + \mathrm { g } \right)$
C) $\hat { \mathrm { P } } _ { 0 } = \widehat { \mathrm { D} } _ { 0 } / \left( \mathrm { r } _ { s } - \mathrm { g } \right)$
D) $\hat { \mathrm { P } } _ { 0 } = \hat { \mathrm { D } } _ { 1 } / \left( \mathrm { r } _ { \mathrm { s } } - \mathrm { g } \right)$
E) $\hat { \mathrm { r } } _ { 0 } = \hat { \mathrm { D } } _ { 0 } / \left( \mathrm { P } _ { 0 } - \mathrm { g } \right)$

Question 49

Assume that a firm distributes all of its earnings as dividends. Which of the following is indicated by a price-earnings (P/E) ratio of 10?

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)The 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 50

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)$38.00
B)$40.00
C)$45.00
D)$44.00
E)$50.00

Question 51

A firm has earnings before interest and taxes (EBIT) of $22 million, total invested capital of $74 million, and average cost of funds of 12 percent. The firm has a marginal tax rate of 35 percent, and 4.2 million shares of the firm are outstanding. What is the firm's economic value added (EVA) of the firm?

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

Question 52

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

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

Question 53

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 the simple (not effective) annual rate of return?

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

Question 54

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 >Earnings per share (EPS)
E)Price-earnings ratio (P/E) ratio > EVA

Question 55

The economic value added (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 without threatening the firm's current value?

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

Question 56

Which of the following formulas calculates price-earnings (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 57

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 58

A share of 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)$55.00
B)$50.00
C)$60.00
D)$45.00
E)$40.00

Question 59

_____ is determined by subtracting the costs associated with both the debt and the equity that the firm uses from its after-tax operating income?

A)A firm's price earnings ratio (P/E)
B)A firm's expected capital gains yield
C)A firm's intrinsic value of stock
D)A firm's nonconstant growth of stock
E)A firm's economic value added (EVA)

Question 60

Which of the following is true about the price-earnings (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 by the earnings per share (EPS) to estimate the appropriate 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 61

American depository receipts (ADRs) are foreign stocks listed on stock exchanges located outside the country where the firms are headquartered. 

Question 62

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 63

A proxy fight is an attempt by a group to overthrow the current management team and take control of a business by soliciting stockholders' proxy votes. 

Question 64

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

Question 65

A call provision included with a sinking fund effectively adds a maturity option to a preferred stock issue. 

Question 66

A typical common stock issue has a maturity period of 10 years. 

Question 67

A firm undertakes stock repurchase only if the price of its stock is overvalued. 

Question 68

On January 3 of the current year, the per-share stock price of a firm was $25, and on January 4 of the current year, it was $19. Which of the following is a probable reason for the decrease in the stock price?

A)A boom in the economy
B)A reduction in the cost of debt
C)An increased rate of return
D)Higher future dividends
E)An increase in the firm's growth rate

Question 69

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

Question 70

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

Question 71

A common stock's par value is always equal to the market value of the stock on the last day of the fiscal year in which the stock is issued. 

Question 72

Stock prices move opposite to the changes in the dividends stockholders expect to be paid in the future, but they move in the same direction as changes in rates of return.