Deck 9: The Valuation of Common Stock

Question 1

The dividend-growth model requires that dividends grow annually at the same rate.

Answer 1

False

Question 2

Short-term capital gains and long-term capital gains are taxed at the same rate.

Answer 2

False

Question 3

Past dividend payments have little,if any,impact on a stock's current price.

Answer 3

True

Question 4

Commissions on stock purchases and sales argue for dividends and not capital gains.

Question 5

If a firm operates at a loss,its retained earnings are decreased.

Question 6

Cumulative voting gives more power to minority stockholders.

Question 7

Some firms have more than one class of common stock.

Question 8

Corporate retained earnings are taxed on the individual investor's federal income form.

Question 9

The dividend-growth valuation model depends on dividends and the required rate of return.

Question 10

If a firm retains earnings,total equity increases.

Question 11

Both corporate earnings and cash dividends received by stockholders are taxed by the federal government.

Question 12

The relationship between a firm and its state of incorporation is specified in the bylaws.

Question 13

Most stockholders of publicly held stock have pre-emptive rights.

Question 14

Increases in the market value of a stock generate capital gains when the stock is sold.

Question 15

If the anticipated return exceeds the required rate of return,the investor should buy the stock.

Question 16

The expected return depends on future dividends and future price appreciation.

Question 17

The dividend-growth model includes both the current and past years' dividends.

Question 18

Stockholders in a publicly held corporation have limited liability.

Question 19

Because capital gains are not taxed,most investors discourage the distribution of dividends.

Question 20

Most stockholders have cumulative voting rights.

Question 21

The price to sales ratio is useful even if a firm is operating at a loss,since the P/E ratio cannot be computed.

Question 22

One anomaly to the efficient market hypothesis is that investments in debt of large firms will earn higher returns than investments in their stock.

Question 23

The efficient market hypothesis suggests that the current prices of stocks reflect what the investment community believes the stocks are worth.

Question 24

The required rate of return includes the risk-free rate and a risk premium.

Question 25

Investing in stocks purchased by insiders may generate superior investment results,which is inconsistent with the strong form of the efficient market hypothesis.

Question 26

Value investors tend to prefer stocks with low price to sales and price to book ratios.

Question 27

Since many start-up firms operate at a loss,a financial analyst may use cash flow as an alternative to earnings.

Question 28

The efficient market suggests that,over a period of time,the investor should earn a return that is consistent with the amount of risk the investor bears.

Question 29

U.S.securities markets are efficient in part because these markets are very competitive.

Question 30

Securities prices tend to adjust slowly as new information is disseminated in an inefficient market.

Question 31

The efficient market hypothesis says that no one can outperform the market.

Question 32

An increase in the risk-free rate will tend to decrease stock prices.

Question 33

Stockholders generally have which of the following rights?
1)right to vote
2)right to share in the firm's earnings
3)right to sell the stock

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices

Question 34

If securities markets were inefficient,prices would tend to adjust more slowly.

Question 35

The tendency for securities prices to overreact may create an anomaly that can lead to superior returns.

Question 36

According to the efficient market hypothesis,purchasing high P/E stock should not produce superior investment results.

Question 37

A higher beta decreases the required rate of return.

Question 38

Advantages of the corporate form of business include

A) limited liability for stockholders
B) avoidance of state taxation
C) limited life
D) deductibility of dividends

Question 39

Empirical evidence tends to support the weak and semi-strong forms of the efficient market hypothesis.

Question 40

High P/E stocks should be preferred because they pay larger dividends.

Question 41

The use of price to book ratios to select stocks suggests that

A) high price to book stocks should be purchased
B) low price to book stocks are overvalued
C) a stock should be purchased if it is selling near its historic high price to book ratio
D) a stock should be purchased if it is selling near its historic low price to book ratio

Question 42

Use of P/E ratios will not produce superior investment results according to the

A) weak form of the efficient market hypothesis
B) semi-strong form of the efficient market hypothesis
C) strong form of the efficient market hypothesis
D) all forms of the efficient market hypothesis

Question 43

The efficient market hypothesis requires
1)financial markets to be competitive
2)prices to adjust rapidly
3)prices of undervalued securities to fall

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices

Question 44

The use of P/E ratios to select stocks suggests that

A) high P/E stocks should be purchased
B) low P/E ratio stocks are overvalued
C) a stock should be purchased if it is selling near its historic low P/E
D) a stock should be purchased if it is selling near its historic high P/E

Question 45

The strong form of the efficient market hypothesis suggests
1)inside information will not lead to superior investment results
2)inside information will lead to superior investment results
3)studying financial statements will not lead to superior investment results
4)studying financial statements will lead to superior investment results

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 46

A P/E ratio depends on
1)the firm's dividends
2)the price of the stock
3)the firm's per share earnings

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices

Question 47

An implication of the efficient market hypothesis is

A) securities prices are randomly determined
B) stock prices reflect historical information
C) few investors can expect to outperform the market over a period of time
D) after adjusting for risk, money market securities offer superior returns

Question 48

The risk-adjusted required rate of return includes
1)the firm's earnings
2)the firm's beta coefficient
3)the treasury bill rate (i.e.,the risk-free rate)

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices

Question 49

Earnings are

A) retained
B) distributed
C) invested
D) retained and/or distributed

Question 50

Cumulative voting permits a stockholder to

A) collect extra dividends
B) vote all the shares for one individual
C) cast the total number of votes for one individual
D) vote by proxy

Question 51

If the financial markets were not efficient,

A) all investors would profit
B) prices indicate the proper valuation of securities
C) prices would adjust rapidly
D) an investor may consistently outperform the market

Question 52

According to the dividend-growth model,the valuation of common stock depends on
1)the firm's dividends
2)investors' required rate of return
3)the prior year's dividends

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of these choices

Question 53

Which of the following is not an example of an anomaly to the efficient market hypothesis?

A) the January effect
B) the small firm effect
C) insider purchases and sales
D) high beta stocks

Question 54

The price to sales ratio may be a preferred analytical tool if

A) the firm is not generating cash
B) the firm is not generating earnings
C) the P/E ratio is too high
D) the dividend-growth model suggests the stock is undervalued

Question 55

Higher required returns

A) decrease stock prices
B) are required by the efficient market hypothesis
C) increase dividends
D) are associated with higher dividends

Question 56

A low price to sales ratio suggests

A) the firm is generating cash
B) the firm has no earnings
C) the stock valuation is too high
D) the stock may be undervalued

Question 57

A stock's price will tend to fall if
1)the firm's beta declines
2)the firm's beta increases
3)the risk-free rate declines
4)the risk-free rate increases

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 58

If the required rate of return is 10 percent and the stock pays a fixed $5 dividend,its value is

A) $100
B) $75
C) $50
D) $25

Question 59

Pre-emptive rights permit stockholders to

A) collect dividends before they are reinvested
B) participate in dividend reinvestment plans
C) maintain the proportionate share of ownership
D) vote their shares

Question 60

The weak form of the efficient market hypothesis implies

A) securities prices are randomly determined
B) studying past price behavior will lead to inferior investment decisions
C) past securities prices predict future security prices
D) studying past price behavior does not lead to superior investment decisions

Question 61

Your broker recommends that you purchase XYZ Inc.at $60.The stock pays a $2.40 dividend which (like its per share earnings)is expected to grow annually at 8 percent.If you want to earn 12 percent on your funds,is this a good buy?

Question 62

Investors may use P/E ratios and price/sales ratios to value stocks.If this analysis is used,which of the following is desirable?

A) a high P/E and a low price/sales ratio
B) a high P/E and a high price/sales ratio
C) a low P/E and a low price/sales ratio
D) a low P/E and a high price/sales ratio

Question 63

The risk-free rate of return is 8 percent; the expected rate of return on the market is 12 percent.Stock X has a beta coefficient of 1.3,an earnings and dividend-growth rate of 7 percent,and a current dividend of $2.40.If the stock is selling for $35,what should you do?

Question 64

Two stocks each pay a $1 dividend that is growing annually at 8 percent.Stock A has a beta of 1.3; stock B's beta is 0.8.
a.Which stock is more volatile?

b.If treasury bills yield 6 percent and you expect the market to rise by 12 percent,what is your risk-adjusted required rate of return?

c.Using the dividend-growth model,what is the maximum amount you would be willing to pay for each stock?

d.Why are your valuations different?

Question 65

Presently,Stock A pays a dividend of $2.00 a share,and you expect the dividend to grow rapidly for the next four years at 20 percent.Thus the dividend payments will be
After this initial period of super-growth,the rate of increase in the dividend should decline to 8 percent.If you want to earn 12 percent on investments in common stock,what is the maximum you should pay for this stock?

Question 66

As an investor you have a required rate of return of 14 percent for investments in risky stocks.You have analyzed three risky firms and must decide which (if any)to purchase.Your information is

a.What is the maximum price? Which (if any)should you buy?
b.If you bought Stock A,what is your implied rate of return?
c.If your required rate of return were 10 percent,what should be the price necessary to induce you to buy Stock A?

Question 67

If you purchase TrisCorp stock at $71 a share and the firm pays a $5.20 dividend which is expected to grow at 7.5 percent,what is the implied annual rate of return on the investment?

Question 68

You know the following concerning a common stock:
If you want to earn 10 percent,should you buy this stock? What is the maximum price you should be willing to pay for the stock?

Question 69

If the ratio of price to book exceeds 1.0,

A) the stock is overvalued
B) the firm's assets are understated
C) the price of the stock is greater than the accounting value of the firm
D) the accounting value of the firm is greater than the market value of the firm