Deck 8: The Valuation and Characteristics of Stock

Question 1

With respect to valuation, stocks and bonds are dissimilar in that:

A) bond cash flows are known precisely while stock cash flows are estimates.
B) periodic bond interest payments form an annuity while dividends are unlikely to be constant.
C) bond cash flows are contractual commitments, stock cash flows are not.
D) All of the above

Answer 1

D

Question 2

Which of the following statements is/are correct regarding the intrinsic value of a stock?

A) The intrinsic value of a stock is the same for every well-informed investor.
B) The intrinsic value of a stock is based on forecasted cash flows.
C) The intrinsic value of a stock will change based on how long a stock is expected to be held by the investor.
D) a. and b. above are correct.
E) b. and c. above are correct.

Answer 2

B

Question 3

The market value of common stock is primarily based on:

A) the firm's future earnings.
B) book value.
C) total assets.
D) retained earnings.

Answer 3

A

Question 4

In the constant growth model, the return on a stock can be shown to be equal to the sum of the dividend yield plus the:

A) growth rate.
B) cost of capital.
C) present value yield.
D) yield-to-maturity.

Question 5

On the assumption that a share of stock will be held for two years and then sold, the formula for determining its current price is:

A) P₀ = D₀[PVF_k,0]+D₁[PVF_k,1]+D₂[PVF_k,2]+P₂[PVF_k,2].
B) P₀ = D₀[PVFA_k,0]+D₁[PVFA_k,1]+D₂[PVFA_k,2]+P₂[PVF_k,2].
C) P₀ = D₁[PVF_k,1]+D₂[PVF_k,2]+P₂[PVF_k,2].
D) P₀ = D₀[FVF_k,0]+D₁[FVF_k,1]+D₂[FVF_k,2]+P₂[FVF_k,2].

Question 6

A growth rate that exceeds the market return is called:

A) acceptable growth.
B) supernormal growth.
C) limited growth.
D) normal growth.

Question 7

The differences between stocks and bonds include which of the following?

A) Future cash flows from stocks are not guaranteed.
B) Bonds have a fixed maturity and a guaranteed repayment of principal.
C) The timing and amount of cash flows from a bond are fixed.
D) All of the above
E) None of the above

Question 8

The constant growth model, or Gordon model, is formulated as follows: $$p _ { 0 } = \frac { D _ { 0 } ( 1 + g ) } { k - g }$$ The model can be recast to focus on the expected return implied by the constant growth assumption, as follows:

A) g = [P₀(k-g)/D₀] - 1.
B) D1 = P₀(k - g).
C) k_e = D₁/(P₀ - g).
D) k_e = [D₀(1+g)/P₀]+ g.

Question 9

The considerations associated with stock valuation do not include:

A) the expected future dividend performance of the stock.
B) the estimated selling time and price of the stock.
C) the exchange on which the stock is traded.
D) the market return on stocks of that type.

Question 10

In the constant-growth model, the market return must be ____ the dividend growth rate in order for the formula price to be meaningful.

A) less than
B) equal to
C) greater than
D) proportional to

Question 11

The return on a share of stock consists of two principal yields:

A) the capital gains yield and the capital appreciation yield.
B) the dividend yield and the capital gains yield.
C) the capital gains yield and the earnings per share.
D) All of the above

Question 12

Which of the following best represents the capital gains yield on a stock held for one year?

A) (P₁ - P₀)/P₁
B) (P₁ - P₀)/P₀
C) D₁/P₀ + (P₁ - P₀)/P₁
D) D₁/P₀ + (P₁ - P₀)/P₀
E) D₁/P₁

Question 13

Using the Gordon Model, which of the following statements is most correct?

A) A stock's intrinsic value cannot be calculated if its growth rate is zero.
B) A stock's intrinsic value cannot be calculated if its growth rate is negative.
C) A stock's intrinsic value cannot be calculated unless dividend payments are assumed currently or in the future.
D) b. and c. above are correct.
E) All of the above statements are correct.

Question 14

Which of the following will preclude the use of the Gordon Model for calculating the intrinsic value of a stock?

A) The constant growth percentage is greater than the market return.
B) D₀ is unknown.
C) The constant growth percentage and the market return are very close numerically.
D) Both a. and c. above will preclude use of the Gordon model.
E) All of the above will preclude use of the Gordon model.

Question 15

Total return for a constant growth stock consists of:

A) capital gains yield.
B) dividend Yield.
C) current Yield.
D) Both a & b
E) All of the above

Question 16

Which of the following issues should be considered with respect to the accuracy of stock pricing Models?

A) Assumptions regarding growth rates are imprecise
B) Assumptions regarding market returns are difficult to make accurately.
C) The Gordon Model is only an approximation of the present value of an infinite stream of future cash flows.
D) Both a. and b. above have to be considered.
E) All of the above have to be considered.

Question 17

A company might experience two-stage growth for which of the following reasons?

A) Introduction of a new product
B) A major improvement in the economy that is expected to level out after a few years.
C) A major downturn in the economy that is expected to level out after a few years.
D) Both a. and b. above are correct
E) All of the above are correct

Question 18

Which of the following is true regarding fundamental analysis?

A) Involves research to discover everything about a firm, its business, and its industry
B) Uses data collected on the company to forecast future cash flows
C) Analysts are also referred to as chartists.
D) Both a & b
E) All of the above

Question 19

Which of the following is(are) used to develop a stock's intrinsic value?

A) Fundamental analysis
B) Assumptions about future cash flows
C) Technical analysis
D) Both a and b
E) All of the above

Question 20

Which of the following, holding all other variables constant, will cause an INCREASE in a constant growth stock's current value?

A) An increase in the growth rate
B) An increase in the market return (k)
C) An increase in the number years the stock is held
D) Both a & b
E) All of the above

Question 21

The practice that gives minority stockholders a chance to elect at least one director is called:

A) pre-emptive rights of stockholders.
B) maintaining proportionate ownership.
C) voting rights of stockholders.
D) cumulative voting.

Question 22

In widely held companies, what percentage ownership is generally enough for effective control if no one else owns more than a few percent?

A) 15%-25%
B) 50.1%
C) 30%-40%
D) 5%-10%

Question 23

The process in which a lead bank recruits other banks to share the risk of an IPO is called:

A) copywriting.
B) underwriting.
C) registration.
D) syndication.

Question 24

A seasoned equity offering refers to:

A) the sale of new shares of an existing stock.
B) the sale of new shares of a newly established corporation.
C) the sale of existing shares to finance seasonal demands.
D) an underpriced issue of new equity shares.

Question 25

Which of the following is true of the underwriting of IPOs performed by investment banks?

A) The investment bank is prohibited from profiting from the underwriting.
B) The investment bank is not responsible for reselling the purchased shares in the market.
C) The investment bank commits to buy stock from the issuing company at a fixed price.
D) The investment bank resells the underwritten stock in the market at a discounted price.

Question 26

Which of the following is true of the registration process in an IPO?

A) A prospectus is a part of the S-1 registration document.
B) Form S-1 is a registration statement filed with the Federal Reserve.
C) A prospectus is intended for distribution to the company's existing investors.
D) The registration process is overseen by the Federal Reserve.

Question 27

The process of estimating the level of investor demand and deciding on the price of a share is known as:

A) registration.
B) red herring.
C) book building.
D) retailing.

Question 28

Immediately after an IPO which of the following indicates that the lead investment bank is concerned about the stock's price?

A) The lead investment bank is purchasing shares on the open market.
B) The lead investment bank has initially overpriced the IPO.
C) The lead investment bank has used the book building process to price the IPO.
D) The lead investment bank favors retail investors instead of "insiders" of the financial system.

Question 29

A company and its investment bank decide on the price and the number of shares that will be offered in the IPO:

A) based on the trading response for its IPO Pop.
B) by estimating the expected future cash flows.
C) by estimating the level of investor demand during the road show.
D) by comparing with competitors' market capitalizations.

Question 30

It is important to acknowledge that growth or dividend pricing Models are essentially abstractions of reality and hence have serious practical limitations. The issues relating to accuracy include:

A) estimates of growth rates.
B) estimates of the market rate of interest.
C) the fact that the denominator in the Gordon model is the difference between two numbers that can be close together.
D) All of the above

Question 31

The IPO Pop is a phenomenon in which:

A) the offer is accurately priced eliminating possibilities of volatility when trading begins.
B) the IPO faces negative publicity as it is underpriced and starts trading below the market expectations.
C) the IPO is underwritten by certain investment bankers for an underwriting spread.
D) there is a rapid increase in the stock price after trading begins.

Question 32

The constant growth model is also known as the:

A) Gordon model.
B) next dividend model.
C) normal growth model.
D) both a and c above.
E) All of the above

Question 33

Markets in which information travels quickly and is immediately reflected in prices are called:

A) informed markets.
B) quick markets.
C) liquid markets.
D) efficient markets.

Question 34

Members of the general public who have expressed interest in an IPO during the road show are referred to as:

A) off market investors.
B) auction public.
C) retail investors.
D) insiders.

Question 35

Which of the following is generally true of IPO Pops?

A) Most IPO Pops don't last and the stocks usually underperform.
B) A rapid drop in price of the stock occurs when trading begins.
C) The IPOs are overpriced and are rewarding to investors from the secondary market.
D) The strategy useful only to high net worth investors.

Question 36

Which of the following has a "residual claim" on the firm's resources?

A) Common shareholders
B) Preferred shareholders
C) Bond holders
D) All of the above have a residual claim

Question 37

An initial "quiet period" begins when:

A) a company decides on the price of the stock.
B) a company files a registration statement with the SEC.
C) the SEC accepts the registration statement of a company by declaring it effective.
D) the bank allocates the IPO shares of a company among its investors.

Question 38

Common stockholders have a ____ on both income and assets of the firm.

A) preemptive right
B) residual claim
C) cumulative claim
D) proxy right
E) None of the above

Question 39

____ allow common stockholders to maintain their proportionate share of ownership.

A) Preemptive Rights
B) Cumulative Voting
C) Proxy Fights
D) Indenture Agreements

Question 40

Preemptive rights allow stockholders to:

A) purchase additional shares of stock from the issuing company at a discount.
B) sell their shares of stock back to the issuing company at any time.
C) maintain their proportionate ownership of corporations.
D) purchase preferred stock that may not be available to non-shareholders.
E) all of the above are included in the preemptive rights of a stockholder.

Question 41

Put option values ____, while call option values ____ as the relevant stock price rises.

A) fall, fall
B) fall, rise
C) rise, fall
D) rise, rise

Question 42

A call option's time premium diminishes:

A) as the underlying stock price rises.
B) as the underlying stock price falls.
C) at the point where the exercise price equals the underlying stock price.
D) as the number of months to expiration increases.

Question 43

All of the following are characteristics of preferred stock that make it similar to bonds except:

A) constant periodic payments.
B) ahead of common stock with respect to dividends.
C) no voting rights.
D) periodic payment is tax deductible to the paying company.
E) All of the above characteristics make preferred stock similar to bonds.

Question 44

The efficient market hypothesis asserts that:

A) it is virtually impossible to consistently pick stocks that perform exceptionally well because all publicly available information is immediately reflected in stock prices.
B) studying historic patterns of stock price movements will generally identify winning investments.
C) fundamental analysis performed by individuals often reveals bargains despite the fact that professionals analyze all information as soon as it becomes available.
D) All of the above

Question 45

PDQ, Inc. stock is selling for $80 today. You are expecting a dividend of $3 next year and you plan to sell the stock for $95 one year from now. Calculate the one-year return on PDQ stock.

A) 3.75%
B) 9.50%
C) 18.75%
D) 22.50%

Question 46

Which of the following is not a characteristic of a call option?

A) Fixed price
B) Right to buy
C) Right to sell
D) Specified period

Question 47

____ are contracts that give the owner a temporary right to buy an asset from the issuing firm at a fixed price.

A) Bonds
B) Futures
C) Options
D) Warrants

Question 48

You are considering the purchase of Sanders Corp., a constant growth stock. The stock paid a current price of $3.00. The next year's stock price is expected to be $3.18. If the stock is returning 15%, calculate its dividend yield.

A) 6%
B) 7%
C) 8%
D) 9%

Question 49

If three seats on the board of directors are up for election, cumulative voting on common stock allow stockholders to:

A) cast one vote per share owned for three different candidates.
B) cast up to three votes per share owned for any one candidate.
C) save votes from a prior board of directors' election and cast them in the current election.
D) cumulative voting only applies to preferred stock.
E) None of the above are true

Question 50

Employee stock options are most similar to:

A) call options.
B) put options.
C) Treasury bills.
D) warrants.

Question 51

Nearly all preferred stock comes with the right to receive all past unpaid dividends before common shareholders can receive any dividends. This right is referred to as:

A) the preference feature.
B) the liquidation preference.
C) the cumulative feature.
D) voting preference.

Question 52

Frazier Enterprises stock is selling for $45 today. You are expecting a dividend of $4 next year and a capital gains yield of 10%. Calculate the price of the stock 1-year from now.

A) $45.00
B) $49.50
C) $52.00
D) $55.50

Question 53

How is preferred stock similar to bonds?

A) Constant payment
B) Pays both principal and interest to investor
C) Fixed maturity date
D) Both a & c
E) All of the above

Question 54

The efficient market hypothesis:

A) supports the validity of technical analysis but not fundamental analysis.
B) supports the validity of fundamental analysis but not technical analysis.
C) supports the validity of both technical and fundamental analysis.
D) supports the validity of neither technical nor fundamental analysis.
E) is unrelated to the disciplines of fundamental and technical analysis.

Question 55

Rights that allow stockholders to maintain their proportionate ownership of a corporation are called:

A) proportionate rights.
B) cumulative rights.
C) preemptive rights.
D) Both a and b above
E) All of the above

Question 56

Which of the following concepts is NOT associated with preferred stock?

A) A Fixed Dividend
B) Dividend Growth
C) Dividend Yield
D) Both b & c
E) All of the above

Question 57

Total return for preferred stock consists of:

A) capital gains yield.
B) dividend yield.
C) dividend yield and the present dividend.
D) capital gains yield and dividend yield.

Question 58

Preferred stock is:

A) preferred over common stock with regard to its claim on assets if the firm fails.
B) preferred over common stock with regard to its claim on income for dividend payment.
C) preferred over common stock with regard to voting rights.
D) a and b

Question 59

TOYS4U stock is selling for $70 today. Similar stocks return 15%. You have estimated a capital gains yield of 10%. Calculate the next dividend expected on the stock.

A) $2.00
B) $2.50
C) $3.00
D) $3.50

Question 60

Common stockholders:

A) have a residual claim on both income and assets.
B) are last in line in the event of bankruptcy.
C) have a higher claim on assets than preferred stockholders.
D) Both a & b
E) All of the above

Question 61

A stock just paid a $2.00 dividend that is anticipated to grow at 6% indefinitely. Similar stocks are returning about 13%. The estimated selling price of this stock is:

A) $30.29.
B) $15.38.
C) $16.31.
D) $28.57.

Question 62

You are considering investing in ABC, Inc.'s stock which is selling at $45.95. Similar stocks return 16%. ABC's last dividend ABC was $4.50 and a 6% constant growth rate is anticipated. Should you purchase ABC, Inc.?

A) No, because the stock is overpriced by $1.75.
B) No, because the stock is overpriced by $3.85.
C) Yes, because the stock is underpriced by $1.75.
D) Yes, because the stock is underpriced by $3.85.

Question 63

The last dividend paid by Abbot Labs was $1.00. Abbot's growth rate is expected to be a constant 8% for three years, after which the growth rate is expected to be 10%. Investors require a return of 16% on stocks like Abbot. What should the price of Abbot's stock be?

A) $15.36
B) $16.36
C) $17.00
D) $17.40
E) $18.40

Question 64

The price of a share of stock today is $50.00, and the projected selling price in one year is $55.00. The estimated dividend during the year is $1.00. The expected return on the stock is:

A) 12.00%.
B) 2.00%.
C) 10.91%.
D) 10.00%.

Question 65

Assume a dividend today of $2.50 with anticipated growth over the next three years of 10%. The estimated dividend at the third year is:

A) $3.25.
B) $3.28.
C) $3.33.
D) None of the above

Question 66

Fast Wheels, Inc. expects to pay an annual dividend of $0.72 next year. Dividends have been growing at a compound annual rate of 6 percent and are expected to continue growing at that rate. What is the value of a share of Fast Wheels if similar stocks return 14 percent?

A) $9.00
B) $5.14
C) $9.54
D) none of the above

Question 67

The current price of Zebar is $32.00 and its last dividend was $.60. What is its return if dividends are expected to grow indefinitely at 8 percent?

A) 9.88%
B) 11.38%
C) 18.75%
D) None of the above

Question 68

What is the value of a share of Henley Inc. to an investor who requires a 12 percent rate of return if Henley's last dividend was $1.20? Assume earnings and dividends are expected to grow indefinitely at a rate of 7% per year.

A) $24.00
B) $18.34
C) $25.68
D) None of the above

Question 69

A share of stock is currently selling for $20.80. If the dividend just paid is $2.00 and investors are seeking a 14% return, what is the anticipated rate of constant growth?

A) 1%
B) 4%
C) 0%
D) None of the above

Question 70

A share of stock is currently selling for $31.80. If the anticipated constant growth rate for dividends is 6% and investors are seeking a 16% return, what is the dividend just paid?

A) $1.91
B) $3.18
C) $3.00
D) $5.09

Question 71

A stock just paid an annual dividend of $2.00, which is expected to remain constant indefinitely. The market return is 14%. The estimated selling price of the stock is:

A) $1.76.
B) $14.29.
C) $10.43.
D) None of the above

Question 72

Toys-r-Cool Inc.'s constant growth stock's last dividend was $1.50. It is selling for $30.20 in a market in which similar stocks return 12%. Calculate the stock's anticipated growth rate.

A) 6.7%
B) 8.7%
C) 10.9%
D) 12%

Question 73

Analysts expect a stock to be selling for $22 in one year. It is also expected to pay a $1 dividend during the year. If you require a 15% return on this kind of investment, what is the most you can pay for the stock today?

A) $21.00
B) $18.70
C) $20.00
D) None of the above

Question 74

Berg Inc. has just paid a dividend of $2.00, and is now selling for $48 per share. Similar stocks generally earn a 12.5% return. Assuming that Berg Inc. is a constant growth stock, what is its expected rate of growth?

A) 5.0%
B) 6.0%
C) 7.0%
D) 8.0%
E) 9.0%

Question 75

You are considering purchasing a share of Cass Inc. stock today for $75.00. You forecast no dividend payment this year but two years from today, you expect a $10 dividend. You plan to sell the stock immediately after receiving the dividend. If you want a return of 15% on the investment, how much must your forecast of the stock price be two years from today?

A) $ 89.19
B) $ 92.57
C) $ 99.19
D) $102.57
E) $112.57

Question 76

You are considering investing in B & B, Inc.'s stock and your broker has told you that you can purchase it for $72. You require a return 12% for this type of investment. The last dividend (D₀) that B & B paid was $4 and a 6% constant growth rate is anticipated. Should you purchase B & B, Inc.?

A) No, because the stock is overpriced by $1.33.
B) No, because the stock is overpriced by $3.33.
C) Yes, because the stock is underpriced by $1.33.
D) Yes, because the stock is underpriced by $3.33.

Question 77

A stock is selling for $20.00 (P₀). The projected selling price one year from now (P₁) is $22.50, and the projected dividend payment one year from now (D₁) is $1.00. What is the expected return on an investment in the stock made today?

A) 12.50%
B) 5.00%
C) 15.56%
D) 17.50%

Question 78

The price of a share of stock today is $25.00. If the return on the share is estimated at 18% and the stock generally pays a dividend of $1 per year, what is its projected selling price in one year?

A) $22.30
B) $30.00
C) $28.50
D) $29.50

Question 79

Sharbaugh Inc.'s most recent dividend was $2.00 per share. The dividend is expected to grow at a rate of 4% per year for the foreseeable future. If the market return is 13% on investments with comparable risk, what should the stock sell for today?

A) $16.00
B) $22.22
C) $23.11
D) $50.00
E) $52.00

Question 80

Charlie Company is expected to grow at an annual rate of 6% indefinitely. The return on similar stocks is currently 11%. Charlie's board of directors declared a dividend of $1.85 yesterday. What should a share of Charlie Company sell for?

A) $39.22
B) $37.00
C) $16.82
D) $17.83