11
2) Cumulative voting is advantageous to minority shareholders because it may allow them to elect a
member of the board of directors.
Keywords: Cumulative Voting, Minority Shareholders
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
3) Shareholders, as owners of the corporation, face unlimited liability for the corporation’s debts, while
bondholders, as creditors, may only lose the value of their investment if the company goes bankrupt.
Keywords: Shareholders, Creditors, Limited Liability
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
4) Common stock cannot be worth less than its book value.
Keywords: Common Stock, Book Value
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
5) Convertibility is a common feature of common stock; it allows the common stockholders to convert
their common shares into preferred shares or into bonds.
Keywords: Convertibility
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
6) Common stock does not mature.
Keywords: Common Stock, Maturity Date
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
7) Bondholders and preferred stockholders can be viewed as creditors, whereas the common stockholders
are the true owners of the firm.
Keywords: Common Stock, Preferred Stock, Bonds
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
12
8) If a common stockholder cannot personally attend the meeting of shareholders, then their votes are
lost.
Keywords: Voting Rights, Common Stock
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
9) Under cumulative voting, a 10% shareholder will likely be able to elect 10% of the board of directors.
Keywords: Cumulative Voting, Board of Directors
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
10) Under majority voting, a majority (>50%) shareholder will just be able to elect a simple majority of the
board of directors.
Keywords: Majority Voting, Board of Directors
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
11) Under majority voting, a majority (>50%) shareholder will be able to elect the entire board of
directors.
Keywords: Majority Voting, Board of Directors
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
12) In theory, shareholders select the board of directors, but in reality, management effectively selects the
directors.
Keywords: Board of Directors, Agency Problems
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
13) Limited liability for a corporation’s common shareholders is a protective provision that aids the
corporation in raising funds.
Keywords: Limited Liability
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
13
14) If a shareholder cannot attend the corporation‘s annual meeting, the shares may still be voted using
A) the preemptive right.
B) a proxy.
C) majority voting rules.
D) the cumulative voting right.
Keywords: Proxy
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
15) Minority shareholders have a greater chance of electing a member to the board of directors if the
company uses
A) cumulative voting.
B) majority voting.
C) minority voting.
D) proxy voting.
Keywords: Cumulative Voting
Learning Obj.: L.O. 8.3
AACSB: Analytical Thinking
16) Which of the following is NOT true regarding common stock?
A) Dividends, unlike interest payments, are not tax deductible.
B) Common stock, unlike bond principal, does not mature.
C) Common stockholders are owners of the firm, whereas bondholders are creditors.
D) Dividend payments, like interest payments, are fixed.
Keywords: Common Stock, Dividends
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
17) Consider the following four types of payments that could be made by a normal operating firm:
interest, common dividends, income taxes, and preferred dividends. Compared to the other payments
mentioned, where would you rank common dividend payments in terms of the order of payment if the
firm is liquidating?
A) first
B) second
C) third
D) fourth
Keywords: Common Stock Dividends
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
14
18) Assume that a firm had such serious financial problems that it was about to be liquidated after a
bankruptcy. All of the firm’s assets are about to be sold in order to pay the following claims against the
firm: bondholders, preferred stockholders, common stockholders, and federal income taxes. Of the claims
mentioned, what priority would common stockholders have?
A) first
B) second
C) third
D) fourth
Keywords: Common Stock Claims, Liquidation
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
19) What provision entitles the common shareholder to maintain a proportionate share of ownership in a
firm?
A) the cumulative feature
B) the convertible feature
C) the proportionality clause
D) the preemptive right
Keywords: Preemptive Right, Common Stock
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
20) Which of the following features, or benefits, belong to a firm’s common stockholders?
A) limited liability
B) ownership of the firm
C) voting rights
D) all of the above
Keywords: Common Stock, Limited Liability, Voting Rights
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
21) Who bears the greatest risk of loss of value if a firm should fail?
A) bondholders
B) preferred stockholders
C) common stockholders
D) All of the above bear equal risk of loss.
Answer: C
Diff: 1 Page Ref: 276
Keywords: Claims on Assets, Bankruptcy, Risk
Learning Obj.: L.O. 8.3
AACSB: Reflective Thinking
15
Copyright © 2017 Pearson Education, Inc.
Learning Objective 8.4
1) The most relevant form of growth for valuing a firm’s common stock is internal growth.
Keywords: Common Stock Valuation, Internal Growth
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
2) Because common stock represents a residual interest in the corporation, the value of common stock is
equal to the total firm value less the firm‘s outstanding debt.
Keywords: Common Stock Valuation, Enterprise Value, Residual Interest
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
3) If the expected growth rate for dividends is zero, then the value of common stock will be equal to the
current dividend.
Keywords: Constant Growth Dividend Valuation Model
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
4) A common stock with an expected dividend growth rate of zero would be valued in the same way as
preferred stock, that is, the expected dividend divided by the required return.
Keywords: Preferred Stock, Constant Growth Dividend Valuation Model
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
5) In general, common stock and preferred stock are both valued by calculating the present value of all
expected future cash flows, using the required return as the discount rate.
Keywords: Common Stock, Preferred Stock, Valuation, Present Value, Required Return
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
6) The stock valuation model D1/(rcs – g) requires the stock to grow at a rate greater than the required
return; otherwise, the stock is worthless.
Keywords: Constant Growth Common Stock Valuation Model
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
16
7) The retention ratio is equal to 1 minus the dividend payout ratio.
Keywords: Retention Ratio, Dividend Payout Ratio
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
8) A firm can increase the growth rate of common stockholders’ investment in the firm by retaining more
earnings or increasing return on equity.
Keywords: Growth Rate, Common Stock, Retained Earnings, Return on Equity
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
9) Common stock valuation can be based on the present value of future dividends or alternatively on the
present value of the firm’s future quarterly net income.
Keywords: Common Stock, Valuation, Dividends, Net Income
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
10) The change in the value of a corporation’s common stock as the result of growth is the same
regardless of whether the growth is the result of internal growth or the infusion of new capital.
Keywords: Dividend Valuation Model, Internal Growth
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
11) Historically, price appreciation, or capital gains yield, has accounted for a greater portion of returns
on common stocks than dividend payments.
Keywords: Dividends, Returns on Common Stock, Price Appreciation
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
12) Common stockholders demand a return on the price paid for their common stock, but since retained
earnings on the balance sheet are merely “on paper” they do not require a return on earnings that have
been retained.
Keywords: Required Return, Retained Earnings
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
17
13) The common stock of a constant-growth firm is valued in the same manner as its preferred stock.
Keywords: Constant Growth Common Stock Valuation Model, Preferred Stock
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
14) Asymmetric Frames Corp. had a return on equity of 15%. The corporation’s earnings per share was
$6.00, its dividend payout ratio was 40% and its profit–retention rate was 60%. If these relationships
continue, what will be United Financial Corp.’s internal growth rate?
A) 6.0%
B) 8.6%
C) 9.0%
D) 15.6%
Keywords: Internal Growth Rate, Profit-Retention Rate
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
15) ACME, Inc. expects its current annual $2.50 per share common stock dividend to remain the same for
the foreseeable future. Therefore, the value of the stock to an investor with a required return of 12% is
A) $3.00.
B) $18.33.
C) $20.83.
D) $30.00.
Keywords: Constant Growth Dividend Valuation Model
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
16) Which of the following changes will make the value of a stock go up, other things being held
constant?
A) The required return decreases.
B) The required return increases.
C) In general, investors become more risk averse.
D) The growth rate of dividends decreases.
Keywords: Risk-Return Trade-off, Required Return, Stock Valuation
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
18
17) If two firms have the same current dividend and the same expected growth rate, their stocks must sell
at the same current price or else the market will not be in equilibrium.
A) false, because the required return could be different
B) true, because we are using a dividend valuation model
C) true, if markets are semi-strong form efficient
D) true, if investors are risk-averse
Keywords: Dividend, Growth Rate, Stock Valuation
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
18) You are considering the purchase of a common stock that paid a dividend of $2.00 yesterday. You
expect this stock to have a growth rate of 15 percent for the next 3 years, resulting in dividends of
D1 = $2.30, D2 = $2.645, and D3 = $3.04. The long-run normal growth rate after year 3 is expected to be
10 percent (that is, a constant growth rate after year 3 of 10% per year forever). If you require a 14 percent
rate of return, how much should you be willing to pay for this stock?
A) $89.75
B) $83.65
C) $56.46
D) $62.57
Keywords: Constant Growth, Stock Valuation
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
19) Which of the following statements concerning the required rate of return on stocks is true?
A) The higher an investor‘s required rate of return, the higher the value of the stock.
B) If risk is reduced, the required return will decrease because more investors are risk-averse.
C) The required return on preferred stock is generally higher than the required return on common stock.
D) The higher the risk, the higher the required return, other things being equal.
Keywords: Required Return, Risk, Stock Valuation
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
20) Which of the following statements concerning the constant growth dividend valuation model is true?
A) The required rate of return must exceed the growth rate.
B) The dividend growth rate must be bigger than 8%.
C) The growth rate must increase every year.
D) The required rate of return must be equal to the growth rate for dividends.
Keywords: Required Return, Constant Growth Dividend Valuation Model
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
19
21) A small biotechnology research corporation has been experiencing losses for the first three years of its
existence, and thus has a negative balance in retained earnings. The corporation’s stock price, however, is
$1 per share. Which of the following statements is MOST correct?
A) Investors are irrational to pay $1 per share when earnings per share have been negative for three
years.
B) Investors believe the stock is worth $1 per share because future earnings (and cash flows) are expected
to be positive.
C) The corporation’s accountants must have made a mistake because retained earnings may not be
negative.
D) The required return on the stock will be small because the company has very few assets.
Keywords: Required Return, Retained Earnings
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
22) A small company struggling to reach profitability just announced a major new government contract
that will validate its technology and generate revenue for the next several years. The announcement of
the contract will
A) cause the stock price to increase because rcs (the required return) is likely to increase.
B) cause the stock price to decrease because the government usually pays below market price for the
goods and services it purchases.
C) cause the stock price to increase because rcs (the required return) is likely to decrease and g (the
growth rate in future dividends) is likely to increase.
D) have no effect on the stock price because the company has not yet paid any dividends.
Keywords: Required Return, Growth Rate, Stock Valuation
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
23) Using the constant growth dividend valuation model and assuming dividends will growth a constant
rate forever, the increase in the value of the stock each year should be equal to the
A) growth rate in dividends, g.
B) required return on the stock, rcs.
C) dividend yield plus the capital gains yield.
D) dividend yield.
Keywords: Constant Growth Dividend Valuation Model
Learning Obj.: L.O. 8.4
AACSB: Reflective Thinking
20
24) Nogrowth Corporation expects their dividend to stay at $0.50 per share each year into the foreseeable
future. Therefore
A) the stock will be valued at $0.50 times the number of years an investor plans to keep it.
B) the value of the stock can be estimated as $0.50 divided by an investor’s required rate of return.
C) the value of the stock cannot be determined using the dividend valuation model because the growth
rate is zero.
D) the value of the stock is positive only if the required return is negative.
Keywords: Constant Growth Dividend Valuation Model
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
25) A financial analyst expects Crane Service Inc. to pay a dividend of $2 per share one year from today, a
dividend of $3 per share in years two, and estimates the value of the stock at the end of year two to be
$22. If your required return on Crane Service stock is 14 %, what is the most you would be willing to pay
for the stock today if you plan to sell the stock in two years?
A) $20.99
B) $26.75
C) $26.90
D) $27.00
Keywords: Stock Valuation, Present Value
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking
26) Perrine Industrial Inc. just paid a dividend of $5 per share. Future dividends are expected to grow at a
constant rate of 7% per year. What is the value of the stock if the required return is 16%?
A) $33.44
B) $55.56
C) $59.44
D) $65.87
Keywords: Constant Growth Dividend Valuation Model
Learning Obj.: L.O. 8.4
AACSB: Analytical Thinking