Principles of Managerial Finance, Brief Ed., 8e (Zutter/Smart)
Chapter 7 Stock Valuation
7.1 Differences between debt and equity
1) Unlike creditors, equityholders are owners of the firm.
2) Unlike equityholders, creditors are owners of the firm.
3) Holders of equity have claims on both income and assets that are secondary to the claims of
creditors.
4) The tax deductibility of interest lowers the cost of debt financing.
5) Interest paid to bondholders is tax deductible.
6) Dividends paid to stockholders are tax deductible.
7) Which of the following is an advantage for a firm to issue common stock over long-term debt?
A) the cost of equity financing being less than the cost of debt financing
B) the primary claim of equityholders on income and assets in the event of liquidation
C) no maturity date on which the par value of the issue must be repaid
D) the tax deductibility of dividends which lowers the cost of equity financing
8) Which of the following is a difference between common stock and bonds?
A) Bondholders have a voice in management; common stockholders do not.
B) Bondholders have a senior claim on assets and income relative to stockholders.
C) Stocks have a stated maturity but bonds do not.
D) Dividend paid to stockholders is tax-deductible but interest paid to bondholders are not.
9) Holders of equity capital ________.
A) own the firm
B) receive interest payments
C) receive guaranteed income
D) have loaned money to the firm
10) Because equityholders are the last to receive any distribution of assets as a result of
bankruptcy proceedings, they expect ________.
A) fixed dividend payments
B) greater returns from their investment than the return that bondholders expect
C) all profits to be paid out in dividends
D) warrants to be attached to the stock issue
11) If bankruptcy were to occur, ________ would have the first claim on assets.
A) preferred stockholders
B) unsecured creditors
C) equity stockholders
D) secured creditors
1) The market value of common stock is related to its par value because both are sensitive to the
reactions of investors to new information.
2) Common stockholders are often referred to as residual claimants.
3) Common stock can be either privately owned by private investors or publicly owned by public
investors.
4) The market value of common stock is completely unrelated to its par value.
5) The par value on a common stock is used as a basis for determining its fixed dividend.
6) The number of authorized shares of common stock is always greater than or equal to the
number of outstanding shares of common stock.
7) The number of outstanding shares of common stock is always greater than or equal to the
number of authorized shares of common stock.
8) Supervoting shares of common stock provide shareholders with more votes per share
compared with ordinary shares of common stock.
9) Most investors pay taxes on dividends at the same rate at which their ordinary income is
taxed.
10) Treasury stocks held within the corporation do not have voting rights but have a claim on
assets in liquidation.
11) Regarding the tax treatment of payments to securities holders, it is TRUE that ________.
A) interest and preferred stock dividends are not tax-deductible, while common stock dividends
are tax deductible
B) interest and preferred stock dividends are tax-deductible, while common stock dividends are
not tax-deductible
C) common stock dividends and preferred stock dividends are tax-deductible, while interest is
not tax-deductible
D) common stock dividends and preferred stock dividends are not tax-deductible, while interest
is usually tax-deductible
12) Which of the following is TRUE of outstanding shares?
A) A firm cannot sell more shares than the outstanding shares mentioned in the charter.
B) Authorized shares become outstanding shares when they are issued or sold to investors.
C) Outstanding shares are indicated in a firm’s corporate charter.
D) Outstanding shares are the shares repurchased by the firm.
13) Shares of stock currently owned by a firm’s shareholders are called ________.
A) authorized shares
B) issued shares
C) outstanding shares
D) treasury shares
14) If a firm has class A and class B common stock outstanding, it usually means that ________.
A) each class receives a different dividend
B) the par value of each class is different
C) the dividend paid to one of the classes is tax deductible by the corporation
D) the classes have different voting rights
15) Common stockholders expect to earn a return by receiving ________.
A) semiannual interest
B) fixed periodic payments
C) dividends
D) annual interest
16) The purpose of nonvoting common stock is to ________.
A) limit the voting power of the management
B) allow the minority interest to elect one director
C) raise capital without giving up any voting control
D) give preference on distribution of earnings to those shareholders who own the stock
17) A proxy statement gives shareholders the right ________.
A) of one vote for each share owned
B) to give up their vote to another party
C) to maintain their proportionate ownership in the corporation when new common stock is
issued
D) to sell their share of stock at a premium
18) A proxy battle is the attempt by ________.
A) the creditors of a bankrupt corporation to seize assets of the corporation
B) the management to dismiss the board of directors for their incapability to manage the
operations
C) a nonmanagement group to unseat the existing management and gain control of the firm
D) the employees to form trade unions to influence decisions on behalf of members
19) The attempt by a nonmanagement group to gain control of the management of a firm by
soliciting a sufficient number of proxy votes is called a ________.
A) hostile takeover
B) bankruptcy proceeding
C) proxy battle
D) management buyout
20) In a ________, new shares are sold to the existing shareholders.
A) private placement
B) public offering
C) rights offering
D) direct placement
21) Treasury stock refers to the ________.
A) sale of stock at a price greater than the par value
B) stock issued by the US government
C) repurchase of outstanding stock
D) authorization of additional shares of stock by the board of directors
22) Which of the following is TRUE of the issuance of nonvoting common stock?
A) It is issued in the event of a hostile takeover to preserve the interests of existing owners.
B) It helps the corporation to raise capital through the sale of common stock, without giving up
its voting control.
C) It helps the existing stockholders to automatically transfer their voting rights to new
stockholders without any legal proceeding.
D) It tends to result in the dilution of voting rights of current stockholders.
23) Which of the following is TRUE of par value of a common stock?
A) It is determined on the basis of the stock’s market value.
B) It is an arbitrary value established for legal purposes in a firm’s corporate charter.
C) It indicates the market value at which the stock was originally sold.
D) It allows stockholders to purchase additional shares at a price below the market price.
24) A firm issued 5,000 shares of $1 par-value common stock, receiving proceeds of $20 per
share. The amount recorded for the paid-in capital in excess of par account is ________.
A) $5,000
B) $95,000
C) $100,000
D) $0
25) A firm issued 10,000 shares of $2 par-value common stock, receiving proceeds of $40 per
share. The amount recorded for the paid-in capital in excess of par account is ________.
A) $420,000
B) $380,000
C) $400,000
D) $800,000
26) A firm issued 10,000 shares of no par-value common stock, receiving proceeds of $40 per
share. The amount recorded is ________.
A) $0 in the Common Stock account
B) $0 in the Paid-in Capital in Excess of Par account
C) $400,000 in the Common Stock account
D) $400,000 in the Paid-in Capital in Excess of Par account
27) ________ allows stockholders to purchase additional shares at a price below the market
price, in direct proportion to their number of owned shares.
A) A rights offering
B) Treasury stock
C) Preemptive rights
D) Proxy statements
28) Which of the following is TRUE of a common stock?
A) It gives voting rights which permit determination of the amount of dividend receivable.
B) It gives claims on income and assets which are superior to the claims of creditors of the firm.
C) Dividends on common stock are fully tax-deductible.
D) There is no fixed dividend payment obligation for the company.
29) Stock rights provide the stockholder with ________.
A) the right to purchase additional shares in direct proportion to their number of owned shares
B) the right to elect the board of directors
C) cumulative voting privileges over the preference stockholders
D) the opportunity to receive extraordinary earnings
30) The preemptive right gives shareholders the right ________.
A) to caste one vote for each share owned at the annual meeting of the company
B) to give up their vote to another party if they do not attend the annual meeting
C) to maintain their proportionate ownership in the corporation when new common stock is
issued
D) to sell their share of stock at a premium in the event of liquidation
31) A firm has the balance sheet accounts, Common Stock and Paid-in Capital in Excess of Par,
with values of $10,000 and $250,000, respectively. The firm has 10,000 common shares
outstanding. If the firm had a par value of $1, the stock originally sold for ________.
A) $24/share
B) $25/share
C) $26/share
D) $30/share
32) A firm has the balance sheet accounts, Common Stock and Paid-in Capital in Excess of Par,
with values of $40,000 and $500,000, respectively. The firm has 40,000 common shares
outstanding. If the firm had a par value of $1, the stock originally sold for ________.
A) $11.50/share
B) $12.50/share
C) $13.50/share
D) $15.50/share
33) Preferred stock is a special form of stock having a fixed periodic dividend that must be paid
prior to payment of any interest to outstanding bonds.
34) In the case of liquidation, bondholders are paid before preferred stockholders, who in turn
are paid before common stockholders.
35) In the case of liquidation, common stockholders are paid before preferred stockholders, who
in turn are paid before bondholders.
36) Preferred stock has characteristics of debt since it provides a fixed periodic cash payment.
37) The amount of the claim of preferred stockholders in liquidation is normally equal to the
market value of the preferred stock.
38) Cumulative preferred stocks are preferred stocks for which all passed (unpaid) dividends in
arrears must be paid along with the current dividend prior to the payment of dividends to
common stockholders.
39) Because preferred stock is a form of ownership and has no maturity date, its claims on
income and assets are secondary to those of the firm’s creditors.
40) No-par preferred stock has no stated face value, but its annual dividend is stated as a
percentage of the market value.
41) A preferred stockholder is sometimes referred to as a residual owner, since in essence he or
she receives what is left—the residual—after all other claims on the firm’s income and assets
have been satisfied.
42) A call feature is a feature that allows preferred stockholders to change each share into a
stated number of shares of common stock.
43) Although preferred stock provides added financial leverage in much the same way as bonds,
it differs from bonds in that the issuer can pass a dividend payment without suffering the
consequences that result when an interest payment is missed on a bond.
44) Preferred stockholders are often referred to as residual claimants.
45) Which of the following typically applies to common stock but not to preferred stock?
A) par value
B) dividend yield
C) legally considered as equity in the firm
D) voting rights
46) Which of the following is TRUE of common stocks?
A) The common stock of a corporation can be either privately or publicly owned.
B) Firms often issue common stock with no par value.
C) Preemptive rights often result in a dilution of ownership.
D) A firm’s corporate charter indicates the rate at which dividends are paid.
47) Which of the following is TRUE of equity?
A) equityholders do not have voting rights.
B) It does not mature, so repayment is not required.
C) It is a temporary form of financing for a firm.
D) Equity financing is obtained from creditors.
48) Equity capital can be raised through ________.
A) the money market
B) the NYSE bond market
C) the stock market
D) a private placement with an insurance company
49) Common stockholders are sometimes referred to as ________.
A) non preemptive right holders
B) managers
C) creditors
D) residual owners
50) Which of the following is TRUE of common stock?
A) It is often considered quasi-debt due to fixed payment obligation.
B) It pays a fixed dividend.
C) It gives the holder voting rights which permit selection of the firm’s directors.
D) Its holders have priority over preferred stockholders in the event of liquidation of assets.
51) A proxy statement is a statement transferring ________.
A) the ownership of a bondholder to another party
B) the votes of a bondholder to the another party
C) the votes of a stockholder to another party
D) the ownership of a stockholder to another party
52) Which of the following is typically a feature of common stock?
A) Most common stocks are callable.
B) Most common stocks are cumulative.
C) Common stocks have a maturity value.
D) Common stocks may or may not pay dividends.
53) The claims of the equityholders on a firm’s assets have priority over the claims of creditors
because the equityholders are the owners of the firm.
54) Preemptive rights allow common stockholders to maintain their proportionate ownership in
the corporation when when the firm sells new shares of stock.
55) Stock rights allow stockholders to purchase additional shares of stock in direct proportion to
the number of shares they own.
56) A common stockholder has no guarantee of receiving any cash inflows, but receives what is
left after all other claims on the firm’s income and assets have been satisfied.
61) ADRs are ________.
A) securities, backed by American depositary shares (ADSs), that permit U.S. investors to hold
shares of non-U.S. companies and trade them in U.S. markets
B) securities, backed by Securities Exchange Commission (SEC), that permit all investors to
hold shares of U.S. companies and trade them in U.S. markets
C) securities, backed by American depositary shares (ADSs), that permit non-U.S. investors to
hold shares of U.S. companies and trade them in U.S. markets
D) securities, backed by Securities Exchange Commission (SEC), that permit U.S. investors to
hold shares of non-U.S. companies and trade them in international markets.
62) ________ are promised a fixed periodic dividend that must be paid prior to paying any
common stock dividends.
A) Preferred stockholders
B) Common stockholders
C) Bondholders
D) Creditors
63) Dividends in arrears that must be paid to the preferred stockholders before payment of
dividends to common stockholders are ________.
A) cumulative
B) nonparticipating
C) participating
D) convertible
64) An 8 percent preferred stock with a market price of $110 per share and a $100 par value pays
a cash dividend of ________.
A) $4.00
B) $8.00
C) $8.80
D) $80.00
65) From a corporation’s point of view, a disadvantage of issuing preferred stock is ________.
A) that it increases financial leverage
B) that it has to give fixed payments as well as voting rights to the holders
C) its excellent merger security
D) that the dividends are not tax-deductible
66) Which of the following is a disadvantage of issuing preferred stock from the common
stockholders’ perspective?
A) There is a seniority of preferred stockholder’s claim over common stockholders.
B) The preferred stockholders have superior voting rights in the selection of board of directors.
C) The preferred stockholders are always paid a higher proportion of dividend payments.
D) Issuance of preferred stocks will result in a higher risk, to the disadvantage of common
stockholders.