Chapter 09: Stocks and Their Valuation
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1. A proxy is a document giving one party the authority to act for another party, including the power to vote shares of
common stock. Proxies can be important tools relating to control of firms.
a. True
b. False
2. The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the
firm. This right helps protect current stockholders against both dilution of control and dilution of value.
a. True
b. False
3. If a firm’s stockholders are given the preemptive right, then they can call for a meeting to vote to replace the
management. Without the preemptive right, dissident stockholders must seek a change in management through a proxy
fight.
a. True
b. False
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9. When a new issue of stock is brought to market, the marginal investor determines the price at which the stock will
trade.
a. True
b. False
10. The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model
used to find the price of perpetual preferred stock or other perpetuities.
a. True
b. False
11. According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value
of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash
flows during the subsequent constant growth period.
a. True
b. False
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17. If a stock’s expected return as seen by the marginal investor exceeds his or her required return, then the investor will
buy the stock until its price has risen enough to bring the expected return down to equal the required return.
a. True
b. False
18. If a stock’s market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the
stock until its price has fallen down to the level of the investor’s estimate of the intrinsic value.
a. True
b. False
19. For a stock to be in equilibrium, two conditions are necessary: (1) The stock‘s market price must equal its intrinsic
value as seen by the marginal investor, and (2) the expected return as seen by the marginal investor must equal his or her
required return.
a. True
b. False
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22. An increase in a firm’s expected growth rate would cause its required rate of return to
a. increase.
b. decrease.
c. fluctuate less than before.
d. fluctuate more than before.
e. possibly increase, possibly decrease, or possibly remain constant.
23. If a given investor believes that a stock’s expected return exceeds its required return, then the investor most likely
believes that
a. the stock is experiencing supernormal growth.
b. the stock should be sold.
c. the stock is a good buy.
d. management is probably not trying to maximize the price per share.
e. dividends are not likely to be declared.
24. The preemptive right is important to shareholders because it
a. allows managers to buy additional shares below the current market price.
b. will result in higher dividends per share.
c. is included in every corporate charter.
d. protects the current shareholders against a dilution of their ownership interests.
e. protects bondholders and thus enables the firm to issue debt with a relatively low interest rate.
Chapter 09: Stocks and Their Valuation
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a. The two stocks should have the same expected dividend.
b. The two stocks could not be in equilibrium with the numbers given in the question.
c. A’s expected dividend is $0.50.
d. B’s expected dividend is $0.75.
e. A’s expected dividend is $0.75 and B’s expected dividend is $1.20.
29. Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which
of the following statements is CORRECT?
a. If Stock A has a lower dividend yield than Stock B, then its expected capital gains yield must be higher than
Stock B’s.
b. Stock B must have a higher dividend yield than Stock A.
c. Stock A must have a higher dividend yield than Stock B.
d. If Stock A has a higher dividend yield than Stock B, then its expected capital gains yield must be lower than
Stock B’s.
e. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.
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32. A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate
of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, then
which of the following statements is CORRECT?
a. The company’s current stock price is $20.
b. The company’s dividend yield 5 years from now is expected to be 10%.
c. The constant growth model cannot be used because the growth rate is negative.
d. The company’s expected capital gains yield is 5%.
e. The company’s expected stock price at the beginning of next year is $9.50.
33. Which of the following statements is CORRECT?
a. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.
b. Two firms with the same expected dividend and growth rate must also have the same stock price.
c. It is appropriate to use the constant growth model to estimate a stock’s value even if its growth rate is never
expected to become constant.
d. If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%,
then the stock’s dividend yield is also 5%.
e. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
Chapter 09: Stocks and Their Valuation
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a. The stock’s required return is 10%.
b. The stock’s expected dividend yield and growth rate are equal.
c. The stock’s expected dividend yield is 5%.
d. The stock’s expected capital gains yield is 5%.
e. The stock’s expected price 10 years from now is $100.00.
38. Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium,
which of the following statements is CORRECT?
X Y
Price $25 $25
Expected dividend yield 5% 3%
Required return 12% 10%
a. Stock Y pays a higher dividend per share than Stock X.
b. Stock X pays a higher dividend per share than Stock Y.
c. One year from now, Stock X should have the higher price.
d. Stock Y has a lower expected growth rate than Stock X.
e. Stock Y has the higher expected capital gains yield.
