Chapter 9—COMMON STOCKS AND PREFERRED STOCKS
MULTIPLE CHOICE
1. Which of the following is not a characteristic of common stock:
a.
it has no maturity date
b.
it is considered a permanent form of long-term financing
c.
it has claims on assets prior to those of preferred stock
d.
it is a residual form of ownership
2. Stockholders’ equity includes all of the following except:
a.
Common stock at par
b.
Treasury stock
c.
Contributed capital in excess of par
d.
Retained earnings
3. The book value per share of common stock is calculated by dividing ____ by the number of shares
outstanding
a.
market value of common stock
b.
total assets
c.
total stockholders’ equity plus preferred stock
d.
total common stockholders’ equity
4. 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
5. Common stockholders have a number of general rights, including all of the following except:
a.
voting rights
b.
management rights
c.
asset rights
d.
dividend rights
6. The book value of an asset represents
a.
the market value
b.
the discounted cash flow value
c.
the historic acquisition cost of the asset
d.
stockholders’ acquisition value
7. A change in the market price of an asset will occur as a result of changes in:
a.
investors’ required rates of return
b.
investors’ expected returns from the asset
c.
book value of the asset
d.
a and b only
8. In the constant-growth dividend valuation model, the required rate of 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
9. In the constant-growth dividend valuation model, the required rate of return on a common stock can be
shown to be equal to the sum of the dividend yield plus:
a.
Yield-to–maturity
b.
Cost of capital
c.
Present value yield
d.
Price appreciation yield
10. The valuation of common stock is considerably more complicated than the valuation of bonds or
preferred stocks because:
a.
The returns can take two forms, i.e. annual cash payments and price appreciation
b.
Common stock dividends are normally expected to grow and not remain constant
c.
The returns from common stocks are generally larger and more certain than the returns
from bonds and preferred stocks
d.
a and b only
11. Many preferred stocks are treated as ____ in determining their values.
a.
Fixed assets
b.
Perpetuities
c.
Convertible securities
d.
Constant growth securities
12. In the valuation of common stock, the simple annuity and perpetuity formulas used in the valuation of
bonds and preferred stock are not generally applicable because:
a.
Investors buy common stock for much different reasons than they buy bonds or preferred
stock.
b.
Returns accruing to common stock should never be capitalized (discounted) in order to
determine a price.
c.
Unlike bonds and preferred stock, common-stock is a short term investment.
d.
Common stock dividends are normally expected to grow over time, rather than being
constant as are payments on most bonds and most preferred stock.
13. One of the assumptions of the constant growth dividend valuation model is that
a.
the investor’s required rate of return is equal to the expected dividend yield.
b.
the required rate of return is greater than the dividend growth rate.
c.
the required rate of return increases at a constant rate.
d.
the dividend rate (in dollars) will remain constant.
14. Stockholders’ equity equals
a.
both preferred stock and common equity
b.
total claims
c.
additional paid-in capital plus capital surplus
d.
total liabilities and total surplus
15. A common stock’s book value is calculated
a.
as a multiple of the stock’s price / earning ratio
b.
on the basis of income statement ratios
c.
on the basis of balance sheet figures
d.
on the value of income statement figures
16. Dillinger, Inc. is planning to raise additional capital for expansion by selling 500,000 common shares
at $16 each. The existing stockholders’ equity section of their balance sheet is shown below. What will
the retained earnings figure be immediately after the sale of the new equity?
Common stock; $1 par value; authorized, 3,000,000 shares; issued and
outstanding, 3,000,000 shares
$ 3,000,000
Additional paid-in capital
6,500,000
Retained earnings
4,752,000
Total stockholders’ equity
$14,252,000
a.
$12,252,000
b.
$14,000,000
c.
$4,752,000
d.
$3,500,000
17. The returns investors receive from holding common stocks may be in two forms. They are
a.
cash dividend payments and capital gains
b.
future earnings and treasury stock
c.
stock splits and stock dividends
d.
cash dividends and stock dividends
18. The constant growth dividend valuation model does not hold when
a.
ke is greater than g
b.
dividends are growing faster than 4 percent
c.
g is greater than ke
d.
the current dividend is known
19. If the general level of interest rates in the economy moves up, then investors will require a ____ rate of
return on securities, and, in general, stock prices should ____, ceteris paribus.
a.
lower, decline
b.
higher, increase
c.
higher, decline
d.
lower, increase
20. If competition in an industry increases, the future growth potential should
a.
decrease
b.
increase
c.
not be affected
d.
be negative
21. When evaluating a firm based on price/earnings multiples, the evaluator must determine the
price/earnings multiple for
a.
the general market
b.
the S&P 500
c.
firms in the same industry
d.
small capitalization firms
22. The rights of stockholders to share equally on a per share basis in any distributions of corporate
earnings is known as ____.
a.
preemptive rights
b.
voting rights
c.
asset rights
d.
dividend rights
23. In the constant growth dividend valuation model, the required rate of return on a common stock is
equal to the sum of the ____.
a.
capital gains yield and cost of capital
b.
present value yield and dividend yield
c.
cost of capital and dividend yield
d.
capital gains yield and dividend yield
24. In the constant growth dividend valuation model, it is assumed that the ____.
a.
dividend growth rate exceeds the required rate of return
b.
firm’s future dividend payments are expected to grow at a constant rate forever
c.
dividend growth rate equals the required rate of return
d.
none of these answers is correct
25. Which of the following statements concerning preferred stocks is (are) true?
a.
Preferred stockholders have a prior claim on the income and assets of the firm as
compared to the claims of lenders.
b.
Preferred stock dividends per share are normally increased as the earnings of the firm
increase.
c.
Preferred dividends per share are usually not cut or suspended unless the firm is faced with
serious financial problems.
d.
none of these are correct
26. Rank in ascending order (lowest to highest) the relative risk associated with holding the preferred
stock, common stock and bonds of a firm:
a.
preferred stock, bonds, common stock
b.
bonds, common stock, preferred stock
c.
common stock, preferred stock, bonds
d.
bonds, preferred stock, common stock
27. Preferred stock has a priority over common stock with regard to the company’s
a.
assets
b.
voting rights
c.
dividends
d.
both assets and dividends
28. The principal disadvantage of preferred stock financing is
a.
its high after-tax cost as compared with long-term debt
b.
the decrease in the firm’s degree of financial leverage
c.
the required payment of dividends
d.
the reduction in control
29. Which of the following features (if any) of preferred stock provides the investor with a measure of
protection against inflation?
a.
adjustable dividend rate
b.
cumulative feature
c.
call feature
d.
none of these are correct
30. What is the value of a share of stock of HOV Inc. to an investor who requires a 12 percent rate of
return if HOV’s current dividend is $1.20? Assume earnings and dividends are expected to grow at a
compound annual rate of 7 percent.
a.
$24.00
b.
$18.34
c.
$25.68
d.
$70.00
31. The current price of Zebar is $32.00 and the current dividend is $.60. What is an investor’s required
rate of return on Zebar if dividends are expected to grow perpetually at a compound annual rate of 8
percent?
a.
9.88%
b.
11.38%
c.
18.75%
d.
10.03%
32. 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 stock of Fast Wheels to an investor who requires a 14 percent rate of return?
a.
$9.00
b.
$5.14
c.
$9.54
d.
$14.40
33. Zero-Sum Enterprise expects to pay an annual dividend of $0.48 next year. Dividends and earnings
have been growing at a compound annual rate of 8 percent and are expected to continue growing at
that rate. What is an investor’s required rate of return on Zero-Sum if the current price is $12?
a.
12.3%
b.
12.0%
c.
10.0%
d.
10.3
34. Assume Zero-Sum Enterprise pays an annual dividend of $1.40 per share and that neither earnings nor
dividends are expected to grow in the future. What is the value of Zero-Sum’s stock to an investor who
requires a 14 percent rate of return?
a.
$14.00
b.
$10.00
c.
$20.00
d.
0
35. Over the past 7 years the dividends of Sunshine Mining have grown from $0.24 to the current level of
$.53. What is the approximate annual compound growth rate of Sunshine’s dividends?
a.
20.8%
b.
12.0%
c.
9.5%
d.
10.0%
36. Assume that the dividend ($3.25) on Central Power Company’s common stock issue is paid annually at
the end of the year. This dividend is not expected to increase for the foreseeable future. Determine the
value of this stock to an investor who requires a 12 percent rate of return.
a.
$3.25
b.
$39
c.
$12
d.
$27.08
37. During the past 8 years, Wellington Company’s common stock dividends have grown from $2.00 to
$3.19. Estimate the compound annual dividend growth rate over the 8 year period.
a.
59.5%
b.
6%
c.
12%
d.
7.3%
38. Wilshire Company’s earnings and common stock dividends have been growing at an annual rate of 4
percent over the past several years. The firm currently (t = 0) pays an annual dividend of $4.00.
Assuming that Wilshire’s common stock dividends continue growing at the past rate for the
foreseeable future, determine the value of the company’s common stock to an investor who requires a
13 percent rate of return on these securities.
a.
$44.44
b.
$36.81
c.
$46.22
d.
$54.00
39. What is the rate of return to an investor in the stock of Bajo, Inc. if the current dividend of $0.80 is not
expected to change in the foreseeable future? The current price of Bajo is $13.25.
a.
6.04%
b.
8.0%
c.
24.15%
d.
10.6%
40. The stock of Music City is selling for $37.50 and pays a current annual dividend of $1.10. What is the
implied growth rate of dividends for this firm (assume dividends are expected to grow at a constant
rate) if an investor’s required rate of return is 14 percent?
a.
11.07%
b.
14.0%
c.
11.4%
d.
10.75%
41. If the stock of Sun Computers is selling for $34 and the current dividend is $0.48, what is the implied
constant growth rate of dividends to an investor who requires a 14% rate of return?
a.
12.54%
b.
12.41%
c.
14.00%
d.
15.41%
42. Phillips Industries common stock currently sells for $50 and is expected to pay a dividend of $3.00
next year. Determine the implied growth rate for Phillips Industries dividends assuming that an
investor’s required rate of return on this stock is 14%.
a.
6%
b.
8%
c.
14%
d.
20%
43. Assume that the dividend on Central Power Company’s $3.25 preferred stock issue is paid annually at
the end of the year. Determine the value of this preferred stock to an investor who requires a 12
percent rate of return.
a.
$3.25
b.
$39
c.
$12
d.
$27.08
44. An Allied Northern preferred stock pays a $3.84 annual dividend. What is the value of the stock to an
investor who requires a 9.5 percent return?
a.
$40.42
b.
$42.67
c.
$38.40
d.
$36.48
45. What is the rate of return on a preferred stock that has a par value of $50, a market price of $46.50, and
a dividend of $4.10?
a.
8.20%
b.
11.34%
c.
8.82%
d.
12.20%
46. What is the required rate of return to the investor who is willing to purchase a Duke Power preferred
stock with a $8.70 dividend, a par value of $100, and a current market price of $87?
a.
10.7%
b.
8.7%
c.
9.4%
d.
10.0%
47. Determine the value of a LASKA 6.25% cumulative preferred stock, series D, par value $75 to an
investor who requires a 9.5% rate of return on a security with this risk.
a.
$65.79
b.
$49.34
c.
$75.00
d.
$114.00
48. What is the value of an MDI $2.67 perpetual preferred stock to an investor who requires a 7% annual
rate of return? Assume the par value is $60.00.
a.
$85.71
b.
$38.14
c.
$59.33
d.
$60.00
49. What is the current value of a share of Augat common stock if its current dividend is $1.50 and
dividends are expected to grow at the annual compound growth rate of 20 percent into the foreseeable
future? Assume the investor has a required rate of return of 15 percent, and expects to sell the security
in 5 years.
a.
$56.87
b.
$30.00
c.
$25.00
d.
none of these answers are correct.
50. Over the past 8 years UTX Company common stock dividends have grown from $2.70 to $5.00 per
share (currently). Determine the value of UTX common stock to an investor who requires a 16% rate
of return, assuming that dividends continue growing for the foreseeable future at the same rate as over
the past 8 years.
a.
$62.50
b.
$31.25
c.
$67.50
d.
$46.96
51. Lawton Company common stock currently sells for $38 and pays (year 0) a dividend of $2. Determine
the implied growth rate for Lawton assuming that an investor’s required rate of return is 12% and that
the stock can be evaluated using a constant growth valuation model.
a.
6.74%
b.
17.26%
c.
6.4%
d.
4.56%
52. Helix common stock currently sells for $30 and its current dividend is $1.50. If the required rate of
return on Helix stock is 15%, what is the implied growth rate of its earnings and dividends?
a.
13.5%
b.
9.5%
c.
10.0%
d.
30.0%
53. Over the past 5 years, NBA’s common stock earnings per share have grown from $0.62 to $0.91. If an
investor is NBA stock is assumed to have a required rate of return of 14%, what is the current value of
NBA if its current dividend is 0.12? Assume EPS will continue to grow at a constant rate.
a.
$2.16
b.
$1.62
c.
$4.94
d.
$2.00
54. Morton Industries’ common stock sells for $54. Dividends are expected to continue to grow at a rate of
8% annually. If investors in Morton require a 13% rate of return, what is the current dividend?
a.
$2.70
b.
$2.50
c.
$4.00
d.
$7.02
55. Pace Enterprises’ common stock sells for $29, and its dividends are expected to grow at a rate of 9
percent annually. If investors in Pace require a return of 14%, what is the expected dividend next year?
a.
$1.33
b.
$2.40
c.
$1.45
d.
$1.60
56. The common stock of Happy Nappy Mattress Mfg. currently sells for $88.50 and its current (D0)
dividend is $1.10. Determine the implied growth rate for Happy Nappy assuming that an investor’s
required rate of return is 14% and that earnings and dividends are expected to grow at a constant rate.
a.
13.9%
b.
12.3%
c.
13.8%
d.
12.6%
57. Men In Black Tuxedo Shops, Inc. currently pays a dividend of $1.20 per share. Dividends are expected
to increase at the rate of $0.10 per share for the next eight years. Determine the current value of MIB’s
common stock to an investor who expects to be able to sell the stock for $28 after 5 years. Assume that
the investor requires a 12 percent rate of return on the security.
a.
$66
b.
$28
c.
$21.20
d.
$15.88
58. Over the past 10 years the dividends of Chop Shop Barbers, Inc. have grown from $0.45 to $1.82 per
share. Determine the value of Chop Shop’s common stock to an investor who requires a 20% rate of
return, assuming that dividends continue growing at the same rate as they grew over the past 10 years.
a.
$36.40
b.
$41.86
c.
$43.68
d.
$20.93
59. Moo-Cow Creamery’s common stock sells for $37 and its dividend is expected to grow at a rate of 8
percent annually. What is the expected dividend (D1) given that an investor requires a return of 16
percent?
a.
$2.74
b.
$3.20
c.
$5.92
d.
$2.96
60. During the past 10 years, High Flying Airlines’ common stock dividends have grown from $0.24 to
$0.62. If the past growth of dividends is expected to continue at the same rate in the future, what is the
current value of High Flying’s common stock to an investor who requires an 18% rate of return?
a.
$7.75
b.
$3.79
c.
$8.53
d.
$10.42
61. Dippity-Do-Dah Party Dips, Inc. has common stock that sells for $23.50 and its earnings are expected
to grow at a rate of 12% annually. What is the current dividend (Do) for an investor who requires a
15% return?
a.
$0.71
b.
$0.63
c.
$0.34
d.
$0.31
62. During the past 7 years, Lippo’s earnings have grown from $0.78 to $1.95 per share. If the past growth
rates are expected to continue into the future, what is the current value of Lippo’s common stock to an
investor who requires a 16% rate of return?
a.
$97.50
b.
$13.93
c.
$111.15
d.
$48.50
63. Which of the following claims is/are paid before the claim of common stockholders?
I. Board of Directors bonuses.
II. Taxes owed to the federal and state agencies.
a.
I only
b.
II only
c.
Both I and II
d.
Neither I nor II
ESSAY
1. Explain some features of preferred stock.
2. Why is preferred stock considered a hybrid security?
3. Why is common stock considered to be a residual form of ownership?