CHAPTER 7: COMMON STOCK: CHARACTERISTICS, VALUATION,
AND ISSUANCE
1. Which of the following is not a characteristic of common stock:
a. has no maturity date
b. considered a permanent form of long-term financing
c. has claims on assets prior to those of preferred stock
d. 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
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
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. In a reverse stock split
a. the number of shares are decreased
b. the market value is decreased
c. retained earnings decrease
d. par value decreases
8. Which of the following is not an advantage of common stock financing?
a. no fixed dividend obligation
b. can lower the firm’s weighted cost of capital
c. allows the firm a greater degree of flexibility in financial planning
d. involves relatively high flotation costs
9. AVIX has 6.8 million shares outstanding and the firm’s charter provides for a majority voting procedure. The
company has seven directors up for reelection. What is the minimum number of shares needed to ensure the
election of one director?
a. 850,001
b. 5,950,001
c. 3,400,001
d. none of these
10. 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. investors’ required rates of return and their expected returns from the asset
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
11. 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
12. 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
13. 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. The returns can be in annual cash payments or price appreciation, and they are normally expected to grow
and not remain constant
14. Many preferred stocks are treated as in determining their values.
a. Fixed assets
b. Perpetuities
c. Convertible securities
d. Constant growth securities
15. 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.
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
16. 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
17. The most important factor to be considered in the valuation of a closely held firm is
a. earnings growth
b. book value of the firm
c. earnings capacity
d. the general economic outlook
18. 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
19. 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
20. When a stock is split 2 for 1, then the figure on the firm’s balance sheet is cut in half.
a. value of the common stock
b. par value
c. capital surplus
d. retained earnings
21. From an accounting standpoint, stock dividends involve a transfer from the
a. common stock account
b. cash account
c. retained earnings account
d. capital surplus account
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
22. Which one of the following is not a reason a firm may decide to repurchase its own stock?
a. future corporate needs
b. financial restructuring
c. investment
d. disposition of excess warrants
23. 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
24. 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
25. 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
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
26. 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
27. If competition in an industry increases, the future growth potential should
a. decrease
b. increase
c. not be affected
d. be negative
28. The zero growth dividend valuation model is used when a firm’s future dividends are expected to remain
constant,
a. so the value of the firm should also remain constant
b. so the required rate of return should also remain constant
c. and the firm cannot be valued
d. forever
29. 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
30. 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
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
31. result in what is known as treasury stock.
a. Stock dividends
b. Stock repurchases
c. Stock splits
d. Reverse stock splits
32. A firm that wishes to raise additional equity capital by selling a portion of the existing owners’ stock while
maintaining control of the firm should consider a .
a. stock split
b. stock dividend
c. share repurchase
d. separate class of nonvoting stock
33. A firm may use a stock repurchase .
a. as part of a financial restructuring
b. to dispose of excess cash
c. to reduce overhead
d. as part of a financial restructuring and to dispose of excess cash
34. 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
35. 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 cannot be forecast for any future time
d. firm is experiencing a period of poor performance, after which normal growth is expected
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
36. An arrangement whereby an investment banker agrees to purchase an entire new issue of securities is called
a. competitive bidding
b. syndication
c. a negotiated bid
d. underwriting
37. The difference between the selling price to the public of a new issue and the net the issuing firm actually
receives is known as the
a. negotiating spread
b. underwriting spread
c. bid spread
d. SEC cost
38. A is a group of underwriters who agree to underwrite a new issue in order to spread the risk.
a. purchasing syndicate
b. cartel
c. bidding group
d. financial institution
39. All of the following are advantages of private security placements (over a public offering) except
a. reduced flotation costs
b. greater flexibility
c. lower interest rates
d. save time
40. A firm may sell its common stock directly to its existing stockholders through a
a. private placement
b. cash offering
c. rights offering
d. direct placement
41. Direct issuance costs are
a. higher for common stock than for preferred stock issues
b. dependent on the quality of the issue
c. dependent on the size of the issue
d. all of these are correct
42. In marketing a new security issue, the investment banker assumes the risk of not being able to sell the security
at a favorable price in each of the following cases except:
a. a best efforts offering
b. a negotiated underwriting
c. a competitively bid underwriting
d. assumes the risk in all of the above
43. An investment banker is generally thought to be qualified to advise a corporation on a variety of matters,
including all the following except:
a. long range financial planning
b. the marketing of securities
c. the timing of securities
d. the firm’s new product marketing decisions
44. In addition to direct costs, there are other costs associated with new security offerings. These other costs
include all of the following except:
a. the cost of incentives such as the “Green Shoe” option
b. the cost of overpricing
c. the cost of stock price declines
d. the cost of management time
45. A procedure that allows a firm to file a master registration statement with the SEC and then sell an offering of
common stock in small increments is known as .
a. a Green Shoe option
b. an IPO
c. rule 215
d. a shelf registration
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
46. Which of the following are reasons why large multinational corporations may sell equity in international
markets rather than selling stock only in the country in which they are domiciled?
a. Global equity offerings result in higher price per share.
b. The existence of a 12-hour per day trading schedule
c. Higher positive returns around the time of the announcement to sell in global markets
d. Private placements are not an option.
47. The P/E ratio indicates
a. how much investors are willing to pay for $1 of current earnings
b. the current yield
c. the current price
d. how risky the stock is
48. Common stock dividends normally are paid
a. monthly
b. quarterly
c. semi-annually
d. annually
49. In stock quotations, the last column, showing the net change, indicates the net change in
a. a share’s price during the day
b. the dividend yield
c. the closing price from the previous day’s close
d. a share’s high price during the day
50. 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. $19.62
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
51. 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%
52. 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. $8.16
53. What is the current value of the common stock of Clump Dump Kitty Litter, Limited if you know the current
dividend yield is 6.14%, the PE is 16, and the annual dividend is $1.35?
a. $21.60
b. $21.99
c. $8.29
d. $98.24
54. Bellbottom Gongs, Inc. pays a quarterly dividend of $0.70, has a PE ratio of 14 and closed yesterday at
$48.25.What is the dividend yield?
a. 5.45%
b. 1.45%
c. 5.8%
d. 7.25%
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
55. If the common stock of Comdisco pays an annual dividend of $0.28, has a PE ratio of 11 and closed at 25,
what are the current earnings per share?
a. $3.08
b. $2.27
c. $7.00
d. $1.12
56. If Night Owl Lamps pays an annual dividend of $1.54, has a PE of 13, and its last closing price was 40, then
its dividend yield must be:
a. 11.85%
b. 3.85%
c. 15.40%
d. 3.25%
57. 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
58. 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
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
59. 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%
60. 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
61. During the past 8 years, Beef Wellington Cattle 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. 19%
62.
Moonshine Company, a producer of fine liqueurs, has 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 Moonshine’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. $48.62
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
63.
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. 11.06%
64.
The stock of Melody 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%
65.
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%
66.
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%
Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
67.
CPU Company currently (t = 0) pays a dividend of $2.50 per share on its common stock. Dividends are
expected to increase at the rate of $.25 per share for the next several years. Determine the current value of
CPU’s common stock to an investor who expects to be able to sell the stock for $35 per share after 3 years,
given that the investor requires a 14 percent rate of return on this security.
a. $24
b. $30.54
c. $19.64
d. $68.75
68.
What is the current value of Frocks & Socks Clothiers, Inc. to an investor who has a required rate of return of
12 percent? The current dividend is $1.00 and the dividends are expected to grow 8 percent per year for 3
years. At the end of 3 years the investor expects to sell the security for $76.
a. $79.51
b. $56.90
c. $51.13
d. $76.00
69.
What is the current value of a share of HiGro common stock that does not pay a current dividend? Earnings
are growing at a 20 percent per year rate for the next 10 years. Assume the investor has a required rate of
return of 15 percent and expects to sell the security in 5 years. Current earnings are $1.50 per share.
a. $56.87
b. $62.21
c. $25.00
d. There is insufficient information to solve this problem.