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Corporate Finance: Core Principles & Apps, 5e (Ross)
Chapter 6 Stock Valuation
1) Alto stock pays an annual dividend of $1.10 a share and has done so for the past 6 years. No
changes in the dividend amount are expected. The relevant market rate of return is 7.8 percent.
Given this, one share of this stock
A) is basically worthless as it offers no growth potential.
B) is valued as a nonconstant growth stock.
C) is valued as a perpetuity.
D) is valued as a differential growth stock.
E) has a current market value of $1.10.
2) A stock that pays a constant annual dividend will have a market price that
A) increases when the market rate of return increases.
B) decreases when the market rate of return increases.
C) decreases over time.
D) increases over time.
E) always remains constant.
3) The underlying assumption of the dividend growth model is that a stock is worth
A) the present value of the future income provided by that stock.
B) the same amount to every investor.
C) an amount computed as the next annual dividend divided by the market rate of return.
D) an amount computed as the last annual dividend divided by the required rate of return.
E) the same amount as any other stock that paid the same dividend this year.
4) Based on the dividend growth model, an increase in investors’ overall level of required returns
will
A) cause the market values of all stocks to decrease, all else held constant.
B) not affect overall stock market prices.
C) cause dividend growth rates to increase to offset this change.
D) cause non–dividend-paying stocks to decrease in price while dividend-paying stock prices
remain constant.
E) cause some stock prices to rise while others fall.
5) Differential growth refers to the stock of a firm that increases its dividend by
A) three or more percent per year.
B) a stated percent each year.
C) a rate that is expected to be sustainable indefinitely.
D) an amount in excess of $.25 per year.
E) varying rates over a period of time.
6) Which one of these represents the portion of a stock’s rate of return that is attributable to the
growth rate of the dividends?
A) Capital gains yield
B) Real rate of return
C) Interest yield
D) Inflation rate
E) Dividend yield
7) Which one of these formulas is used to estimate a firm’s growth rate?
A) Annual dividend / Current stock price
B) (1 – Dividend payout ratio) × r
C) Retention ratio × ROE
D) Retention ratio × ROA
E) (1 – Dividend payout ratio) × R
8) The total return on a stock is equal to
A) Annual dividend / Current stock price.
B) Capital gains yield – Dividend yield.
C) Capital gains yield + Dividend yield.
D) (1 + Dividend yield) × (1 + Inflation rate) – 1.
E) (1 + Capital gains yield) / (1 + Dividend yield) – 1.
9) The expected dividend yield is equal to
A) Dividend yield × Next year’s stock price.
B) Expected cash dividend / Current stock price.
C) Expected cash dividend / Next year’s stock price.
D) (Retention ratio × Expected earnings) / Current stock price.
E) (Dividend payout ratio × Expected earnings) / Next year’s stock price.
10) The rate at which a stock’s price is expected to appreciate (or depreciate) is called the
________ yield.
A) current
B) capital gains
C) dividend
D) total
E) earnings
11) According to finance professionals, which one of these factors has the biggest impact on a
firm’s PE ratio?
A) Accounting practices of the firm
B) Risk-level of the firm
C) Size of the firm
D) Growth opportunities
E) Age of the firm
12) The EV/EBITDA ratio has an advantage over the PE ratio in situations where comparisons are
being made of firms that vary based on their
A) method of depreciation.
B) rate of growth.
C) degree of leverage.
D) level of cash.
E) sales level.
13) Which of these factors are most associated with a high PE ratio?
A) High growth opportunities and high risk
B) Low risk and low growth opportunities
C) Conservative accounting practices and low risk
D) High risk and low growth opportunities
E) Aggressive accounting practices and high growth opportunities
14) The free cash flow model, as compared to other models, tends to be most helpful when valuing
a share of stock in a:
A) firm that pays dividends that increase at a constant rate of growth.
B) firm having similar growth opportunities as other firms.
C) non–dividend-paying firm that has external financing needs.
D) firm that plans to lower its dividend growth rate in the near future.
E) firm that pays a fixed annual dividend.
15) Multiple classes of stock are primarily created to
A) allow certain shareholders to retain control of a firm.
B) replace cash dividends with share repurchases.
C) allow common stock to have cumulative privileges.
D) eliminate pre-emptive rights.
E) ensure all shareholders have equal rights.
16) A ________ is a form of equity security that has a stated liquidating value.
A) debenture
B) bond
C) common stock
D) preferred stock
E) proxy
17) The voting procedure whereby shareholders may cast all of their votes for one candidate for
the board of directors is called ________ voting.
A) democratic
B) deferred
C) straight
D) cumulative
E) proxy
18) The voting procedure where you must control 50 percent plus one of the outstanding shares of
stock to guarantee that you will win a seat on the board of directors is called ________ voting.
A) proxy
B) cumulative
C) deferred
D) straight
E) democratic
19) The voting procedure where a shareholder grants authority to another individual to vote his/her
shares is called ________ voting.
A) proxy
B) deferred
C) straight
D) cumulative
E) democratic
20) Jack owns shares of stock in Boynton Foods and wants to be elected to the company’s board of
directors. There are 10,000 shares of stock outstanding and each share is granted one vote for each
open position on the board. Presently, the company is voting to elect two new directors. Jack can
be assured of his election
A) if straight voting applies and he owns at least 25 percent of the shares, plus one additional share.
B) if straight voting applies and he owns at least one-third of the shares, plus one additional share.
C) if cumulative voting applies and he owns 25 percent of the shares, plus one additional share.
D) only if cumulative voting applies and he owns the majority of the shares.
E) if cumulative voting applies and he owns one-third of the shares, plus one additional share.
21) Denver Wool is owned by a group of shareholders who all vote independently and who all
want personal control over the firm. There are three open seats and Danielle is one of six
contenders. If straight voting is utilized and Danielle is a current shareholder, then he
A) is only permitted to elect one director, regardless of the number of shares he owns.
B) will be assured of his election if he owns at least one-sixth, plus one, of the outstanding shares.
C) must own at least two-thirds of the shares, plus one, to exercise control over the elections.
D) can only be assured of his election if he owns sufficient shares to control the entire election.
E) can be assured of his election provided he owns more shares than any other single shareholder.
22) Greener Grass Co. pays a constant annual dividend of $1 a share and has 1,000 shares of
common stock outstanding. The company
A) must always show a current liability on its balance sheet of $1,000 for dividends payable.
B) must still declare each dividend before it becomes an actual company liability.
C) is obligated to continue paying $1 a share each year.
D) can deduct $1,000 a year as a business expense as a result of its dividend payment.
E) can be forced into bankruptcy by its shareholders if it fails to pay at least $1 a year in dividends.
23) Corporate dividends
A) are a source of tax-free income for individual investors.
B) reduce the taxable income of the payer.
C) are only 70 percent taxable to corporate shareholders.
D) are paid out of pretax income and thus are taxed at the personal level.
E) are taxed at the personal level even though they are paid from after-tax income.
24) The owner of preferred stock
A) owns shares that generally have a stated liquidating value of $1,000 per share.
B) has the right to veto the outcome of an election held by the common shareholders.
C) has the right to collect payment on any unpaid dividends as long as the stock is noncumulative.
D) is entitled to a distribution of income prior to the common shareholders.
E) is guaranteed voting rights similar to a common shareholder.
25) Which one of the following statements concerning preferred stock is correct?
A) Unpaid preferred dividends are a liability of the firm whether or not they have been declared.
B) Preferred shareholders may be granted voting rights if preferred dividend payments remain
unpaid.
C) Any unpaid preferred dividends will accrue interest at a rate equal to the dividend rate.
D) All unpaid dividends on both cumulative and noncumulative preferred stock must be paid
before any common stock dividends can be declared.
E) Preferred dividends will be paid quarterly only when the firm has current net income that
exceeds the amount of the quarterly dividend.
26) Staggered elections
A) apply only in situations where multiple classes of stock exist.
B) primarily benefit minority shareholders.
C) increase turnover on the board of directors.
D) are used with straight voting.
E) help prevent takeovers.
27) The market in which new securities are originally sold to investors is called the ________
market.
A) dealer
B) auction
C) over-the-counter
D) secondary
E) primary
28) Lew, an individual investor, sold 100 shares of Global Tech stock on Monday. Janice, another
individual investor, purchased those shares but never met Lew. You know for certain that this trade
occurred in which market?
A) Primary market
B) Dealer market
C) NASDAQ
D) Secondary market
E) NYSE
29) A market participant who buys and sells securities from inventory is called a
A) broker.
B) trader.
C) principal.
D) capitalist.
E) dealer.
30) An agent who arranges security transactions among investors without maintaining an
inventory is called a
A) broker.
B) trader.
C) capitalist.
D) principal.
E) dealer.
31) What is the primary role of a designated market maker (DMM)?
A) Provide a two-sided market
B) Act as a floor broker
C) Function as a supplementary liquidity provider
D) Act as a one-sided trader
E) Process only electronic trades
32) A dealer will buy at the ________ price and sell at the ________ price.
A) bid; bid
B) ask; ask
C) ask; bid
D) bid; ask
E) spread; spread
33) What is the primary business of the NYSE?
A) Set market prices
B) Provide a face-to-face trading floor
C) Attract and process order flow
D) Provide a primary market
E) Regulate securities trading
34) NASDAQ has which one of these features?
A) Broker system
B) Trading floor
C) Multiple market maker system
D) Designated market maker system
E) Trading stations called “posts”
35) A securities market primarily consisting of dealers who buy and sell for their own inventories
is generally referred to as a(n) ________ market.
A) over-the-counter
B) auction
C) broker
D) regional
E) trading floor
36) Electronic communications networks (ECNs)
A) have open access to the NYSE but no access to NASDAQ.
B) totally replaced face-to-face trading on the NYSE in 2015.
C) are available only to financial institutional traders.
D) act to increase liquidity in the financial markets.
E) are used solely by market makers to place bid and ask quotes.
37) Which one of the following transactions occurs in the primary market?
A) Repurchase of GHI stock from Tim by GHI
B) Tax-free gift of DEF stock to Heather by Jennifer
C) Sale of ABC stock by Fred Jones to Mary Smith
D) Initial sale of JKL stock by JKL to Jamie
E) Transfer of MNO stock from Tom to his son, Jon
38) Which one of the following statements concerning dealers and brokers in the financial markets
is correct?
A) A broker never assumes ownership of the securities being traded.
B) A dealer pays the ask price when purchasing securities.
C) A broker earns income in the form of a bid-ask spread.
D) A dealer in market securities arranges sales between buyers and sellers for a fee.
E) A broker deals solely in the primary market.
39) A stock quote shows a last price of 32.13, a P/E of 17, and a net change of −.23. Based on this
information, which one of the following statements is correct?
A) The closing price on the previous trading day was $.23 lower than today’s closing price.
B) A dealer can purchase the stock for $.23 less than an investor can.
C) The earnings per share decreased by $.23 a share this year.
D) The earnings per share have increased by 17 percent this year.
E) The earnings per share are equal to 1/17th of $32.13.
40) A stock report contains the following information: P/E 21.4, closing price 28.16, dividend
1.10, net chg .06, and an ask of 28.22 × 300. Which one of the following statements is correct
given this information?
A) The stock price has increased by 6 percent thus far this year.
B) The closing price on the previous trading day was $28.10.
C) The earnings per share are approximately $2.
D) The dividend yield is 21.4 percent.
E) The bid-ask spread is $.300.
41) In a stock market report, the open price represents the
A) price a dealer is willing to pay.
B) price at which a designated market maker will sell.
C) first trade of the day.
D) closing price on the previous trading day.
E) current bid price.
42) Blasco just paid an annual dividend of $1.63 a share. What is one share of this stock worth to
you if the dividends increase by 3 percent annually and you require a rate of return of 14 percent?
A) $12.40
B) $11.99
C) $10.54
D) $15.26
E) $11.64
43) Tyler Industries stock traditionally provides a rate of return of 13.7 percent. The company just
paid an annual dividend of $1.21 a share and recently announced it will commence increasing its
dividends by 1.6 percent each year. For this stock to return its traditional rate, what should the
market price of this stock be?
A) $10.00
B) $11.62
C) $10.16
D) $9.12
E) $8.97
44) The ELL common stock pays an annual dividend of $2.23 a share and is committed to
maintaining a constant dividend. How much are you willing to pay for one share of this stock if
your required return is 16 percent?
A) $14.56
B) $14.67
C) $13.94
D) $13.88
E) $14.04
45) Winslow Brothers common stock sells for $36.60 a share and pays an annual dividend that
increases by 1.8 percent annually. The market rate of return on this stock is 14.7 percent. What is
the amount of the last dividend paid?
A) $5.29
B) $4.64
C) $4.84
D) $4.56
E) $5.37
46) Ernst Electrical increases its annual dividend by 1.8 percent annually. The stock commands a
market rate of return of 18 percent and sells for $19.07 a share. What is the expected amount of the
next dividend?
A) $3.03
B) $3.07
C) $3.18
D) $3.21
E) $3.09
47) The Olde Mill just paid an annual dividend of $.38 a share and plans on decreasing this amount
by 1 percent annually. What is the expected dividend for Year 6?
A) $.3542
B) $.3602
C) $.3636
D) $.3578
E) $.3584
48) JJ Companies will pay an annual dividend of $4.20 a share on its common stock next year. Last
week, the company paid a dividend of $4.00 a share. The company adheres to a constant rate of
growth dividend policy. What will one share of this stock be worth 8 years from now if the
applicable discount rate is 14 percent?
A) $68.95
B) $81.44
C) $74.21
D) $71.16
E) $77.09
49) Wilton’s Market just announced its next annual dividend will be $1.62 a share with future
dividends increasing by 2.2 percent annually. How much will one share of this stock be worth 6
years from now if the required return is 12.5 percent?
A) $16.76
B) $17.92
C) $18.14
D) $18.32
E) $15.79
50) Shares of ABBO stock are currently selling for $14.43 a share. The last annual dividend paid
was $1.61 a share, and dividends increase at a constant rate. If the market rate of return is 14
percent, what is the dividend growth rate?
A) 2.32%
B) 2.56%
C) 1.81%
D) 2.05%
E) 2.50%
51) XanEx is a new firm that just paid an annual dividend of $1 a share. The firm plans to increase
its dividend by 10 percent a year for the next 4 years and then decrease the growth rate to 2 percent
annually. If the required rate of return is 18.25 percent, what is one share of this stock worth today?
A) $8.05
B) $8.19
C) $11.05
D) $11.19
E) $14.81
52) The Extreme Reaches Corp.’s last annual dividend was $1.98 per share. The company is
planning on paying $2, $2, $2.50, and $3 a share over the next 4 years, respectively. After that, the
dividend will be a constant $2.50 per share per year. What is the current price of this stock if the
rate of return is 13 percent?
A) $19.17
B) $21.96
C) $16.57
D) $18.70
E) $23.71