75) Which of the following is typically a feature of preferred stocks?
A) They are settled prior to common stocks during liquidation.
B) They are mostly noncumulative in nature.
C) They are paid dividends that grow at a constant rate.
D) They carry voting rights and have maturity date.
76) Identify whether the key characteristic describes common stock (CS) or preferred stock (PS).
________ 1. Source of financing which places minimum constraints on the firm
________ 2. Used by young firms receiving investment funds from venture capital firms
________ 3. Potential dilution of earnings and voting power
________ 4. Fixed financial obligation
________ 5. Increases the firm’s borrowing power
________ 6. May have cumulative and participating features
________ 7. May be convertible into another type of security
________ 8. Last to receive earnings or distribution of assets in the event of bankruptcy
________ 9. Frequently includes a call feature
77) Edward Accounting Services has an outstanding issue of 1,000 shares preferred stock with a $100 par
value, an 9 percent annual dividend, and 5,000 shares of common stock outstanding. If the stock is cumulative
and the board of directors has not paid the preferred dividend for the last two years, how much must
preferred stockholders be paid (in total, not per share) before dividends are paid to common stockholders?
78) American Depositary Receipts (ADRs) are claims issued by U.S. banks representing ownership of
shares of a foreign company’s stock held on deposit by the U.S. bank in the foreign market and issued in
dollars to U.S. investors.
7.3 Common stock valuation
1) Which of the following is true of securities analysts?
A) They raise initial external equity finance privately for firms.
B) They are primarily involved in underwriting of securities.
C) They find prospective buyers for new stocks or bonds issue.
D) They use a variety of models and techniques to value stocks.
2) Investors purchase a stock when they believe that it is undervalued and sell when they feel that it is
overvalued.
3) In an efficient market, the expected return and the required return are equal.
4) In an efficient market, stock prices adjust quickly to new public information.
5) In an inefficient market, stock prices adjust quickly to new public information.
6) In an inefficient market, securities are typically in equilibrium, which means that they are fairly priced
and that their expected returns equal their required returns.
7) In an efficient market, securities are typically in equilibrium, which means that they are fairly priced
and that their expected returns equal their required returns.
8) To a buyer, an asset’s value represents the minimum price that he or she would pay to acquire it.
9) If the expected return is less than the required return, investors will sell the asset, because it is not
expected to earn a return commensurate with its risk.
10) If the expected return were above the required return, investors would buy an asset, driving its price
up and its expected return down.
11) Efficient-market hypothesis is the theory describing the behavior of a market in which securities are
typically in equilibrium, security prices fully reflect all public information available and react swiftly to
new information, and, because stocks are fairly priced, investors need not waste time looking for
mispriced securities.
12) If a market is truly efficient, investors should not waste their time trying to find and capitalize on
mispriced securities.
13) Behavioral finance is a growing body of research that anomalies that are not consistent with the
efficient markets theory.
14) The constant growth model is an approach to dividend valuation that assumes a constant future
dividend.
15) The constant growth model is an approach to dividend valuation that assumes that dividends grow at
a constant rate indefinitely.
16) Rational buyers and sellers use their assessment of an asset’s risk and return to determine its value.
Relative to this concept, which of the following is true?
A) To a buyer the asset’s value represents the minimum price that he or she would pay to acquire it.
B) To a seller the asset’s value represents the maximum sale price.
C) To a buyer the asset’s value represents the maximum price that he or she would pay to acquire it.
D) To a seller the asset’s value represents the price at which he acquired the asset.
17) According to the efficient market hypothesis, prices of actively traded stocks ________.
A) can be under- or overvalued in an efficient market
B) can only be undervalued in an efficient market
C) do not differ from their true values in an efficient market
D) can only be overvalued in an efficient market
18) If an asset’s expected return is less than its required return, rational investors will ________.
A) buy the asset, which will drive the price up and cause expected return to reach the level of the
required return
B) sell the asset, which will drive the price down and cause the expected return to reach the level of the
required return
C) sell the asset, which will drive the price up and cause the expected return to reach the level of the
required return
D) buy the asset, since price is expected to increase
19) If the expected return is above the required return on an asset, rational investors will ________.
A) buy the asset, which will drive the price up and cause expected return to reach the level of the
required return
B) buy the asset, which will drive the price down and cause the expected return to reach the level of the
required return
C) sell the asset, which will drive the price up and cause the expected return to reach the level of the
required return
D) sell the asset, since price is expected to decrease
20) Which of the following is true of efficient-market hypothesis?
A) Securities are typically in disequilibrium, meaning they are fairly priced and their expected returns are
more than their required returns.
B) Insider trading scandals have proven that stocks are not fully and fairly priced; as a result, it would be
worthwhile for investors should spend time searching for mispriced (over– or undervalued) stocks.
C) At any point in time, security prices fully reflect all internal information available about the firm and
its securities, and these prices are insensitive to new information.
D) Since stocks are fully and fairly priced, it follows that investors should not waste their time trying to
find and capitalize on miss-priced (undervalued or overvalued) securities.
21) Preferred stock is valued as if it were a ________.
A) fixed-income obligation
B) bond
C) perpetuity
D) common stock
22) A firm has an issue of preferred stock outstanding that has a stated annual dividend of $4. The
required return on the preferred stock has been estimated to be 16 percent. The value of the preferred
stock is ________.
A) $64
B) $16
C) $25
D) $50
23) A certain preferred stock will pay a dividend of $1.20 per share till perpetuity. If the required return is
10 percent, the value of the preferred stock is ________.
A) $120
B) $10
C) $12
D) $100
24) A firm has an issue of preferred stock outstanding that has a par value of $100 and a 4% dividend. If
the current market price of the preferred stock is $50, the yield on the preferred stock is ________.
A) 4.00%
B) 6.00%
C) 8.00%
D) 12.00%
25) The ________ is utilized to value preferred stock.
A) capital asset pricing model
B) arbitrage pricing model
C) zero-growth model
D) Black-Scholes model
26) In the Gordon model, the value of a common stock is the ________.
A) net value of all assets which are liquidated for their exact accounting value
B) actual amount each common stockholder would expect to receive if the firm’s assets are sold
C) present value of a non-growing dividend stream
D) present value of a constant growing dividend stream
27) Emmy Lou, Inc. has an expected dividend next year of $5.60 per share, a growth rate of dividends of
10 percent, and a required return of 20 percent. The value of a share of Emmy Lou, Inc.’s common stock is
________.
A) $28.00
B) $56.00
C) $22.40
D) $18.67
28) A firm has experienced a constant annual rate of dividend growth of 9 percent on its common stock
and expects the dividend per share in the coming year to be $2.70. The required return on the firm’s stock
is 12 percent. The value of the firm’s common stock is ________.
A) $22.50/share
B) $9/share
C) $90/share
D) $30/share
29) You are planning to purchase the stock of Ted’s Sheds Inc. and you expect it to pay a dividend of $3 in
1 year, $4.25 in 2 years, and $6.00 in 3 years. You expect to sell the stock for $100 in 3 years. If your
required return for purchasing the stock is 12 percent, how much would you pay for the stock today?
A) $75.45
B) $77.24
C) $81.52
D) $85.66
30) Smith Corporation’s common stock is expected to pay a dividend of $3.00 forever and currently sells
for $21.42. What is the required rate of return?
A) 10%
B) 12%
C) 13%
D) 14%
31) Julian is considering purchasing the stock of Pepsi Cola because he really loves the taste of Pepsi.
What should Julian be willing to pay for Pepsi today if it is expected to pay a $2 dividend in one year and
he expects dividends to grow at 5 percent indefinitely? Julian requires a 12 percent return to make this
investment.
A) $28.57
B) $29.33
C) $31.43
D) $43.14
32) Harry Corporation’s common stock currently sells for $179.85 per share. Harry paid a dividend of
$10.18 yesterday, and dividends are expected to grow at a constant rate of 6 percent forever. If the
required rate of return is 12 percent, what will Harry Corporation’s stock sell for one year from now,
immediately after it pays its next dividend?
A) $190.64
B) $187.04
C) $195.40
D) $179.84
33) Tangshan China Company’s stock is currently selling for $80.00 per share. The expected dividend one
year from now is $4.00 and the required return is 13 percent. What is Tangshan’s dividend growth rate
assuming that dividends are expected to grow at a constant rate forever?
A) 8%
B) 9%
C) 10%
D) 11%
34) Tangshan China’s stock is currently selling for $160.00 per share and the firm’s dividends are expected
to grow at 5 percent indefinitely. Assuming Tangshan China’s most recent dividend was $5.50, what is
the required rate of return on Tangshan’s stock?
A) 7.3%
B) 8.6%
C) 9.5%
D) 10.6%
35) Daniel Custom Cycles’ common stock currently pays no dividends. The company plans to begin
paying dividends beginning 3 years from today. The first dividend will be $3.00 and dividends will grow
at 5 percent per year thereafter. Given a required return of 15 percent, what would you pay for the stock
today?
A) $25.33
B) $18.73
C) $29.86
D) $22.68
36) Jia’s Fashions recently paid a $2 annual dividend. The company is projecting that its dividends will
grow by 20 percent next year, 12 percent annually for the two years after that, and then at 6 percent
annually thereafter. Based on this information, how much should Jia’s Fashions common stock sell for
today if her required return is 10.5%?
A) $54.90
B) $60.80
C) $59.16
D) $69.30
37) The board of directors of Ride World, Inc. has declared $5.00 common stock dividend, payable one
year from today, and accepted a plan to freeze the dividend at $5 per year indefinitely. What is the value
of the Ride World’s common stock if the required rate of interest is 15 percent?
38) Jia’s Kitchen Stuff has recently sold 1,000 shares of preferred stock. What is the per share value of the
stock assuming 10 percent required rate of return and a preferred dividend of $6.75?
39) Aunt Tilly’s Fur Company has been experiencing several years of financial difficulty and, thus, has
considered maintaining its dividend payment at $2.50 indefinitely. What is the value of its common stock
if the required rate of return is 8.5 percent?
40) In response to the stock market’s reaction to its dividend policy, the Nico’s Toy Company has decided
to increase its dividend payment at a rate of 4 percent per year. The firm’s most recent dividend is $3.25
and the required rate of interest is 9 percent. What is the maximum you would be willing to pay for a
share of the stock?
41) Uncle Tim’s Inventions has an expected dividend next year of $3.60 and a required return of 12
percent. Assuming the same dividend will be paid indefinitely, calculate the value of a share of common
stock assuming a zero growth rate of dividends.