a. True
b. False
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT, assuming stocks are in equilibrium?
a. The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.
b. Assume that the required return on a given stock is 13%. If the stock’s dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.
c. A stock’s dividend yield can never exceed its expected growth rate.
d. A required condition for one to use the constant growth model is that the stock’s expected growth rate exceeds its required rate of return.
e. Other things held constant, the higher a company’s beta coefficient, the lower its required rate of return.
Answer Choices:
a. The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.
b. Assume that the required return on a given stock is 13%. If the stock’s dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.
c. A stock’s dividend yield can never exceed its expected growth rate.
d. A required condition for one to use the constant growth model is that the stock’s expected growth rate exceeds its required rate of return.
e. Other things held constant, the higher a company’s beta coefficient, the lower its required rate of return.
Answer: a. The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.
Question: According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock.
Answer Choices:
a. True
b. False
Answer: False
Question: Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?
Answer Choices:
a. All common stocks fall into one of three classes: A, B, and C.
b. All common stocks, regardless of class, must have the same voting rights.
c. All firms have several classes of common stock.
d. All common stock, regardless of class, must pay the same dividend.
e. Some class or classes of common stock are entitled to more votes per share than other classes.
Answer: e. Some class or classes of common stock are entitled to more votes per share than other classes.
Question: The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation’s taxable income.
a. True
b. False
Answer Choices:
a. True
b. False
Answer: b. False
Question: 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 this investor’s required return.
Answer Choices:
a. True
b. False
Answer: True
Question: The corporate valuation model cannot be used unless a company pays dividends.
Answer Choices:
a. True
b. False
Answer: False
Question: Markets are in equilibrium, which of the following conditions will exist?
a. Each stock’s expected return should equal its realized return as seen by the marginal investor.
b. Each stock’s expected return should equal its required return as seen by the marginal investor.
c. All stocks should have the same expected return as seen by the marginal investor.
d. The expected and required returns on stocks and bonds should be equal.
e. All stocks should have the same realized return during the coming year.
Answer Choices:
a. Each stock’s expected return should equal its realized return as seen by the marginal investor.
b. Each stock’s expected return should equal its required return as seen by the marginal investor.
c. All stocks should have the same expected return as seen by the marginal investor.
d. The expected and required returns on stocks and bonds should be equal.
e. All stocks should have the same realized return during the coming year.
Answer: b. Each stock’s expected return should equal its required return as seen by the marginal investor.
Question: 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.
Answer Choices:
a. True
b. False
Answer: True
Question: 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.
Answer Choices:
a. increase.
b. decrease.
c. fluctuate less than before.
d. fluctuate more than before.
e. possibly increase, possibly decrease, or possibly remain constant.
Answer: e. possibly increase, possibly decrease, or possibly remain constant.
Question: The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm’s WACC.
a. True
b. False
Answer Choices:
a. True
b. False
Answer: b. False
Question: From an investor’s perspective, a firm’s preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer’s standpoint, these risk relationships are reversed: bonds are the most risky for the firm, preferred is next, and common is least risky.
Answer Choices:
a. True
b. False
Answer: True
Question: If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks
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.
Answer Choices:
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.
Answer: c. the stock is a good buy.
Question: When a new issue of stock is brought to market, it is the marginal investor who determines the price at which the stock will trade.
Answer Choices:
a. True
b. False
Answer: True
Question: The corporate valuation model can be used only when a company doesn’t pay dividends.
Answer Choices:
a. True
b. False
Answer: False
Question: If a stock’s expected return as seen by the marginal investor exceeds this investor’s 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.
Answer Choices:
a. True
b. False
Answer: True
Question: Projected free cash flows should be discounted at the firm’s weighted average cost of capital to find the firm’s total corporate value.
Answer Choices:
a. True
b. False
Answer: True
Question: Preferred stock is a hybrid—a sort of cross between a common stock and a bond—in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.
Answer Choices:
a. True
b. False
Answer: False
Question: Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT?
Answer Choices:
a. The two stocks must have the same dividend per share.
b. If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
c. If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
d. The two stocks must have the same dividend growth rate.
e. The two stocks must have the same dividend yield.
Answer: b. If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
Question: 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?
Answer Choices:
a. If Stock A has a lower dividend yield than Stock B, 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, 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.
Answer: a. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B’s.
Question: The preemptive right is important to shareholders because it
Answer Choices:
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.
Answer: d. protects the current shareholders against a dilution of their ownership interests.
Question: The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.
a. True
b. False
Answer Choices:
a. True
b. False
Answer: a. True
Question: The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.
a. True
b. False
Answer Choices:
a. True
b. False
Answer: b. False
Question: 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.
Answer Choices:
a. True
b. False
Answer: True
Question: 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.
Answer Choices:
a. True
b. False
Answer: True