Answer Options:
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: To implement the corporate valuation model, we discount projected free cash flows at the cost of equity capital.
Answer Options:
a. To implement the corporate valuation model, we discount net operating profit after taxes (NOPAT) at the weighted average cost of capital.
b. To implement the corporate valuation model, we discount projected net income at the weighted average cost of capital.
c. To implement the corporate valuation model, we discount projected net income at the weighted average cost of capital.
d. To implement the corporate valuation model, we discount projected free cash flows at the cost of equity capital.
e. The corporate valuation model requires the assumption of a constant growth rate in all years.
Answer: A. To implement the corporate valuation model, we discount net operating profit after taxes (NOPAT) at the weighted average cost of capital.
Question: The corporate valuation model cannot be used unless a company pays dividends.
Answer Options:
a. True
b. False
Answer: B. False
Question: Classified stock differentiates various classes of common stock, and using it is one way companies can meet special needs such as when owners of a start-up firm need additional equity capital but don’t want to relinquish voting control.
Answer Options:
a. True
b. False
Answer: A. True
Question: The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold.
Answer Options:
a. True
b. False
Answer: B. False
Question: Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock’s market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor’s required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.
Answer Options:
a. True
b. False
Answer: B. False
Question: The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT?
Answer Options:
a. The stock’s dividend yield is 7%.
b. The stock’s dividend yield is 8%.
c. The current dividend per share is $4.00.
d. The stock price is expected to be $54 a share one year from now.
e. The stock price is expected to be $57 a share one year from now.
Answer: D. The stock price is expected to be $54 a share one year from now.
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 Options:
a. True
b. False
Answer: A. True
Question: A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?
Answer Options:
a. The company’s current stock price is $20.
b. The company’s dividend yield 5 years from now is expected to be 10%.
c. The constant growth model cannot be used because the growth rate is negative.
d. The company’s expected capital gains yield is 5%.
e. The company’s expected stock price at the beginning of next year is $9.50.
Answer: E. The company’s expected stock price at the beginning of next year is $9.50.
Question: The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value.
Answer Options:
a. True
b. False
Answer: A. True
Question: Which of the following statements is CORRECT?
Answer Options:
a. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.
b. If a stock has a required rate of return r_s = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.
c. The stock valuation model, P_0 = D_1/(r_s – g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.
d. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
e. The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.
Answer: C. The stock valuation model, P_0 = D_1/(r_s – g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.
Question: Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
Answer Options:
a. Stock A must have a higher stock price than Stock B.
b. Stock A must have a higher dividend yield than Stock B.
Answer: A. Stock A must have a higher stock price than Stock B.