Chapter 7 Reading: Stocks (Equity)--Characteristics and Valuation

Investors that rely on dividend income as a significant portion of their annual income tend to prefer this type of stock because it pays large, consistent dividends.

Income Stocks

What would be the change in the expected value of Monroe Manufacturing's stock if investors required a return of 16% on the company's stock?

P0 = 3.75 x (1+.05) / (0.16 - .05) = -13.42

Which of the following statements best describes how a change in a firm's stock price would affect a stock's capital gains yield? The capital gains yield on a stock that the investor already owns has a direct relationship with the firm's expected future stock price. The capital gains yield on a stock that the investor already owns has an inverse relationship with the firm's expected future stock price.

The capital gains yield on a stock that the investor already owns has a direct relationship with the firm's expected future stock price.

Savannah has to postpone her purchase of Seattle Seafood's preferred shares for just over four months. By the time she is ready to invest, the return on alternative investments of comparable risk has increased. She should expect the cost of her investment in Seattle Seafood's preferred shares to be ________ expensive.

less

Assume that Savannah delays her investment for another few months, and that when she is finally ready to make her 175-share investment in Seattle Seafood, the market price of Seattle Seafood's preferred stock has changed to $174.70 per share. If she pays this price to acquire each share of Seattle Seafood's preferred stock, what rate of return will Savannah earn on her investment? Remember that the shares have a par value of $100 and a dividend rate of 5.50%. 4.10% 2.99% 3.15% 2.52%

3.15%

Common stockholders have the right to elect a firm's board of directors, who in turn appoint the officers who manage the company. Most common stockholders transfer their right to vote to a second party through this instrument.

Proxy

Usually has no specified maturity date

common stock

May have a sinking fund provision

debt

Usually has no voting rights

debt

Edinburgh Exports pays an annual dividend rate of 11.80% on its preferred stock that currently returns 15.81% and has a par value of $100.00 per share. What is the value of Edinburgh's preferred stock? $74.64 per share $89.57 per share $100.00 per share $111.95 per share

dividend (ignore the %)/current return (as a decimal not %) = 11.80/.1581 = 74.64

Savannah is considering the purchase of 175 shares of the preferred stock of Seattle Seafood Company. The stock carries a par value of $100 per share and an annual dividend rate of 5.50%. Alternative investments of comparable risk are generating yields of 4.25%. Given this information, the per-share value of Seattle Seafood's preferred stock should be: $97.06 $161.76 $129.41 $116.47

per share value of Seattle Seafood's preferred stock should be: 5.5/4.25% = 129.41

For the same issuing firm and on the same day of issuance, which security tends to have a lower after-tax cost to the issuer, debt or preferred stock? Why is this the case? Debt, because its interest payments are not tax deductible Preferred stock, because its has priority over debt in the payment of dividends and the distribution of liquidated assets Preferred stock, because preferred stock issues are not allowed to have sinking fund provisions Debt, because its interest payments are tax deductible

Debt, because its interest payments are tax deductible

The return on this type of stock primarily comes from capital gains.

Growth Stocks

Which of the following conditions must hold true for the constant growth valuation formula to be useful and give meaningful results? The required rate of return, rsrs, must be greater than the long-run growth rate. The company's growth rate needs to change as the company matures. The company's stock cannot be a zero growth stock. Grade It Now Save & Continue

The required rate of return, rs, must be greater than the long-run growth rate.

Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $2.65 at the end of the year. Its dividend is expected to grow at a constant rate of 9.50% per year. If Walter's stock currently trades for $28.00 per share, then the expected rate of return on the stock is ________

2.65 / 28 = .09464286 .09464286 + .095 = .1896 = 18.96%

If Super's stock is in equilibrium, the current expected capital gains yield on Super's stock will be _____ per share.

= growth rate = 3.14%

If Super's stock is in equilibrium, the current expected dividend yield on the stock will be _______ per share.

= required return -growth rate= 7.88%-3.15%=4.73%

Super's expected stock price one year from today will be ______ per share.

=2.16*(1+3.15%)^2/(7.88%-3.15%)=$48.63

Super Carpeting Inc. just paid a dividend (D0D0) of $2.16, and its dividend is expected to grow at a constant rate (g) of 3.15% per year. If the required return (rs) on Super's stock is 7.88%, then the intrinsic, or theoretical market, value of Super's shares is ________ per share.

D0 = 2.16 , g = 3.15 , ke = 7.88 D1 = D0*(1+g) = 2.16(1+.0315) = 2.2280 P0 = D1/(ke-g) P0 = 2.2280/(7.88%-3.15%) =47.10 (correct answer is 47.15)

Which of the following statements is true about the constant growth model? When using a constant growth model to analyze a stock, if an increase in the required rate of return occurs while the growth rate remains the same, this will lead to an increased value of the stock. When using a constant growth model to analyze a stock, if an increase in the required rate of return occurs while the growth rate remains the same, this will lead to a decreased value of the stock.

When using a constant growth model to analyze a stock, if an increase in the required rate of return occurs while the growth rate remains the same, this will lead to a decreased value of the stock.

In some cases, individuals who start a business have special voting rights that help them exercise more control over the firm. They own a special class of stock called ______ shares.

founders'

The formula for the valuation of a share of preferred stock is P0=D/rsP0=D/rs. In this equation, the variable rs represents the

required rate of return on investment

Sony, a Japanese multinational firm, issued stock that trades on the FTSE exchange in London. The statement above is an example of which of the following? A Yankee stock An American Depository Receipt (ADR) A Euro stock

A Euro stock

Parrot Transport Corp. has the right to buy back its preferred stock from its preferred stockholders; however, the company will have to pay the preferred stockholders an amount greater than the par value of the preferred stock. Which type of provision does Parrot have in its preferred stock agreement? A sinking fund provision A call provision A participating provision

A call provision

The CEO of EchoStar Communications, Charlie Ergen, owned around 5% of the company's stock, but his multiple votes per share gave him around 90% of the vote. Based on this example, which of the following statements is true? -Classified shares have super-voting rights, which give more control to a certain class of investors. -Classified shares are not issued with the purpose of providing super-voting rights to a certain class of investors.

Classified shares have super-voting rights, which give more control to a certain class of investors.

You have taken a job as an entry-level analyst, and your boss has asked you to find the expected value of Monroe Manufacturing's stock. As you were doing your research, you found out that Monroe Manufacturing just paid a dividend (D0D0) of $3.75. The firm has experienced consistent growth of 5% for the last couple of years, and you believe that the firm will continue to grow at the same rate in the future. If investors require a return of 13% on Monroe Manufacturing's stock, what is the expected value of the company's stock? $39.38 $49.22 $54.14 $44.30

D1 = Do * (1+g) = 3.75 * (1+0.05) = 3.9375 expected value of stock = D1/(r-g) = 3.9375/(13%-5%) = .49218 = $49.22

Consider this case: Last year, Jackson Tires reported net sales of $80,000,000 and total operating costs (including depreciation) of $52,000,000. Jackson Tires has $83,500,000 of investor-supplied capital, which has an after-tax cost of 12.5%. If Jackson Tires's tax rate is 40%, how much value did its management create or lose for the firm during the year (rounded to the nearest whole dollar)? $6,362,500 $37,562,500 $1,749,688 $39,662,500

Economic Value Added(EVA)= Net Operating Profit After Taxes (NOPAT)-Invested Capital*WACC Again: NOPAT= Earnings before Interest and Taxes(EBIT)*(1- Tax Rate) Again: EBIT= Net Sales-Operating Expenses-Depreciation As given in the question: Net Sales= $ 80,000,000 and Operating Expenses Including Depreciation= $52,000,000, putting these values into the formula for EBIT we get;EBIT= $ 80,000,000-$52,000,000 ie. $28,000,000 Putting the value of EBIT and tax rate of 40% or .4 in the formula for NOPAT we get: Again as given in the question: Invested capital = $ 83,500,000 and WACC= 12.5% or .125, using these values and the value of NOPAT in the formula for Economic Value Added we get:Economic Value Added= $16,800,000-($ 83,500,000*.125) ie. $ 6,362,500.Since EVA is positive so the company has added a value of: =$ 6,362,500.

Which of the following statements is true? Increasing dividends will always increase the stock price. Increasing dividends will always decrease the stock price, because the firm is depleting internal funding resources. Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth.

Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth.

This protects common stockholders from the management team of a firm issuing a large number of additional shares and purchasing these shares themselves in an attempt to gain greater control over the company.

Preemptive Right

Suppose that there is high unemployment, which causes interest rates to fall, which in turn pulls the preferred stock's yield to 9.49%. The value of the preferred stock will _______

increase

Walter's dividend is expected to grow at a constant growth rate of 9.50% per year. What do you expect to happen to Walter's expected dividend yield in the future? It will stay the same. It will decrease. It will increase.

it will stay the same