Chapter 7 - Corporate Finance

True or false: Common stock has a set maturity.

False - Common stock has no maturity.

True or false: Daily stock prices can only be found by looking up the stock in newspapers.

False

The constant-growth model assumes that _________.

dividends change at a constant rate

"Inside Quotes" represent the _________ and the ________.

highest bid price; lowest ask price

Stock price reporting has increasingly moved from traditional print media to the ______ in recent years.

internet

Gleason, Inc., elects its board of directors on a staggered basis using cumulative voting. This implies that:

all open positions are filled with one round of voting, assuming there are no tie votes.

A person who brings buyers and sellers together is called a(n) ______.

broker

Someone who maintains an inventory of stocks and buys and sells those stocks is known as a ____.

dealer

All else constant, the dividend yield will increase if the stock price ____.

decreases

A PE ratio that is based on estimated future earnings is known as a ____________ PE ratio.

forward

The value of a firm is derived using the firm's ______ rate and its _______ rate.

growth; discount

New York Stock Exchange Designated Market Makers (DMMs) were formerly called ________ .

specialists

Earnings over the coming year are expected to be $3 and a benchmark PE of 15 applies to earnings over the previous year. The _____, or forecast, price over the coming year is $45.

target

Using a benchmark PE ratio against current earnings yields a forecasted price called a _______ price.

target

Delfino's expects to pay an annual dividend of $1.50 per share next year. What is the anticipated dividend for Year 5 if the firm increases its dividend by 2 percent annually?

$1.50 ×(1.02)^4

A benchmark PE ratio can be determined using:

-a company's own historical PEs -the PEs of similar companies

Which of the following are cash flows to investors in stocks?

Capital gains Dividends

P1 = (__ + P2)/(1 + R)

D 2

The trading of existing shares occurs in the ______ market.

secondary

The dividend yield is determined by dividing the expected dividend (D1) by:

the current price (P0)

NASDAQ has which of these features?

Computer Network of Securities Dealers Multiple Market Maker System

R = ______

D1/P0 + g

The price of a share of common stock is equal to the present value of all ______ future dividends.

expected

When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:

one vote per share held

The fundamental business of the New York Stock Exchange is to attract _______.

order flow

True or false: A PE ratio that is based on estimated future earnings is called a regressive PE ratio.

FALSE Forward PE ratio

The dividend yield is defined as:

next year's expected dividend divided by the current market price per share.

True or false: Total return is calculated by adding the dividend yield and the capital gains yield.

true

Triad common stock is selling for $27.80 a share and has a dividend yield of 2.8 percent. What is the dividend amount?

Dividend =.028 ×$27.80 = $.78

What is the formula for the present value of a growing perpetuity where C1 is the net cash flow, R is the required return and g is the growth rate?

P=C1/(R-g)

If unpaid preferred dividends must be "caught up" before any common dividends can be paid, they are called _________ dividends.

cumulative

If the growth rate (g) is zero, the capital gains yield is ____.

zero

Three special case patterns of dividend growth discussed in the text include:

zero growth constant growth non-constant growth

A particular stock sells for $43.20 share and provides a total return of 11.6 percent. The total return is evenly divided between the capital gains yield and the dividend yield. Assuming a constant dividend growth rate, what is the current dividend per share?

(.116/2) = [D0 × (1 + (.116/2)]/$43.20 D0 = $2.37

The Glass Ceiling paid an annual dividend of $1.64 per share last year and just announced that future dividends will increase by 1.3 percent annually. What is the amount of the expected dividend in Year 6?

D6= $1.64 ×(1.013)^6 = $1.77

Which statement is true? From a legal perspective, preferred stock is a form of corporate equity. All classes of stock must have equal voting rights per share. Common shareholders elect the corporate directors while the preferred shareholders vote on mergers and acquisitions. Preferred dividends provide tax-free income to individual investors. Preferred shareholders prefer noncumulative dividends over cumulative dividends.

From a legal perspective, preferred stock is a form of corporate equity.

Which of the following are rights of common stock holders? The right to share proportionally in any common dividends paid. The right to vote on matters of importance. First claim on any assets in the event of liquidation. The right to dividends each year The right to share proportionally in any residual value in the event of liquidation.

The right to share proportionally in any common dividends paid. The right to vote on matters of importance. The right to share proportionally in any residual value in the event of liquidation.

Industrial Products has both common and noncumulative preferred stock outstanding. The dividends on these stocks are $1.10 per quarter per share of common and $2.25 per quarter per share of preferred. The company has not paid any dividends for the past two quarters but is expected to pay dividends on both the common and the preferred stock next quarter. What is the minimum amount the firm must pay per share to its preferred stockholders next quarter if it plans to pay a common dividend?

Minimum preferred dividend = $2.25 The firm needs to pay only the current dividend as the preferred stock is noncumulative.

The two most important stock markets in the U.S. are the New York Stock Exchange and ______.

NASDAQ

This type of growth describes a company that grows quickly at first, then slower in future years.

Non-constant

Which of the following defines the primary market? The primary market is where stocks are issued for the first time. Primary markets are markets that are regulated by the Fed. The primary market is where stocks trade once they have been issued. Primary markets are markets for basic goods and services.

The primary market is where stocks are issued for the first time.

The NYSE differs from the NASDAQ primarily because the NYSE has:

a face-to-face auction market a physical location

Dixie Mart plans to pay dividends of $1.36, $1.15, $1.35, and $.40 at the end of the next four years, respectively. After that, the company will be sold and shareholders are expected to receive $82.40 per share in Year 6 when the sale should be finalized. If the required return is 11.4 percent, what is the current value of one share of this stock?

P0 = $1.36 / 1.114 + $1.15 / 1.1142 + $1.35 / 1.1143 + $.40 / 1.1144 + $82.40 / 1.1146 P0 =$46.50

Which of the following ratios might be used to estimate the value of a stock?

The Price/Sales ratio The Price/Earnings ratio

When valuing a stock using the constant-growth model, D1 represents the:

the next expected annual dividend.

Which of the following are reasons that make valuing a share of stock more difficult than valuing a bond? Dividends are unknown and uncertain Dividends are unknown but certain Different stock issues have different maturity dates The required rate of return is unobservable Stock has no set maturity

Dividends are unknown and uncertain The required rate of return is unobservable Stock has no set maturity

Which one of the following is true about dividend growth patterns?

Dividends may grow at a constant rate.

(T/F) For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.

False: Neither dividends nor capital gains are fixed or guaranteed.

Gamma Corp. is expected to pay the following dividends over the next four years: $7.50, $8.25, $15, and $1.80. Afterward, the company pledges to maintain a constant 4 percent growth rate in dividends, forever. If the required return is 14 percent, what is the current share price?

P4 = ($1.80 × 1.04)/(.14 -.04) = $18.72 P0 = ($7.50/1.14) + ($8.25/1.14^2) + ($15/1.14^3) + [($1.80 + 18.72)/1.14^4] = $35.20

What information do we need to determine the value of a stock using the zero growth model?

Dividend Discount rate

A preferred stock sells for $54.20 a share and has a market return of 9.68 percent. What is the dividend amount?

Dividend = .0968 ×$54.20 = $5.25

Breakfast Hut pays a constant annual dividend of $1.39 per share. How much are you willing to pay for one share if you require a rate of return of 14.6 percent?

P = $1.39 /.146 = $9.52

If a company's growth for Years 1 through 3 is 20% but stabilizes at 5% beginning in Year 4, its growth pattern would be described as _______.

non-constant

Dividends are

paid out of net income.

Mary owns 100 shares of stock. Each share entitles her to one vote per open seat on the board of directors. Assume there are three open seats in the current election and Mary casts all 300 of her votes for a single candidate. What is the term used to describe this type of voting?

Cumulative

Braxton's Cleaning Company stock is selling for $32.60 a share based on a rate of return of 13.8 percent. What is the amount of the next annual dividend if the dividends are increasing by 2.4 percent annually?

D1 = $32.60 ×(.138-.024) = $3.72

Which of the following represents the valuation of stock using a zero growth model?

Dividend/Discount rate = D/R

In the dividend growth model, the expected return for investors comes from which two sources?

Growth rate Dividend Yield

The ______ can be interpreted as the capital gains yield.

Growth rate The growth rate can be interpreted as the capital gains yield. In the formula R = dividend yield plus capital gains yield, dividend yield = D/P and capital gains yield = g.

TMS just paid an annual dividend of $2.84 per share on its stock. The dividends are expected to grow at a constant rate of 1.85 percent per year. If investors require a rate of return of 10.4 percent, what will be the stock price be in Year 11?

P11 = ($2.84 ×1.0185^12)/(.104-.0185) = $41.39

Village East expects to pay an annual dividend of $1.40 per share next year, and $1.68 per share for the following two years. After that, the company plans to increase the dividend by 3.4 percent annually. What is this stock's current value at a discount rate of 13.7 percent?

P3= ($1.68 × 1.034) / (.137 - .034)= $16.86 P0 = $1.40 / 1.137 + $1.68 / 1.137^2 + ($1.68+ $16.86)/ 1.137^3 P0= $15.15

Preferred stock has preference over common stock in the:

distribution of corporate assets payment of dividends

Which one of the following is an electronic network that enables Katie to sell her shares of ABC stock directly to Marti?

ECN

P1 - Price in one year D1 - Next expected Dividend R - Discount rate P0 - Price today D0 - Dividend just paid

P1 - Price in one year D1 - Next expected Dividend R - Discount rate P0 - Price today D0 - Dividend just paid