chapter 9

When stockholders assign their right to vote to another party, this is called

A proxy. Proxy fights occur when a dissident group of stockholders solicits proxies in competition with the firm's management. If the dissident group obtains a majority of the proxies, then it can gain control of the board of directors and oust existing management.

A preemptive right gives stockholders the right to call for a meeting to vote to replace the management. Without the preemptive right, dissident stockholders would have to seek a change in management through a proxy fight.

False A preemptive right is used to maintain shareholder positions if new shares are issued.

An investor using the DCF stock valuation model would assign a value based on the length of time he or she plans to hold the stock.

False The investor needs to consider the value during the holding period as well as the price at which the share will be sold to someone else.

To find the total return on a share of stock, find the dividend yield and subtract any commissions paid when the stock is purchased and sold.

False Total return is dividend yield plus capital appreciation.

Your sister-in-law, a stockbroker at Invest Inc., is trying to sell you a stock with a current market price of $25. The stock's last dividend (D0) was $2.00, and earnings and dividends are expected to increase at a constant growth rate of 10%. Your required return on this stock is 20%. From a strict valuation standpoint, you should:

Not buy the stock; it is overvalued by $3.00.

The preemptive right is important to shareholders because it:

Protects the current shareholders against a dilution of their ownership interests. A preemptive right is used to maintain shareholder positions if new shares are issued.

Assume that a company's dividends are expected to grow at a rate of 25% per year for 5 years and then to slow down and to grow at a constant rate of 5% thereafter. The required (and expected) total return, rs, is expected to remain constant at 12%. Which of the following statements is correct?

Right now, it would be easier (require fewer calculations) to find the dividend yield expected in Year 7 than the dividend yield expected in Year 3.

Which of the following statements about stock classes is CORRECT?

Some classes of common stock are entitled to more votes per share than other classes. Classified stock is a way to differentiate shares of common stock that have different privileges, but not all firms have classified stock.

Which of the following assumptions would cause the constant growth stock valuation model to be invalid? The constant growth model is given below:

The required rate of return is less than the growth rate. If this equation is used in situations when rs is less than g, the results will be both wrong and meaningless.

In order to prevent dilution of control or dilution of value, shareholders use preemptive rights to purchase, on a pro rata basis, any new shares issued by the firm.

True A preemptive right is used to maintain shareholder positions if new shares are issued.

A document that gives one party the authority to act for another party is a proxy. This includes the power to vote shares of common stock. Proxies can be important tools relating to control of firms.

True A proxy is used by shareholders to vote their common shares.

Because stock has a residual claim rather than a contractual obligation, the cash flows associated with common stock are more difficult to estimate than those related to bonds.

True Bonds are paid before common stock, and it is difficult to estimate what will be left over.

Classified stock is the differentiation of different shares of common stock. It gives companies a way to meet special needs such as when owners of a start-up firm need additional equity capital but do not want to relinquish voting control.

True Classified stock is a way to differentiate shares of common stock that have different privileges.

To find the firm's total corporate value, discount projected free cash flows at the firm's weighted average cost of capital.

True Corporate value is based on cash flows discounts at the weighted average cost of capital.

The type of classified stock where the shares are owned by the firm's founders is called founder's shares. With founders' shares, shareholders generally have more votes per share than with other classes of common stock.

True Founders' shares are a common type of classified stock that are used to differentiate shares of common stock that have different privileges.

The marginal investor determines the price at which a new issue of stock will trade when it is brought to market.

True The marginal trade is the one that closes the IPO and sets the price of trading.