Finance Chapter 9

You can estimate the value of a company's stock using models such as the corporate valuation model and the dividend discount model. Which of the following companies would you choose to evaluate if you were using the discounted dividend model to estimate the value of the company's stock? A company that is in a high-growth stage and plans to retain all its earnings for the next few years to support its growth. A company that has been distributing a portion of their earnings every quarter for the past six years.

A company that has been distributing a portion of their earnings every quarter for the past six years.

Based on your understanding of stock prices and intrinsic values, which of the following statements is true? A stock's intrinsic value is based on true investor returns. A stock's intrinsic value is based only on the perceived risk of a stock.

A stock's intrinsic value is based on true investor returns.

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

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

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

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

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

Which of the following statements accurately describes the relationship between earnings and dividends when all other factors are held constant? Long-run earnings growth occurs primarily because firms retain earnings and reinvest them in the business. Paying a higher percentage of earnings as dividends will result in a higher growth rate. Dividend growth and earnings growth are unrelated.

Long-run earnings growth occurs primarily because firms retain earnings and reinvest them in the business.

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? a.The dividend yield will be higher in the early years and then will decline as the annual capital gains yield gets larger and larger, other things held constant. b.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. c.The stock price will grow each year at the same rate as the dividends. d.The stock price will grow at a different rate each year during the first 5 years, but its average growth rate over this period will be the same as the average growth rate in dividends; that is, the average stock price growth rate will be (25% + 5%)/2. e.Because the growth rate is 25% in the first 5 years, the stock's realized return will always be greater than the stock's required return.

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? 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 common stocks, regardless of class, must pay the same dividend. d.Some classes of common stock are entitled to more votes per share than other classes. e.All firms have several classes of common stock.

Some classes of common stock are entitled to more votes per share than other classes.

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.

Which of the following describe the reason(s) why maximization of intrinsic stock value benefits society? Check all that apply: The owners of stock are society. Successful companies attract more talent. Workers prefer companies that minimize operating costs. Consumers benefit when companies rise prices beyond reasonable levels.

The owners of stock are society. Successful companies attract more talent.

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

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

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

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

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

True

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

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

True

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 growth rate occurs while the required return 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 growth rate occurs while the required return 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 growth rate occurs while the required return remains the same, this will lead to an increased value of the stock.

The preemptive right is important to shareholders because it _____. a.enables the firm to issue debt with a relatively low interest rate because the bondholders are protected b.allows managers to buy additional shares below the current market price c.will result in higher dividends per share d.is included in every corporate charter e.protects the current shareholders against a dilution of their ownership interests

e.protects the current shareholders against a dilution of their ownership interests