Chapter 10

Stock Valuation
Multiple Choice Questions

Instructions: For each question there are several answers. Clearly mark the best
answer.
1. The expected rate of return on a share of common stock whose dividends are growing at a
constant rate (g) is which of the following?
A. (D1 + g)/Vc
B. D1/Vc + g
C. D1/g
D. D1/Vc

2. Common stockholders are essentially:

A. Creditors of the firm.
B. Managers of the firm.
C. Owners of the firm.
D. All of the above.

3. ________ gives minority shareholders more power to elect board of directors.

A. Preemptive right
B. Majority voting
C. Proxy fights
D. Cumulative voting

4. CEO naming friends to the board of directors and paying them more than the norm is an
example of the:
A. Agency problem.
B. Preemptive right.
C. Majority voting feature.
D. Proxy fights.

5. A decrease in the ________ will cause an increase in common stock value.

A. growth rate
B. required rate of return
C. last paid dividend
D. both B and C

6. KDP's most recent dividend was $2.00 per share and is selling today in the market for $70.
The dividend is expected to grow at a rate of 7% per year for the foreseeable future. If the
 market return is 10% on investments with comparable risk, should you purchase the stock?
A. No, because the stock is overpriced $1.33.
B. No, because the stock is overpriced $3.33.
C. Yes, because the stock is underpriced $1.33.
D. Yes, because the stock is underpriced $3.33.

7. An issue of common stock currently sells for $50.00 per share, has an expected dividend to
be paid at the end of the year of $2.50 per share, and has an expected growth rate to infinity
of 5% per year. If investors' required rate of return for this particular security is 12% per
year, then this security is:
A. Overvalued and offering an expected return higher than the required return.
B. Undervalued and offering an expected return higher than the required return.
C. Overvalued and offering an expected return lower than the required return.
D. Undervalued and offering an expected return lower than the required return.

8. Which investor incurs the greatest risk?

A. Mortgage bondholder
B. Preferred stockholder
C. Common stockholder
D. Debenture bondholder

9. What allows common stockholders the right to cast a number of votes equal to the number of
directors being elected?
A. The majority voting provision
B. The casting feature
C. The cumulative voting provision
D. The proxy method

10.The shareholder can cast all votes for a single candidate or split them among various
candidates through:
A. Proxy fights.
B. Cumulative voting.
C. Call provisions.
D. Majority voting.

11.Common stockholders expect greater returns than bondholders because:

A. They have no legal right to receive dividends.
B. They bear greater risk.
C. In the event of liquidation, they are only entitled to receive any cash that is left after all
creditors are paid.
D. All of the above.

12.If a stock has a much higher than normal P/E ratio, investors probably expect:
A. Slow growth in earnings.
B. Rapid growth in earnings.
C. Large increases in the price of the stock.
D. a declining stock price

13.Which of the following factors will influence a firm's P/E ratio?

A. The investors' required rate of return
B. Firm investment opportunities
C. General market conditions
D. All of the above

14.The P/E ratio is calculated by dividing:

A. The current stock price by stockholders' equity.
B. Total assets by net income.
C. The current stock price by earnings per share.
D. The current stock price by operating cash flow per share.

15.If the ROE on a new investment is less than the firm's required rate of return:
A. The investment increases the firm's value.
B. The investment leaves the firm's value unchanged.
C. The effect on the firm's value is unpredictable.
D. The investment reduces the firm's value.

16.Which of the following statements is true?

A. Preferred stockholders are entitled to dividends before common stockholders can receive
dividends.
B. Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not
pay back the investment.
C. The market value of preferred stock, like bonds, will usually fluctuate in value primarily as
the result of market rates of interest.
D. All of the above.

17.Which of the following statements concerning preferred stock is correct?

A. Preferred stock generally is more costly to the firm than common stock.
B. Most issues of preferred stock have a cumulative feature.
C. Preferred dividend payments are tax-deductible.
D. Preferred stock is a riskier form of capital to the firm than bonds.

18.Edison Power of light has an outstanding issue of cumulative preferred stock with an annual
fixed dividend of $2.00 per share. It has not paid the preferred dividend for the last 3 years,
but intends to pay a dividend on the common stock in the coming year. Before Edison can
pay a dividend on the common stock
A. Preferred shareholders may cast all their votes for a single director.
B. Preferred shareholders must receive dividends totaling $8.00 per share.
C. Preferred shareholders must receive $2.00 per share.
D. Will not necessarily receive any dividend.

19.Which of the following provisions is unique to preferred stockholders and usually NOT
available to common stockholders?
A. Cumulative dividends feature
B. Voting rights
C. Fixed dividend
D. Both A and C

20.McMillen House of Books recently paid a $3 dividend on its preferred stock. Investors
require a 6% return on the stock. The stock is currently selling for $45. Is the stock a good
buy?
A. Yes, as it is undervalued $5.
B. Yes, as it is undervalued $10.
C. No, as it is overvalued $5.
D. No, as it is overvalued $10.

21.Horizon Communications stock pays a fixed annual dividend of of $3.00. Because of lower
inflation, the market's required yield on this preferred stock has gone from 12% to 10%. As a
result:
A. Horizon's dividend decreased by 6 cents.
B. The value of Horizon's preferred increased by $3.00.
C. The value of Horizon's preferred decreased by $5.00.
D. The value of Horizon's preferred increased by $5.00.

22.Preferred stock is similar to a bond in the following way.

A. Preferred stock always contains a maturity date.
B. Both investments provide a fixed income.
C. Both contain a growth factor similar to common stock.
D. None of the above.

23.A decrease in the ________ will increase the value of preferred stock.
A. expected rate of return
B. life of the investment
C. dividend paid
D. both A and C

24.Which of the following formulas is appropriate to find the value of preferred stock with a
fixed dividend?
A. Value of preferred stock = Annual Preferred Stock Dividend (1+ growth rate)/Market's
Required Yield on Preferred Stock
B. Value of preferred stock = Annual Preferred Stock Dividend (1+ growth rate)/Market's
Required Yield on Preferred Stock - growth rate
C. Value of preferred stock = Annual Preferred Stock Dividend/Market's Required Yield on
 Preferred Stock
D. Value of preferred stock = Annual Preferred Stock Dividend/Investor's Required Yield on
Preferred Stock

25.Expected cash flow for a preferred stock primarily consists of:

A. Dividend payments.
B. Changes in the price of the stock.
C. Interest payments.
D. Both A and B.
26.Preferred stock is similar to common stock in that:
A. It has no fixed maturity date.
B. The nonpayment of dividends can bring on bankruptcy.
C. Dividends are limited in amount.
D. All of the above.

27.How is preferred stock affected by a decrease in the required rate of return?

A. The value of a share of preferred stock decreases.
B. The dividend increases.
C. The dividend decreases.
D. The value of a share of preferred stock increases.

28.An example of a primary market transaction is:

A. A new issue of stock by Evergreen Solar.
B. A purchase of Microsoft stock on NASDAQ.
C. Target repurchasing some its own stock from an investor.
D. A sale of IBM stock on the NYSE.

29.The largest market for bond trading is:

A. NYSE.
B. NASDAQ.
C. AMEX.
D. The CBOT.

30.Which of the following companies is most likely to trade on the New York Stock Exchange?
A. Dell
B. Genzyme Transgenics
C. Coca Cola
D. Tata Motors

31.Which of the following exchanges has the strictest listing requirements?

A. AMEX
B. Nasdaq
C. NYSE
D. OTC
32.A small, newly listed technology company is most likely to be listed on:
A. AMEX.
B. NYSE.
C. NASDAQ National Markets.
D. NASDAQ Capital Markets.

33.Listing requirements for the New York Stock Exchange include:

A. Profitability.
B. Market value.
C. Breadth of ownership.
D. All of the above.

34.Preferred stock valuation usually treats the preferred stock as a

A. Capital asset.
B. Perpetuity.
C. Common stock.
D. Long-term bond.

35.Preferred stock is similar to a bond in the following way

A. Preferred stock always contains a maturity date.
B. Both investments provide a stated income stream.
C. Both contain a growth factor similar to common stock.
D. Both provide interest payments.

36.Cumulative preferred stock

A. Requires dividends in arrears to be carried over into the next period.
B. Has a right to vote cumulatively.
C. Has a claim to dividends before bonds.
D. Has a higher required return than common stock.

37.How is preferred stock similar to bonds?

A. Dividend payments to preferred shareholders (much like bond interest payments to
bondholders) are tax deductible.
B. Investors can sue the firm if preferred dividend payments are not paid (much like
bondholders can sue for non-payment of interest payments).
C. Preferred stockholders receive a dividend payment (much like interest payments to
bondholders) that is usually fixed.
D. Preferred stock is not like bonds in any way.

38.Most preferred stocks have a feature that requires all past unpaid preferred dividend
payments be paid before any common stock dividends can be paid. What is the name of this
feature?
A. Participating
B. Cumulative
C. Provisional
D. Convertible

39.Many preferred stocks have a provision that entitles a company to repurchase its preferred
stock from their holders at stated prices over a given time period. What is the name of this
provision?
A. Cumulative
B. Putable
C. Callable
D. Convertible

40.Many preferred stocks have a feature that requires a firm to periodically set aside an amount
of money for the retirement of its preferred stock. What is the name of this feature?
A. Convertible
B. Callable
C. Cumulative
D. Sinking fund

41.Keyes Corporation preferred stock pays an annual dividend of $7 per share. Which of the
following statements is true for an investor with a required return of 9%?
A. The value of the preferred stock is $7 because the dividend is fixed at $7 each year.
B. The value of the preferred stock is $63.00 per share.
C. The value of the preferred stock is $77.78 per share.
D. The value of the preferred stock is $6.30 per share because of the 9% required return.

42.Which of the following statements concerning preferred stock is most correct?

A. Preferred stock is valued the same as zero coupon bonds because the cash flow patterns are
similar.
B. If a corporation issues 4% preferred stock with a par value of $100, the dividend will
increase by 4% per year.
C. Preferred stock dividends are typically the same each year, allowing a preferred stock to be
valued as perpetuity.
D. Preferred stock dividends are calculated as a percentage of common stock dividends,
although the preferred stock dividends must be paid first.

43.How is preferred stock affected by a decrease in the required rate of return?

A. The value of a share of preferred stock increases.
B. The dividend increases.
C. The dividend decreases.
D. The dividend yield increases.

44. If a shareholder cannot attend the corporation's annual meeting, the shares may still be
voted using
A. The preemptive right.
B. A proxy.
C. Majority voting rules.
D. The cumulative voting right.

45. Minority shareholders have a greater chance of electing a member to the board of directors
if the company uses
A. Cumulative voting.
B. Majority voting.
C. Minority voting.
D. Proxy voting.

46. Preferred stock differs from common stock in that

A. Preferred stock usually has a maturity date.
B. Preferred stock investors have a higher required return than common stock investors.
C. Preferred stock dividends are fixed.
D. Common stock investors have a required return and preferred stock investors do not.

47. How is preferred stock similar to common stock?

A. Preferred dividend payments usually have unlimited growth potential.
B. Investors cannot sue a corporation for the non-payment of dividends.
C. Both preferred and common stockholders have voting control of a firm.
D. Preferred stock dividends and common stock dividends are fixed.

48. Which of the following is not true regarding common stock?

A. Dividends, unlike interest payments, are not tax deductible.
B. Common stock, unlike bond principal, does not mature.
C. Common stockholders are owners of the firm, whereas bondholders are creditors.
D. Dividend payments, like interest payments, are fixed.

49. Consider the following four types of payments that could be made by a normal operating
firm: interest, common dividends, income taxes, and preferred dividends. Compared to the
other payments mentioned, where would you rank common dividend payments in terms of
the order of payment if the firm is liquidating?
A. First
B. Second
C. Third
D. Fourth

50. Assume that a firm had such serious financial problems that it was about to be liquidated
after a bankruptcy. All of the firm's assets are about to be sold in order to pay the following
claims against the firm: bondholders, preferred stockholders, common stockholders, and
federal income taxes. Of the claims mentioned, what priority would common stockholders
have?
A. First
B. Second
C. Third
D. Fourth