Chapter 7: Equity Markets and Stock Valuation

CHAPTER 7 Equity Markets and Stock Valuation

I. DEFINITIONS

Topic: GROWING PERPETUITY [Link] asset characterized by cash !o"s that increase at a constant rate ore#er is ca!!ed a: A$ Gro"in% perpet&ity. '$ Gro"in% ann&ity. ($ (o))on ann&ity. *$ Perpet&ity d&e. E$ Pre erred stoc+. Ans"er: A

Topic: *I,I*EN* GROWT- .O*E/ [Link] stoc+ #a!&ation )ode! that deter)ines the c&rrent stoc+ price as the ne1t di#idend di#ided by the 2disco&nt rate !ess the di#idend %ro"th rate$ is ca!!ed the: A$ 3ero %ro"th )ode!. '$ *i#idend %ro"th )ode!. ($ (apita! Asset Pricin% .ode!. *$ Earnin%s capita!ization )ode!. Ans"er: '

Topic: *I,I*EN* YIE/* 4.A stoc+5s ne1t e1pected di#idend di#ided by the c&rrent stoc+ price is the: A$ (&rrent yie!d. '$ Tota! yie!d. ($ *i#idend yie!d. *$ (apita! %ains yie!d. E$ Earnin%s yie!d. Ans"er: (

Topic: (APITA/ GAIN6 YIE/* [Link] rate at "hich the stoc+ price is e1pected to appreciate 2or depreciate$ is the: A$ (&rrent yie!d. '$ Tota! yie!d. ($ *i#idend yie!d. *$ (apita! %ains yie!d.

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 1

Chapter 7: Equity Markets and Stock Valuation

E$ Earnin%s yie!d. Ans"er: *

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: (O..ON 6TO(8 9.E:&ity "itho&t priority or di#idends or in the e#ent o ban+r&ptcy is ca!!ed: A$ *&a! c!ass stoc+. '$ (&)&!ati#e stoc+. ($ *e erred stoc+. *$ Pre erred stoc+. E$ (o))on stoc+. Ans"er: E

Topic: PRE;ERRE* 6TO(8 <.E:&ity "ith priority or di#idends and in the e#ent o ban+r&ptcy is ca!!ed: A$ *&a! c!ass stoc+. '$ (&)&!ati#e stoc+. ($ *e erred stoc+. *$ Pre erred stoc+. E$ (o))on stoc+. Ans"er: *

Topic: (U.U/ATI,E ,OTING =.The #otin% proced&re "here shareho!ders )ay cast a!! o their #otes or one )e)ber o the board is: A$ *e)ocratic #otin%. '$ (&)&!ati#e #otin%. ($ 6trai%ht #otin%. *$ *e erred #otin%. E$ Pro1y #otin%. Ans"er: '

Topic: 6TRAIG-T ,OTING >.The #otin% proced&re "here shareho!ders )ay cast a!! o their #otes or each )e)ber o the board is: A$ *e)ocratic #otin%. '$ (&)&!ati#e #otin%. ($ 6trai%ht #otin%. *$ *e erred #otin%. E$ Pro1y #otin%. Ans"er: (

Topic: PRO?Y ,OTING @.The #otin% proced&re "here shareho!ders %rant a&thority to another indi#id&a! to #ote their shares is ca!!ed: A$ *e)ocratic #otin%. '$ (&)&!ati#e #otin%.

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 4

Chapter 7: Equity Markets and Stock Valuation

($ 6trai%ht #otin%. *$ *e erred #otin%. E$ Pro1y #otin%. Ans"er: E

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: *UA/ (/A66 6TO(8 1A. E:&ity "ith di erentia! #otin% ri%hts andBor di#idend pay)ent c!ai)s is ca!!ed: A$ *&a! c!ass stoc+. '$ (&)&!ati#e stoc+. ($ *e erred stoc+. *$ Pre erred stoc+. E$ (o))on stoc+. Ans"er: A

Topic: [Link],E RIG-T 11. Pree)pti#e ri%ht re ers to: A$ The ri%ht o shareho!ders to share proportionate!y in di#idends paid. '$ The ri%ht o shareho!ders to share proportionate!y in any ne" stoc+ iss&es so!d. ($ The ri%ht o shareho!ders to share proportionate!y in !i:&idated assets. *$ The ri%ht o shareho!ders to #ote at ann&a! shareho!der )eetin%s. E$ None o the abo#e. Ans"er: '

Topic: *I,I*EN*6 10. Pay)ents )ade by a corporation to its shareho!dersC in the or) o either cashC stoc+C or pay)ents in +indC are ca!!ed: A$ Retained earnin%s. '$ Net inco)e. ($ *i#idends. *$ Redistrib&tions. E$ In &sed e:&ity. Ans"er: (

Topic: [Link] .AR8ET 14. The )ar+et in "hich ne" sec&rities are ori%ina!!y so!d to in#estors is the DDDDDDDD )ar+et. A$ dea!er '$ a&ction ($ o#erEtheEco&nter 2OT($ *$ secondary E$ pri)ary Ans"er: E

Topic: 6E(ON*ARY .AR8ET 17. The )ar+et in "hich pre#io&s!y iss&ed sec&rities are traded a)on% in#estors is the: A$ *ea!er )ar+et. '$ A&ction )ar+et. ($ O#erEtheEco&nter 2OT($ )ar+et.

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 9

Chapter 7: Equity Markets and Stock Valuation

*$ 6econdary )ar+et. E$ Pri)ary )ar+et. Ans"er: *

<

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: *EA/ER 19. An a%ent "ho b&ys and se!!s sec&rities ro) in#entory is ca!!ed a DDDDDDDDDDD. A$ bro+er '$ trader ($ capita!ist *$ principa! E$ dea!er Ans"er: E

Topic: 'RO8ER 1<. An a%ent "ho arran%es sec&rity transactions a)on% in#estors is ca!!ed a DDDDDDDDDDDD. A$ bro+er '$ trader ($ capita!ist *$ principa! E$ dea!er Ans"er: A

Topic: NY6E .E.'ER 1=. The o"ner o a seat on the Ne" Yor+ 6toc+ E1chan%e 2NY6E$ is a2n$ DDDDDDDDDDD o the e1chan%e. A$ riend '$ )e)ber ($ a%ent *$ tr&stee E$ c&sto)er Ans"er: '

Topic: 6PE(IA/I6T 1>. A NY6E )e)ber actin% as a dea!er in one or )ore sec&rities on the e1chan%e !oor is a2n$: A$ ;!oor trader. '$ E1chan%e c&sto)er. ($ 6pecia!ist. *$ ;!oor bro+er. E$ (o))ission bro+er. Ans"er: (

Topic: ;/OOR 'RO8ER 1@. A NY6E )e)ber e1ec&tin% orders or co))ission bro+ers on a ee basis is a2n$: A$ ;!oor trader. '$ E1chan%e c&sto)er. ($ 6pecia!ist.

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e =

Chapter 7: Equity Markets and Stock Valuation

*$ ;!oor bro+er. E$ ;!oor a%ent. Ans"er: *

>

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: (O..I66ION 'RO8ER 0A. A NY6E )e)ber e1ec&tin% b&y and se!! orders ro) c&sto)ers once trans)itted to the e1chan%e !oor is ca!!ed a2n$: A$ ;!oor trader. '$ E1chan%e c&sto)er. ($ 6pecia!ist. *$ ;!oor bro+er. E$ (o))ission bro+er. Ans"er: E

Topic: ;/OOR TRA*ER 01. A NY6E )e)ber "ho trades or his or her o"n acco&ntC tryin% to anticipate te)porary price !&ct&ationsC is ca!!ed a2n$: A$ ;!oor trader. '$ E1chan%e c&sto)er. ($ 6pecia!ist. *$ ;!oor bro+er. E$ (o))ission bro+er. Ans"er: A

Topic: 6UPER*OT 6Y6TE. 00. The e!ectronic syste) &sed on NY6E a!!o"in% orders to be trans)itted direct!y to the specia!ist is ca!!ed the DDDDDDDDDDD syste). A$ NA6*AF '$ 6&per*OT ($ Instinet *$ Internet E$ bro+era%e Ans"er: '

Topic: OR*ER ;/OW 04. The strea) o c&sto)er b&y and se!! orders or sec&rities is ca!!ed: A$ 6trea) o conscio&sness. '$ Tradin% #o!&)e. ($ Order !o". *$ The bidEas+ spread. E$ The 6&per*OT syste). Ans"er: (

Topic: IN6I*E FUOTE6 07. The inside :&otes or a sec&rity are the: A$ ;irst posted bid and as+ :&otes o the tradin% day. '$ The prices :&oted GinsideG the e1chan%eC i.e.C on the tradin% !oor.

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e @

Chapter 7: Equity Markets and Stock Valuation

($ -i%hest bid :&ote and !o"est as+ :&ote. *$ /o"est bid :&ote and hi%hest as+ :&ote. E$ The a#era%e o the c&rrent bid and as+ :&otes. Ans"er: (

1A

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: TI(8ER 6Y.'O/ 09. The short a!phabetic abbre#iation or an e1chan%eE!isted stoc+ by "hich the iss&e is identi ied in the )ar+et is ca!!ed the stoc+5s DDDDDDDDDDD. A$ open na)e '$ tradin% ran%e ($ e1chan%e na)e *$ tic+er sy)bo! E$ priceBearnin%s description Ans"er: *

II CONCEPTS

Topic: *I,I*EN* GROWT0<.O#er the past o&r yearsC a co)pany has paid di#idends o [Link] HA.@AC HA.>AC and HA.=AC respecti#e!y. This pattern is e1pected to contin&e into the &t&re. This is an e1a)p!e o a co)pany payin% a: A$ *i#idend that dec!ines by 1AI each year. '$ *i#idend that dec!ines at a constant rate. ($ *i#idend that dec!ines by a decreasin% a)o&nt. *$ *i#idend that dec!ines at a decreasin% rate. E$ *i#idend that dec!ines at an increasin% rate. Ans"er: E

Topic: (O..ON ,6. PRE;ERRE* 6TO(8 0=.Which o the o!!o"in% is a tr&e state)ent re%ardin% p&b!ic!yEtraded e:&ity sec&ritiesJ A$ (o))on stoc+ #a!&ation is typica!!y si)p!er than the #a!&ation o pre erred stoc+. '$ The )ar+et price o a stoc+ is %reater than the present #a!&e o a!! &t&re di#idends. ($ ;&t&re stoc+ di#idends are a !e%a!!yEbindin% !iabi!ity o the corporation. *$ A share o pre erred stoc+ represents a !iabi!ity o a corporation. E$ Pre erred stoc+ has so)e eat&res o both co))on stoc+ and bonds. Ans"er: E

Topic: 6TO(8 ,A/UATION 0>.(o))on stoc+ #a!&ation re:&iresC a)on% other thin%sC in or)ation re%ardin% the: I. E1pected di#idend %ro"th rate. II. (&rrent di#idend pay)ent. III. Par #a!&e o the co))on stoc+. A$ I on!y '$ I and II on!y

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 11

Chapter 7: Equity Markets and Stock Valuation

($ I and III on!y *$ II and III on!y E$ IC IIC and III Ans"er: '

10

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: (O..ON ,6. PRE;ERRE* 6TO(8 0@.Which o the o!!o"in% typica!!y app!ies to co))on stoc+ b&t NOT to pre erred stoc+J A$ Par #a!&e '$ *i#idend yie!d ($ /e%a!!y considered as e:&ity in the ir) *$ ,otin% ri%hts E$ The di#idends are a ta1Eded&ctib!e e1pense Ans"er: *

Topic: *I,I*EN* GROWT- .O*E/ [Link] i!!&strated &sin% the di#idend %ro"th )ode!C the tota! ret&rn on a share o co))on stoc+ is co)prised o a DDDDDDDDDDD. A$ capita! %ains yie!d and a di#idend %ro"th rate '$ capita! %ains %ro"th rate and a di#idend %ro"th rate ($ di#idend payo&t ratio and a re:&ired rate o ret&rn *$ di#idend yie!d and the present di#idend E$ di#idend yie!d and a capita! %ains yie!d Ans"er: E

Topic: WA// 6TREET KOURNA/ FUOTE6 [Link] o the o!!o"in% ite)s "o&!d &s&a!!y appear or a stoc+ :&ote in "he Wall Street JournalJ A$ (apita! %ains rate '$ *i#idend yie!d ($ N&)ber o shares o&tstandin% *$ Par #a!&e o the stoc+ E$ *i#idend %ro"th rate Ans"er: '

Topic: (O..ON 6TO(8 ,A/UATION 40.;or yo&n% co)paniesC the type o di#idend %ro"th #a!&ation )ode! that is typica!!y )ost appropriate is the DDDDDDDDDDD )ode!. A$ zero %ro"th '$ s&pernor)a! %ro"th ($ nonconstant %ro"th *$ %ro"in% perpet&ity E$ dec!inin% %ro"th Ans"er: '

Topic: PRE;ERRE* 6TO(8 ,A/UATION [Link]#en no chan%e in re:&ired ret&rnsC pre erred stoc+ prices "i!!: A$ Increase o#er ti)e at a rate o rI. '$ *ecrease o#er ti)e at a rate o rI. ($ Increase o#er ti)e at a rate e:&a! to the di#idend %ro"th rate.

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 14

Chapter 7: Equity Markets and Stock Valuation

*$ *ecrease o#er ti)e at a rate e:&a! to the di#idend %ro"th rate. E$ Re)ain &nchan%ed. Ans"er: E

17

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: PRE;ERRE* ,6. (O..ON 6TO(8 [Link] o the o!!o"in% ter)s is typica!!y associated "ith 'OT- pre erred stoc+ and co))on stoc+J A$ Pro1y '$ ,otin% ri%hts ($ *i#idend yie!d *$ Arreara%e E$ (&)&!ati#e #otin% Ans"er: (

Topic: *I,I*EN* GROWT- .O*E/ 49.I di#idends on a co))on stoc+ are e1pected to %ro" at a constant rate ore#erC and i yo& are to!d the )ost recent di#idend paidC the di#idend %ro"th rateC and the appropriate disco&nt rate todayC yo& can ca!c&!ate DDDDDDDDDDD. I. the price o the stoc+ today II. the di#idend that is e1pected to be paid ten years ro) no" III. the appropriate disco&nt rate ten years ro) no" A$ '$ ($ *$ E$ I on!y I and II on!y I and III on!y II and III on!y IC IIC and III Ans"er: '

Topic: 'ON* AN* 6TO(8 YIE/*6 4<.Which o the o!!o"in% state)ents re%ardin% di#idend yie!ds is tr&eJ A$ It )eas&res ho" )&ch the stoc+5s price "i!! increase in a year. '$ It incorporates the par #a!&e o the stoc+ into the ca!c&!ation. ($ It is ana!o%o&s to the c&rrent yie!d or a bond. *$ It is a!"ays %reater than the stoc+5s capita! %ains yie!d. E$ It )eas&res the tota! ann&a! ret&rn an in#estor can e1pect to earn by o"nin% the stoc+. Ans"er: (

Topic: 6TO(8 YIE/*6 4=.Which o the o!!o"in% is 2are$ tr&eJ I. The di#idend yie!d on a stoc+ is the ann&a! di#idend di#ided by the par #a!&e. II. When the constant di#idend %ro"th )ode! ho!dsC % L capita! %ains yie!d. III. The tota! ret&rn on a share o stoc+ L di#idend yie!d M capita! %ains yie!d. A$ I on!y '$ II on!y ($ I and II on!y

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 19

Chapter 7: Equity Markets and Stock Valuation

*$ II and III on!y E$ IC IIC and III Ans"er: *

1<

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: 6TO(8 ,A/UATION 4>.Which o the o!!o"in% state)ents is 2are$ tr&eJ I. The di#idend %ro"th )ode! on!y ho!ds i C at so)e point in ti)eC the di#idend %ro"th rate e1ceeds the stoc+5s re:&ired ret&rn. II. An increase in the di#idend %ro"th rate "i!! increase a stoc+5s )ar+et #a!&eC a!! e!se the sa)e. III. An increase in the re:&ired ret&rn on a stoc+ "i!! increase its )ar+et #a!&eC a!! e!se the sa)e. A$ '$ ($ *$ E$ I on!y II on!y III on!y I and III on!y IC IIC and III Ans"er: '

Topic: 6TO(8 ,A/UATION 4@.Yo& are atte)ptin% to #a!&e a stoc+ in a )at&re ind&stry that is steadi!y shrin+in% in size. O the stoc+ #a!&ation )ode!s st&diedC the )ost appropriate is the DDDDDDDDDDD. A$ perpet&ity )ode! '$ constant %ro"th )ode! ($ s&pernor)a! %ro"th )ode! *$ nonconstant %ro"th )ode! E$ pre erred stoc+ )ode! Ans"er: '

Topic: [Link],E RIG-T6 [Link] a co))on shareho!der in a ir)C yo&r pree)pti#e ri%ht a!!o"s yo& to DDDDDDDDDDD. A$ #ote on shareho!der initiati#es at stoc+ho!der )eetin%s '$ #ote or directors at stoc+ho!der )eetin%s #ia strai%ht #otin% proced&res ($ #ote or directors at stoc+ho!der )eetin%s #ia c&)&!ati#e #otin% proced&res *$ share proportionate!y in any ne" stoc+ the co)pany se!!s E$ share proportionate!y in any di#idends the co)pany decides to dec!are Ans"er: *

Topic: (O..ON 6-ARE-O/*ER RIG-T6 [Link] o the o!!o"in% is a ri%ht o an o"ner o a share o co))on stoc+J A$ The ri%ht to direct!y choose the a&ditin% ir) the co)pany &ses. '$ The ri%ht to s&e the co)pany in ban+r&ptcy proceedin%s i co))on di#idends are not paid. ($ The ri%ht to #ote or directors. *$ The ri%ht to participate in any ne" debt o erin%s the co)pany se!!s to the p&b!ic. E$ Pre erence o#er pre erred shareho!ders in the pay)ent o di#idends. Ans"er: (

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 1=

Chapter 7: Equity Markets and Stock Valuation

Topic: PRE;ERRE* 6-ARE-O/*ER RIG-T6 [Link] o the o!!o"in% isBare a ri%ht o an o"ner o a share o pre erred stoc+J I. The ri%ht to s&e the co)pany in ban+r&ptcy proceedin%s i pre erred di#idends are not paid. II. The ri%ht to recei#e par #a!&e or the shares in the e#ent o a !i:&idation. III. The ri%ht to #ote or directors. A$ '$ ($ *$ E$ I on!y II on!y I and II on!y II and III on!y I and III on!y Ans"er: '

Topic: (O..ON 6-ARE-O/*ER RIG-T6 74.;or "hich o the o!!o"in% iss&es is the co))on shareho!ders5 pro1y re!e#antJ A$ The ri%ht to share proportionate!y in di#idends paid. '$ The ri%ht to share proportionate!y in re)ainin% assets ro) a !i:&idation. ($ The ri%ht to appoint a ne" bond tr&stee or the ir)5s o&tstandin% debt iss&es. *$ The ri%ht to s&e the co)pany in ban+r&ptcy proceedin%s i co))on di#idends are not paid. E$ The ri%ht to #ote on a proposed ta+eo#er o er ro) a co)petitor ir). Ans"er: E

Topic: *I,I*EN*6 [Link] o the o!!o"in% state)ents isBare tr&e re%ardin% di#idendsJ I. *i#idend e1pense is a ta1 ded&ctib!e ite) to the corporation on its inco)e state)ent. II. (o))on stoc+ di#idends are ne#er !iabi!ities o the corporation. III. Pre erred stoc+ di#idends recei#ed by other corporations are not a!"ays &!!y ta1ab!e. A$ '$ ($ *$ E$ II on!y III on!y I and III on!y II and III on!y IC IIC and III Ans"er: '

Topic: *E'T ,6. EFUITY [Link] o the o!!o"in% is ;A/6E re%ardin% the di erences bet"een debt and co))on stoc+J A$ E:&ity is o"nership in a ir) b&t debt is not. '$ 6toc+ho!ders ha#e #otin% po"er "hi!e creditors do not. ($ Periodic pay)ents )ade to either c!ass o sec&rity are ta1 ded&ctib!e or the iss&er. *$ Interest pay)ents are !e%a!!y bindin% "hi!e di#idend pay)ents %enera!!y are not. E$ A p&b!ic!yEtraded co)pany can p&b!ic stoc+ and pri#ate debtC b&t not #ice #ersa.

1>

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Ans"er: (

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 1@

Chapter 7: Equity Markets and Stock Valuation

Topic: PRE;ERRE* 6TO(8 RIG-T6 7<.Which o the o!!o"in% is &s&a!!y a ri%ht o a pre erred stoc+ho!derJ A$ Ri%ht to con#ert shares to co))on stoc+ on de)and. '$ Pree)pti#e ri%ht to participate in the iss&ance o ne" co))on shares. ($ Ri%ht to recei#e di#idend pay)ents be ore any di#idends are paid to co))on stoc+ho!ders. *$ Ri%ht to s&e the co)pany in ban+r&ptcy proceedin%s i pro)ised pre erred di#idends are not paid. E$ Ri%ht to #ote or ne" directors by pro1y. Ans"er: (

7=.I A$ '$ ($ *$ E$

Topic: 6TO(8 (-ARA(TERI6TI(6 so)e shareho!ders ha#e %reater #otin% po"er than othersC it )&st be that: The co)pany has both pre erred stoc+ and co))on stoc+ o&tstandin%. The co)pany has o&tstandin% debent&res. The co)pany is !ocated o&tside the United 6tates in a ta1Eha#en !oca!e. The co)pany has )&!tip!e c!asses o co))on stoc+. The co)pany is in ban+r&ptcy proceedin%s. Ans"er: *

Topic: (U.U/ATI,E ,OTING 7>.DDDDDDDDDDD can protect the interests o )inority shareho!ders. A$ 6trai%ht #otin% )ethods '$ (&)&!ati#e di#idends ($ Pro1y #otin% *$ (&)&!ati#e #otin% )ethods E$ .&!tip!e c!asses o stoc+ Ans"er: *

Topic: (/A66E6 O; 6TO(8 7@.The pri)ary reason or creatin% d&a! or )&!tip!e c!asses o stoc+ has to do "ith: A$ E1chan%e !istin% re:&ire)ents. '$ 6atis yin% NA6*AF by!a"s. ($ ;reezin% o&t )inority shareho!ders. *$ Payin% or ac:&isitions. E$ (ontro! o the ir). Ans"er: E

Topic: 6TRAIG-T ,OTING [Link]& are on the board o directors o a co)pany. I yo& "ant it to be as di ic&!t as possib!e or others to %ain a seat on the boardC yo& sho&!d ens&re that the ir) DDDDDDDDD. A$ has c&)&!ati#e pre erred stoc+ '$ has ca!!ab!eC sec&red bonds ($ has con#ertib!e debent&res *$ has strai%ht #otin% co))on stoc+

0A

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

E$ has c&)&!ati#e #otin% co))on stoc+ Ans"er: *

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 01

Chapter 7: Equity Markets and Stock Valuation

Topic: *I,I*EN*6 [Link] o the o!!o"in% state)ents abo&t di#idends is tr&eJ A$ Pre erred stoc+ di#idends recei#ed are a!"ays &!!yEta1ab!e to corporate in#estors. '$ *i#idends are the on!y so&rce o ret&rn that in#estors earn on co))on stoc+ in#est)ents. ($ The pay)ent o di#idends is at the discretion o the board o directors. *$ The pay)ent o di#idends by the corporation is a ta1Eded&ctib!e b&siness e1pense. E$ A corporation can be s&ed or not payin% &ndec!ared co))on stoc+ di#idends. Ans"er: (

Topic: PRIORITY O; PAY.ENT6 [Link] o the o!!o"in% "o&!d be considered a #io!ation o the ri%hts o one or )ore c!asses o a ir)5s sta+eho!dersJ A$ Pre erred di#idends are not paid and c&)&!ate in arrears. '$ Pre erred stoc+ho!ders are paid be ore co))on shareho!ders in a !i:&idation. ($ (o))on stoc+ho!ders are ab!e to p!ace )e)bers on the board o directors to represent their interests in opposition to the board candidates bac+ed by pre erred shareho!ders. *$ (o))on stoc+ho!ders are ab!e to p!ace )e)bers on the board o directors to represent their interests in opposition to the board candidates bac+ed by bondho!ders. E$ Pre erred shareho!ders recei#e the stated #a!&e o their shares in a !i:&idationC "hi!e debt ho!ders recei#e so)ethin% !ess than ace #a!&e or their bonds. Ans"er: E

Topic: PRE;ERRE* 6TO(8 [Link] erred stoc+ is )&ch !i+e debt in that: I. The pay)ents on both are ta1Eded&ctib!e to the iss&in% ir). II. Neither sec&rity is protected in the e#ent o nonEpay)ent o pro)ised cash !o"s. III. Neither sec&rity participates in any &ne1pected pro its the ir) %enerates. A$ '$ ($ *$ E$ I on!y II on!y III on!y I and II on!y I and III on!y Ans"er: (

Topic: ;/OOR TRA*ER [Link] )ar+et participant typica!!y has the /EA6T interaction "ith the a#era%e in#estorJ A$ (o))ission bro+er '$ 6pecia!ist ($ ;!oor bro+er *$ ;!oor trader E$ .ar+et )a+er Ans"er: *

00

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 04

Chapter 7: Equity Markets and Stock Valuation

Topic: (O..I66ION 'RO8ER [Link] )&st a co))ission bro+er "ishin% to e1ec&te a c&sto)er b&y order atte)pt to !ocate a trader to dea! "ith other than the specia!ist dea!in% in that stoc+J A$ 'eca&se the co))ission bro+er )&st atte)pt to obtain the hi%hest possib!e as+ :&ote. '$ 'eca&se the specia!ist "i!! trade on!y i there is a )atchin% se!! order ro) a di erent c&sto)er. ($ 'eca&se the specia!ist o ten does not carry any shares o stoc+ in in#entory. *$ 'eca&se the specia!ist5s spread is typica!!y #ery !o" co)pared to other bro+ers. E$ 'eca&se the co))ission bro+er is responsib!e or %ettin% the best price or the c&sto)er. Ans"er: E

Topic: NA6*AF 9<.Which o the o!!o"in% is ;A/6E re%ardin% tradin% on the NA6*AFJ A$ (o)pared to other tradin% #en&esC NA6*AF stoc+s are disproportionate!y co)prised o yo&n%er co)panies. '$ Un!i+e the NY6EC NA6*AF tradin% occ&rs at a sin%!eC centra! !ocation. ($ Un!i+e the NY6EC NA6*AF does not ha#e !oor traders. *$ NA6*AF stoc+s typica!!y ha#e )&!tip!e )ar+et )a+ers or each sec&rity. E$ Inside :&otes on the NA6*AF are the hi%hest bid and !o"est as+ :&otes posted or a sec&rity. Ans"er: '

Topic: NA6*AF FUOTE TRAN6PAREN(Y 9=.An indi#id&a! in#estor %atherin% :&otes on a NA6*AF stoc+ ro) a p&b!ic in or)ation so&rce s&ch as YahooN )ost !i+e!y has her access !i)ited to DDDDDDDDDDD. A$ !e#e! 1 ter)ina!s '$ !e#e! 0 ter)ina!s ($ !e#e! 4 ter)ina!s *$ !e#e! 7 ter)ina!s E$ the 6&per*OT syste) Ans"er: '

III.

PROBLEMS

Topic: (U.U/ATI,E ,OTING 9>.6&ppose yo& o"n 9AA shares o 'io%en co))on stoc+. ;o&r directors are to be e!ected. 6ince the ir) &ses c&)&!ati#e #otin%C yo& can cast as )any as DDDDDDDDDDD #otes or a sin%!e director. A$ 109 '$ 09A ($ 9AA *$ 1CAAA E$ 0CAAA Ans"er: E

07

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 09

Chapter 7: Equity Markets and Stock Valuation

Topic: 6TO(8 PRI(E 9@.What "o&!d yo& pay or a share o A'( (orporation stoc+ today i the ne1t di#idend "i!! be H4 per shareC yo&r re:&ired ret&rn on e:&ity in#est)ents is 19IC and the stoc+ is e1pected to be "orth H@A one year ro) no"J A$ H=>.0< '$ H>A.>= ($ H>0.9< *$ H@[Link] E$ H@>.10 Ans"er: ' Response: PA L H4 B 1.19 M @A B 1.19 L H>A.>=

Topic: 6TO(8 PRI(E <[Link] di#idend on 6i)p!e .otors co))on stoc+ "i!! be H4 in 1 yearC H7.09 in 0 yearsC and H<.AA in 4 years. Yo& can se!! the stoc+ or H1AA in 4 years. I yo& re:&ire a 10I ret&rn on yo&r in#est)entC ho" )&ch "o&!d yo& be "i!!in% to pay or a share o this stoc+ todayJ A$ H=9.79 '$ H==.07 ($ H>1.90 *$ H>9.<< E$ H@1.4A Ans"er: ( Response: PA L [Link] B 1.10 M 7.09 B 1.100 M 1A< B 1.104 L H>1.90

Topic: 3ERO GROWT- 6TO(8 RETURN <1.A stoc+ that pays a constant di#idend o H1.9A ore#er c&rrent!y se!!s or H1A.=1. What is the re:&ired rate o ret&rnJ A$ 1AI '$ 10I ($ 14I *$ 17I E$ 19I Ans"er: * Response: H1A.=1 L H1.9A B RO R L 17I

Topic: PRE;ERRE* 6TO(8 *I,I*EN* <0.A'( (o)pany5s pre erred stoc+ is se!!in% or H4A a share. I the re:&ired ret&rn is >IC "hat "i!! the di#idend be t"o years ro) no"J A$ [Link] '$ H0.0A ($ H0.7A *$ H0.>A E$ H4.09 Ans"er: (

0<

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Response: H4A L * B .A>O * L H0.7A

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 0=

Chapter 7: Equity Markets and Stock Valuation

Topic: *I,I*EN* GROWT- .O*E/ <[Link] "o&!d yo& pay today or a stoc+ that is e1pected to )a+e a H0 di#idend in one year i the e1pected di#idend %ro"th rate is 9I and yo& re:&ire a 10I ret&rn on yo&r in#est)entJ A$ H0>.9= '$ H0@.44 ($ H41.74 *$ H74.17 E$ H97.4A Ans"er: A Response: PA L H0 B 2.10 E .A9$ L H0>.9=

Topic: 6TO(8 PRI(E <[Link] stoc+ o .TY Go! Wor!d c&rrent!y se!!s or H@A per share. The ir) has a constant di#idend %ro"th rate o <I and P&st paid a di#idend o H9.A@. I the re:&ired rate o ret&rn is 10IC "hat "i!! the stoc+ se!! or one year ro) no"J A$ H @[Link] '$ H @4.90 ($ H @9.7A *$ H @@.>A E$ H110.=> Ans"er: ( Response: P L H@A 21.A<$ L H@9.7A 0

Topic: *I,I*EN* GROWT- RATE <9./!ano5s stoc+ is c&rrent!y se!!in% or [Link]. The e1pected di#idend one year ro) no" is H0 and the re:&ired ret&rn is 14I. What is this ir)5s di#idend %ro"th rate ass&)in% the constant di#idend %ro"th )ode! is appropriateJ A$ >I '$ @I ($ 1AI *$ 11I Ans"er: A Response: % L .14 E 2H0 B 7A$ L >I

Topic: REFUIRE* RETURN <<.The c&rrent price o ?Y3 stoc+ is H>[Link]. *i#idends are e1pected to %ro" at 9I inde inite!y and the )ost recent di#idend "as H0.=9. What is the re:&ired rate o ret&rn on ?Y3 stoc+J A$ =.4I '$ >.=I ($ @.9I *$ 1A.<I E$ 11.0I Ans"er: '

0>

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Response: R L 2H0.>@ B >A$ M .A9 L >.=I

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 0@

Chapter 7: Equity Markets and Stock Valuation

Topic: REFUIRE* RETURN <=.A'( (orporation5s co))on stoc+ di#idend yie!d is 4.<1IC it P&st paid a di#idend o H0.=9C and is e1pected to pay a di#idend o H0.>@ one year ro) no". *i#idends are e1pected to %ro" at a constant rate inde inite!y. What is the re:&ired rate o ret&rn on A'( stoc+J A$ =.4I '$ >.=I ($ @.9I *$ 1A.<I E$ 11.0I Ans"er: ' Response: 2H0.>@ E 0.=9$ B 0.=9 L .A91O R L .A4< M .A91 L >.=I

Topic: *I,I*EN* YIE/* <>.I 'i% A)pC Inc. stoc+ c!osed at H4< and the c&rrent :&arter!y di#idend is HA.=9 per shareC "hat di#idend yie!d "o&!d be reported or the stoc+ in "he Wall Street JournalJ A$ [Link] '$ 4.<I ($ 9.=I *$ <.<I E$ >.4I Ans"er: E Response: *Y L 2HA.=9 1 7$ B 4< L >.4I

Topic: *I,I*EN* GROWT- .O*E/ <@.8i!!n&) (orp. anno&nces that the di#idend or the ne1t year "i!! be H0.9A per share rather than the ori%ina!!y e1pected H1.9A per share. ;ro) then onC it is e1pected that di#idends "i!! res&)e their historica! constant %ro"th rate o 9I per year. What "o&!d yo& e1pect to happen to the price o the stoc+J I%nore any ta1 e ects. A$ The price "i!! !i+e!y do&b!e. '$ The price "i!! !i+e!y rise by !ess than 1AAI. ($ The price "i!! !i+e!y rise by e1act!y 9AI. *$ The price "i!! re)ain &nchan%ed. E$ The price "i!! !i+e!y rise by the present #a!&e o H1. Ans"er: '

Topic: 6TO(8 PRI(E =A.6&ppose NoGroC Inc. has P&st iss&ed a di#idend o H4.09 per share. 6&bse:&ent di#idends "i!! re)ain at H4.09 inde inite!y. Ret&rns on the stoc+ o ir)s !i+e NoGro are c&rrent!y r&nnin% 1AI. What is the #a!&e o one share o stoc+J A$ H00.9A '$ H0=.09 ($ H40.9A *$ H4=.09 E$ H4@.=9

4A

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Ans"er: ( Response: P L H4.09 B .1A L H40.9A A

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 41

Chapter 7: Equity Markets and Stock Valuation

Topic: *I,I*EN* GROWT- .O*E/ =1.6&ppose Pa!e -oseC Inc. has P&st paid a di#idend o H1.>A per share. 6a!es and pro its or Pa!e -ose are e1pected to %ro" at a rate o >I per year. Its di#idend is e1pected to %ro" by the sa)e a)o&nt. I the re:&ired ret&rn is 17IC "hat is the #a!&e o a share o Pa!e -oseJ A$ H1>.AA '$ H09.0A ($ H0=.>A *$ H4A.<A E$ H40.7A Ans"er: E Response: P L QH1.>A21.A>$R B 2.17 E .A>$ L H40.7A A

Topic: REFUIRE* RETURN =0.6&ppose that yo& ha#e P&st p&rchased a share o stoc+ or H7A. The )ost recent di#idend "as H0 and di#idends are e1pected to %ro" at a rate o =I inde inite!y. What )&st yo&r re:&ired ret&rn be on the stoc+J A$ 9.79I '$ =.AAI ($ 1A.09I *$ 10.49I E$ 14.<9I Ans"er: * Response: R L QH021.A=$R B 7A M E .A= L 10.49I

Topic: NON(ON6TANT *I,I*EN* GROWT=4..cGoni%a!5s .eatsC Inc. c&rrent!y pays no di#idends. The ir) p!ans to be%in payin% di#idends in 4 years. The irst di#idend "i!! be H1.9A and di#idends "i!! %ro" at <I per year therea ter. Gi#en a re:&ired ret&rn o 17IC "hat "o&!d yo& pay or the stoc+ todayJ A$ H14.70 '$ H17.70 ($ H1<.4= *$ H1=.<1 E$ H01.4= Ans"er: ' Response: P L QH1.9A21.A<$R B 2.17 E .A<$ M 1.9A L H01.4=O P L H01.4= B 1.174 L H17.70 4 A

Topic: NON(ON6TANT *I,I*EN* GROWT=7..cIntyre5s .oatsC Inc. c&rrent!y pays no di#idendsC b&t the ir) "i!! be%in payin% di#idends in 4 years. The irst di#idend "i!! be H4 and di#idends are e1pected to %ro" at 7I per year therea ter. Gi#en a c&rrent )ar+et price o H9A.9AC "hat is the re:&ired ret&rn on the stoc+J A$ =I '$ >I ($ @I

40

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

*$ 1AI E$ 10I Ans"er: ( 4 Response: S QH421.A7$ B 2R E .A7$R M 4T B 21 M R$ L H9A.9AO R L @I

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 44

Chapter 7: Equity Markets and Stock Valuation

Topic: NON(ON6TANT *I,I*EN* GROWT=9..cI#er5s .ea!sC Inc. c&rrent!y pays a H0 ann&a! di#idend. In#estors be!ie#e that di#idends "i!! %ro" at 0AI ne1t yearC 10I ann&a!!y or the t"o years a ter thatC and <I ann&a!!y therea ter. Ass&)e the re:&ired ret&rn is 1AI. What is the c&rrent )ar+et price o the stoc+J A$ H97.@A '$ H<A.>A ($ H<<.<A *$ H<@.4A H=9.0A Ans"er: ( 0 4 Response: P L H0.7A B 1.1A M 0.<@ B 1.1A M 4.A1 B 1.1A M =@.== B 1.1A4 L H<<.<A A

Topic: PRE;ERRE* 6TO(8 ,A/UATION =<.The pre erred stoc+ o the /i)ba&%h Instit&te pays a constant ann&a! di#idend o H7 and se!!s or H9A. Yo& be!ie#e the stoc+ "i!! se!! or H40 in one year. Yo& )&stC there oreC be!ie#e that the re:&ired ret&rn on the stoc+ "i!! be DDDDD percenta%e points DDDDDDDD in one year. A$ >O hi%her '$ >O !o"er ($ 1.9O hi%her *$ 0.9O !o"er E$ 7.9O hi%her Ans"er: E Response: c&rrent: H9A L H7 B RO R L >IO &t&re: H40 L H7 B RO R L 10.9I

Topic: NON(ON6TANT *I,I*EN* GROWT==.'io%eneticsC Inc. p!ans to retain and rein#est a!! o their earnin%s or the ne1t 4A years. 'e%innin% in year 41C the ir) "i!! be%in to pay a H4A per share di#idend. The di#idend "i!! not s&bse:&ent!y chan%e. Gi#en a re:&ired ret&rn o 1>IC "hat sho&!d the stoc+ se!! or todayJ A$ H 1.1< '$ H 0.A@ ($ H >.41 *$ H >0.@A E$ H190.A7 Ans"er: A Response: P L H4A B .1> L H1<<.<=O P L H1<<.<= B 1.1>4A L H1.1< 4A A

Topic: NON(ON6TANT *I,I*EN* GROWT=>.'io%eneticsC Inc. p!ans to retain and rein#est a!! o their earnin%s or the ne1t 4A years. 'e%innin% in year 41C the ir) "i!! be%in to pay a H4A per share di#idend. The di#idend "i!! increase at an >I rate ann&a!!y therea ter. Gi#en a re:&ired ret&rn o 1>IC "hat sho&!d the stoc+ se!! or todayJ A$ H 1.1< '$ H 0.A@

47

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

($ H >.41 *$ H >0.@A E$ H190.A7 Ans"er: ' Response: P L H4A B 2.1> E .A>$ L H4AAO P L H4AA B 1.1>4A L H0.A@ 4A A

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 49

Chapter 7: Equity Markets and Stock Valuation

Topic: NEGATI,E *I,I*EN* GROWT- ,A/UATION =@.'oo)er Prod&ctsC Inc. )an& act&res GnoEinha!eG ci%arettes. As their tar%et c&sto)ers a%e and pass onC sa!es o the prod&ct are e1pected to dec!ine. Th&sC de)o%raphics s&%%est that earnin%s and di#idends "i!! dec!ine at a rate o 9I ann&a!!y ore#er. The ir) P&st paid a di#idend o H7O %i#en a re:&ired ret&rn o 1AIC the stoc+ sho&!d se!! today or: A$ [Link] '$ H10.<= ($ H09.44 *$ H0>.AA E$ H>[Link] Ans"er: ( Response: P L QH7 21 E .A9$R B 2.1A M .A9$ L H09.44 A

Topic: NEGATI,E *I,I*EN* GROWT- ,A/UATION >A.'oo)er Prod&ctsC Inc. )an& act&res GnoEinha!eG ci%arettes. As their tar%et c&sto)ers a%e and pass onC sa!es o the prod&ct are e1pected to dec!ine. Th&sC de)o%raphics s&%%est that earnin%s and di#idends "i!! dec!ine at a rate o 9I ann&a!!y ore#er. The ir) P&st paid a di#idend o H7O %i#en a re:&ired ret&rn is 1AIC the price o the stoc+ in 0 years "i!! be: A$ H17.79 '$ H1>.90 ($ H00.>< *$ H09.44 E$ H0@.@9 Ans"er: ( 4 0 Response: P L QH7 21 E .A9$ R B 2.1A M .A9$ L H00.>< L H09.4421 .A9$ 0

Topic: (U.U/ATI,E ,OTING >[Link] is an e!ection bein% he!d to i!! 4 seats on the board o directors o a ir) in "hich yo& ho!d stoc+. There are a tota! o >AA shares o&tstandin%. I the e!ection is cond&cted &nder c&)&!ati#e #otin% and yo& o"n 19A sharesC ho" )any )ore shares )&st yo& b&y to be ass&red o earnin% a seat on the boardJ A$ A '$ 01 ($ 91 *$ 11= E$ 091 Ans"er: ( Response: shares needed L 1B7 2>AA$ M 1L 0AA M 1 L 0A1O b&y 0A1 19A L 91 shares

4<

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: (U.U/ATI,E ,OTING >0.;i#e directors "i!! be e!ected and yo& "ish to be one o the). With c&)&!ati#e #otin%C "hat percenta%e o the shares 2p!&s one$ do yo& need to ha#e on yo&r side to %&arantee yo& a seatJ A$ 10.9I '$ 1<.=I ($ [Link] *$ [Link] E$ 44.4I Ans"er: ' Response: shares needed L 1B< M 1

Topic: (U.U/ATI,E ,OTING >4.A ir) has 9AACAAA shares o&tstandin%. I 7 directors "i!! be e!ectedC ho" )any shares do yo& need to contro! to ass&re yo&rse! a seat on the board &nder c&)&!ati#e #otin% proced&resJ A$ 9ACAA1 '$ <<C<<> ($ 1AACAA1 *$ 109CAA1 E$ 9AACAAA Ans"er: ( Response: shares needed L 1B9 29AACAAA$ L 1AACAAAO 1AACAAA M 1 L 1AACAA1

Topic: (ON6TANT *I,I*EN* GROWT- .O*E/ >7.A ir)5s stoc+ has a re:&ired ret&rn o 10I. The stoc+5s di#idend yie!d is 9I. What is the di#idend the ir) is e1pected to pay in one year i the c&rrent stoc+ price is H9AJ A$ [Link] '$ H0.9A ($ [Link] *$ H4.9A E$ [Link] Ans"er: ' Response: * L H9A 2.A9$ L H0.9A 1

Topic: (ON6TANT *I,I*EN* GROWT- .O*E/ >9.A ir)5s stoc+ has a re:&ired ret&rn o 10I. The stoc+5s di#idend yie!d is 9I. What di#idend did the ir) P&st pay i the c&rrent stoc+ price is H9AJ A$ H0.1> '$ H0.47 ($ H0.9A *$ H0.>= E$ H4.<A Ans"er: ' Response: * L H9A 2.A9$ L H0.9AO * L H0.9A B 1.A= L H0.47 1 A

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 4=

Chapter 7: Equity Markets and Stock Valuation

4>

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: 6TRAIG-T ,OTING ><.Yo&r ir) is con#ertin% ro) c&)&!ati#e #otin% to strai%ht #otin%. Yo& c&rrent!y o"n the )ini)&) n&)ber o shares needed to ass&re yo&rse! a seat on the board in any e!ection &nder c&)&!ati#e #otin%. -o" )any )ore shares )&st yo& p&rchase in order to ass&re yo&rse! a seat &nder strai%ht #otin%J Ass&)e there are a tota! o 0AACAAA shares o&tstandin% and that o&r directors %o &p or e!ection at a ti)e. A$ A '$ 7ACAAA ($ <ACAAA *$ >ACAAA E$ 1AACAA1 Ans"er: ( Response: yo& ha#e: 1B9 20AACAAA$ L 7ACAAA M 1 L 7ACAA1O need: 1B0 20AACAAA$ M 1 L 1AACAAA M 1 L 1AACAA1 need to b&y: 1AACAA1 7ACAA1 L <ACAAA

Topic: 6UPERNOR.A/ GROWT>=.6&ppose the Pa!e -ose (orp. is e1pected to pay a di#idend ne1t year o H0.09 per share. 'oth sa!es and pro its or Pa!e -ose are e1pected to %ro" at a rate o 0AI or the o!!o"in% 0 years and then at 9I per year therea ter inde inite!y. *i#idend %ro"th is e1pected to )atch sa!es %ro"th. I the re:&ired ret&rn is 19IC "hat is the #a!&e o a share o Pa!e -oseJ A$ H00.=9 '$ H0<.AA ($ H0>.9A *$ H40.7A E$ H4@.09 Ans"er: ( 0 4 4 Response: P L H0.09 B 1.19 M 0.=A B 1.19 M 4.07 B 1.19 M 47.A0 B 1.19 L H0>.9A A

Topic: NON(ON6TANT *I,I*EN* GROWT- ,A/UATION >>.6&ppose that sa!es and pro its o O!y Enterprises are %ro"in% at a rate o 4AI per year. At the end o o&r years the %ro"th rate "i!! drop to a steady <I. At the end o year 9C O!y "i!! iss&e its irst di#idend in the a)o&nt o H4 per share. I the re:&ired ret&rn is 19IC "hat is the #a!&e o a share o stoc+J Ass&)e di#idends %ro" at the sa)e rate as earnin%s a ter year 7. A$ H1A.0A '$ H17.>@ ($ H1<.70 *$ H1@.A< E$ H01.A9 Ans"er: * 9 Response: P L QH421.A<$ R B 2.19 E .A<$ M 4 L H4>.44O PA L H4>.44 B 1.19 L H1@.A< 9

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 4@

Chapter 7: Equity Markets and Stock Valuation

Topic: 6UPERNOR.A/ GROWT>@.Et!in% Inc.5s di#idend is e1pected to %ro" at 9I or the ne1t 0 years and then at 4I ore#er. I the c&rrent di#idend is H0 and the re:&ired ret&rn is 17IC "hat is the price o the stoc+J A$ H1@.74 '$ H04.>0 ($ H09.19 *$ H0=.9> E$ H0@.=A Ans"er: A 0 0 Response: P L H0.1A B 1.17 M 0.01 B 1.17 M 0A.<9 B 1.17 L H1@.74 A

Topic: 6UPERNOR.A/ GROWT- ,A/UATION @A.('( stoc+ is e1pected to se!! or H09 t"o years ro) no". 6&pernor)a! %ro"th o 9I is e1pected or the ne1t 0 years. The c&rrent di#idend is H1.=9 and the re:&ired ret&rn is 17I. What constant %ro"th rate is e1pected be%innin% in year 4J A$ 0.4@I '$ 7.1>I ($ 7.=9I *$ 9.1<I E$ 9.>4I Ans"er: E Response: % L R 2* B P $ L .17 Q1.@421M%$ B 09R O % L 9.>4I 4 0

Use the o!!o"in% to ans"er :&estions @1E@>:

6 to c + * & + e E n e r% y

6y) * U 8

* i# 1 .A A

PE 1>

- i 4 1 .9 9

/o 0 @ .7 A

( !o s e 4 A .0 A

( h%. U .9 <

Topic: (O..ON 6TO(8 FUOTE @1.*&+e stoc+ )&st ha#e c!osed at DDDDDDDDDDD per share on the pre#io&s tradin% day. A$ H0@.<7 '$ H4A.=< ($ H4A.@@ *$ H41.99 E$ H40.11 Ans"er: ' Response: 4A.=< E A.9< L 4A.0A

7A

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: *I,I*EN* PER 6-ARE @0.;or the c&rrent yearC the e1pected di#idend per share is: A$ HA.09 '$ [Link] ($ [Link] *$ H4.4A E$ [Link] Ans"er: '

Topic: REFUIRE* RETURN @[Link]&)e the e1pected %ro"th rate in di#idends is 1AI. Then the constant %ro"th )ode! s&%%ests that the re:&ired ret&rn on *&+e stoc+ is: A$ =.7I '$ >.@I ($ [Link] *$ 14.<I E$ 19.>I Ans"er: * Response: R L [Link] 1 1.1A$ B 4A.0AR M .1A L 14.<I

Topic: EARNING6 PER 6-ARE @7.'ased on the :&oteC a %ood esti)ate o EP6 o#er the !ast o&r :&arters is: A$ HA.>A '$ H1.01 ($ H1.<> *$ H1.@1 E$ H0.97 Ans"er: ( Response: EP6 L H4A.0A B 1> L H1.<>

Topic: TRA*ING ,O/U.E @[Link] this tradin% dayC the n&)ber o *&+e shares "hich chan%ed hands "as: A$ 0A@ '$ 0CA@0 ($ 0AC@09 *$ 0A@C09A E$ 0CA@0C9AA Ans"er: E

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 71

Chapter 7: Equity Markets and Stock Valuation

Topic: *I,I*EN* GROWT- RATE @<.Ass&)e that *&+e paid a HA.@0 ann&a! di#idend in the pre#io&s period. What is the di#idend %ro"th rate based on this :&oteJ A$ 7.>I '$ <.AI ($ =.0I *$ >.=I E$ @.@I Ans"er: * Response: % L [Link] B A.@0$ E 1 L >.=I

Topic: 6TO(8 ,A/UATION @=.Yo& be!ie#e that the re:&ired ret&rn on *&+e stoc+ is 1<I and that the e1pected di#idend %ro"th rate is 10IC "hich is e1pected to re)ain constant or the oreseeab!e &t&re. Is the stoc+ c&rrent!y o#er#a!&edC &nder#a!&edC or air!y pricedJ A$ O#er#a!&ed '$ Under#a!&ed ($ ;air!y priced *$ (annot te!! "itho&t )ore in or)ation Ans"er: A Response: P L [Link] 21.10$ R B 2.1< E .10$ L H0>.AAO o#er#a!&ed at H4A.0A in the )ar+et A

Topic: REFUIRE* RETURN @>.Ass&)e that *&+e is se!!in% at its e:&i!ibri&) priceC and that di#idends are e1pected to %ro" at a constant rate o 0AI or the oreseeab!e &t&re. What is the re:&ired ret&rn on the stoc+J A$ 1>.<I '$ [Link] ($ 01.1I *$ 04.4I E$ [Link] Ans"er: E Response: R L 2H1.0A B 4A.0A$ M .0A L 07I

IV.

ESSAYS

Topic: NY6E .E.'ER6 @@./ist the o&r types o NY6E )e)bersC and %i#e a brie de inition o "hat each does. Ans"er: This is a si)p!e !istin% :&estionC the ans"er to "hich sho&!d inc!&de: 21.$ (o))ission bro+er: E1ec&te c&sto)er orders to b&yBse!! stoc+ trans)itted to the e1chan%e !oor.

70

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

20.$ 6pecia!ist 2)ar+et )a+er$: Acts as a dea!er in a s)a!! n&)ber o sec&rities on the e1chan%e !oor. 24.$ ;!oor bro+er: E1ec&te orders or co))ission bro+ers on a ee basis. 27.$ ;!oor trader: Trade or o"n acco&ntC tryin% to anticipate te)porary price !&ct&ations.

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 74

Chapter 7: Equity Markets and Stock Valuation

Topic: NA6*AF ,6. NY6E [Link] are the pri)ary di erences bet"een NA6*AF and NY6EJ Ans"er: Accordin% to the basic in or)ation in the te1tC NY6E has a physica! !ocationC "hi!e NA6*AF does notC and NA6*AF has )&!tip!e )ar+et )a+ers instead o specia!ists or each sec&rity traded. A!soC in NA6*AFC a!! tradin% is e ected thro&%h dea!ers.

Topic: REFUIRE* RETURN [Link] are the co)ponents o the re:&ired rate o ret&rn on a share o stoc+J 'rie !y e1p!ain each. Ans"er: The t"o co)ponents are di#idend yie!dC "hich )eas&res the ann&a! percenta%e inco)e ret&rn on the stoc+C and the capita! %ains yie!dC "hich is the percenta%e price appreciation 2or depreciation$ o the stoc+.

Topic: PRE;ERRE* ,6. (O..ON 6TO(8 1A0.'rie !y e1p!ain the di erences bet"een pre erred and co))on stoc+. Ans"er: (o))on stoc+ho!ders ha#e the ri%ht to #ote on corporate )atters and ha#e the ri%ht to recei#e the resid&a! #a!&e o the ir) a ter a!! !iabi!ities and pre erred stoc+ho!ders are paid in a !i:&idation. Pre erred stoc+ho!ders ha#e a pro)ised di#idendC )ay or )ay not ha#e the ri%ht to co!!ect di#idends that ha#e been passedC and pre erred stoc+ "i!! typica!!y be rated )&ch !i+e bonds. In a !i:&idationC pre erred shareho!ders ha#e a pre erence o#er co))on stoc+ho!ders.

Topic: 6TO(86 ,6. 'ON*6 1A4.E1p!ain "hether it is easier to ind the re:&ired ret&rn on a p&b!ic!y traded stoc+ or a p&b!ic!y traded bondC and e1p!ain "hy. Ans"er: 'ondsC &n!i+e stoc+sC ha#e a ina! )at&rity date and pro)ised pay)ents at i1ed periods o ti)e. ;or stoc+sC the on!y #a!&ation )ode!C "e ha#e &p to this point in the te1t is the di#idend %ro"th )ode! "hich re:&ires esti)ation o a di#idend %ro"th rate and a!so re:&ires that certain conditions be )et be ore the di#idend %ro"th )ode! can be app!ied. Nor)a!!yC a!! o the in or)ation re:&ired to ind the yie!d on a p&b!ic!y traded bond is p&b!ic!y a#ai!ab!e "hi!e on!y the price and )ost c&rrent di#idend are a#ai!ab!e or stoc+s.

77

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e

Chapter 7: Equity Markets and Stock Valuation

Topic: 3EROE*I,I*EN* 6TO(86 1A7.A n&)ber o p&b!ic!y traded ir)s pay no di#idends yet in#estors are "i!!in% to b&y shares in these ir)s. -o" is this possib!eJ *oes this #io!ate o&r basic princip!e o stoc+ #a!&ationJ E1p!ain. Ans"er: O&r basic princip!e o stoc+ #a!&ation is that the #a!&e o a share o stoc+ is si)p!y e:&a! to the present #a!&e o a!! o the e1pected di#idends on the stoc+. Accordin% to the di#idend %ro"th )ode!C an asset that has no e1pected cash !o"s has a #a!&e o zeroC so i in#estors are "i!!in% to p&rchase shares o stoc+ in ir)s that pay no di#idendsC they e#ident!y e1pect that the ir)s "i!! be%in payin% di#idends at so)e point in the &t&re.

Topic: (/A66E6 O; 6TO(8 1A9.A ir) has t"o c!asses o co))on stoc+ o&tstandin%: (!ass AC "hich carries #otin% ri%hts o 1A #otes per share b&t recei#es no di#idends 2e#er$C and (!ass 'C "hich carries #otin% ri%hts o one #ote per share and pays di#idends "hene#er they are dec!ared by the board. Which "o&!d yo& be "i!!in% to pay )ore or and "hyJ Ans"er: This is a #ery openEended :&estion to %et the st&dents thin+in% abo&t the di erin% interests o in#estors. .ana%e)ent o the ir) "o&!d !i+e!y pre er (!ass AC "hi!e in#estors interested in di#idends "o&!d !i+e!y pre er (!ass ' shares. The (!ass ' shares "ith their ordinary #otin% ri%hts and di#idends can be #a!&ed &sin% the di#idend %ro"th )ode!C b&t the (!ass A sharesC "hose #a!&e is deri#ed co)p!ete!y ro) the #otin% ri%htsC "o&!d be #ery di ic&!t to #a!&e.

Ross/Westerfield/Jordan, Essentials of Corporate inance, !/e 79