1.
Preferred stock is referred to as a hybrid security because it has many characteristics of both
common stock and bonds.
2. Because most preferred stocks are perpetuities, their value can be determined by dividing the
annual dividend by an investor's required return.
3. In terms of risk, preferred stock is safer than common stock because it has a prior claim on
assets and income
4. The amount of the preferred stock dividend is generally fixed either as a dollar amount or as a
percentage of the par value.
5. 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
6. 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
7. 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
8. Maynard Inc. 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.
9. Whistle Corp. has a preferred stock that pays a dividend of $2.40. If you are willing to
purchase the stock at $11, what is your required rate of return (round your answer to the nearest .1%
and assume that there are no transaction costs)?
A) 21.8%
B) 11.0%
C) 9.1%
D) 20.1%
10. 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
11. Common stock cannot be worth less than its book value.
12. The common stock of a constant-growth firm is valued in the same manner as its preferred stock.
13. Common stock does not mature.
14. Preferred stock and common stock issued by the same firm will have the same required return
because the riskiness of the firm's cash flows is the same for both securities.
15. 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.
16. 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.
17. ) Because common stock represents a residual interest in the corporation, the value of common
stock is equal to the total firm value less the firm's outstanding debt.
18. The stock valuation model D1/(rcs - g) requires the stock to grow at a rate greater than the required
return; otherwise, the stock is worthless.
.
19. Asymmetric Frames Corp had a return on equity of 15%. The corporation's earnings per share was
$6.00, its dividend payout ratio was 40% and its profit-retention rate was 60%. If these relationships
continue, what will be United Financial Corp's internal growth rate?
A) 6.0%
B) 8.6%
C) 9.0%
D) 15.6%
20. ACME, Inc. expects its current annual $2.50 per share common stock dividend to remain the same
for the foreseeable future. Therefore, the value of the stock to an investor with a required return of
12% is
A) $3.00.
B) $18.33.
C) $20.83.
D) $30.00.
21. You are considering the purchase of a common stock that paid a dividend of $2.00 yesterday. You
expect this stock to have a growth rate of 15 percent for the next 3 years, resulting in dividends of
D1=$2.30, D2=$2.645, and D3=$3.04. The long-run normal growth rate after year 3 is expected to be 10
percent (that is, a constant growth rate after year 3 of 10% per year forever). If you require a 14 percent
rate of return, how much should you be willing to pay for this stock?
A) $89.75
B) $83.65
C) $56.46
D) $62.57
22. A small biotechnology research corporation has been experiencing losses for the first three years of
its existence, and thus has a negative balance in retained earnings. The corporation's stock price,
however, is $1 per share. Which of the following statements is MOST correct?
A) Investors are irrational to pay $1 per share when earnings per share have been negative for three
years.
B) Investors believe the stock is worth $1 per share because future earnings (and cash flows) are
expected to be positive.
C) The corporation's accountants must have made a mistake because retained earnings may not be
negative.
D) The required return on the stock will be small because the company has very few assets.
23) Bensen Co. paid a dividend of $5.25 on its common stock yesterday. The company's dividends are
expected to grow at a constant rate of 8.5% indefinitely. The required rate of return on this stock is
15.5%. You observe a market price of $78.50 for the stock. Should you purchase this stock?
A) No, the market price is above the intrinsic value of the stock.
B) Yes, the market price is below the intrinsic value of the stock.
C) No, the growth rate in dividends is too far below the required return.
D) Yes, but only if you can keep the stock for at least 5 years.
Answer: B
Diff: 2
Keywords: Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills