CHAPTER 09 14STOCKS AND THEIR VALUATION

Topics: Stock market, Preferred stock, Stock Pages: 35 (8682 words) Published: March 10, 2015
CHAPTER 9: STOCKS AND THEIR VALUATION

1. A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms. a. True

b. False

ANSWER: True

2. The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value. a. True

b. False

ANSWER: True

3. If a firm’s stockholders are given the preemptive right, this means that stockholders have 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. a. True

b. False

ANSWER: False

4. Classified stock differentiates various classes of common stock, and using it is one way companies can meet special needs such as when owners of a start-up firm need additional equity capital but don’t want to relinquish voting control. a. True

b. False

ANSWER: True

5. Founders’ shares are a type of classified stock where the shares are owned by the firm’s founders, and they generally have more votes per share than the other classes of common stock. a. True
b. False

ANSWER: True

6. The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold. a. True
b. False

ANSWER: False

7. The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond. a. True

b. False

ANSWER: True

8. According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock. a. True
b. False

ANSWER: False

9. When a new issue of stock is brought to market, it is the marginal investor who determines the price at which the stock will trade. a. True
b. False

ANSWER: True

10. The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities. a. True

b. False

ANSWER: True

11. According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash flows during the subsequent constant growth period. a. True

b. False

ANSWER: True

12. The corporate valuation model can be used only when a company doesn’t pay dividends. a. True
b. False

ANSWER: False

13. The corporate valuation model cannot be used unless a company pays dividends. a. True
b. False

ANSWER: False

14. Projected free cash flows should be discounted at the firm’s weighted average cost of capital to find the firm’s total corporate value. a. True
b. False

ANSWER: True

15. Preferred stock is a hybrid—a sort of cross between a common stock and a bond—in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond. a. True

b. False

ANSWER:False
RATIONALE: Preferred dividends don’t normally grow, and they are not guaranteed.

16. From an investor’s perspective, a firm’s preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer’s standpoint, these risk relationships are reversed: bonds are the most risky for the firm, preferred is next, and common is least risky. a. True

b. False

ANSWER: True

17. If a stock’s expected return as seen by the marginal investor exceeds this investor’s required return, then the...
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