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FIN 100 Principles of Finance part 4

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10.2 The Comparables Approach to Valuing Common Stock

1) If a stock has a much higher than normal P/E ratio, investors probably expect

  1. A) slow growth in earnings.
  2. B) rapid growth in earnings.
  3. C) large increases in the price of the stock.
  4. D) a declining stock price.

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

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

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

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

3) The P/E ratio is calculated by dividing

  1. A) the current stock price by stockholders' equity.
  2. B) total assets by net income.
  3. C) the current stock price by earnings per share.
  4. D) the current stock price by operating cash flow per share.

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

4) The GAP's most recent earnings per share were $1.75. Analysts forecast next year's earnings per share at $1.88. If the appropriate P/E ratio is 15, a share of GAP stock should be valued at

  1. A) $28.20.
  2. B) $26.25.
  3. C) $27.23.
  4. D) $8.57.

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

5) The retail analyst at Morgan-Sachs values stock of the GAP at $38.00 per share. They are using the average industry "forward" P/E ratio of 17. Their forecasted earnings per share for next year is

  1. A) $0.54.
  2. B) $1.50.
  3. C) $2.24.
  4. D) There is not enough information calculate earnings per share.

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

6) Home Depot stock is currently selling for $75 per share. Next year's dividend is expected to be $1.56; next year's earnings per share are expected to be $4.16. Home Depot's P/E ratio is

  1. A) .055.
  2. B) 18.
  3. C) 2.14.
  4. D) 48.

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

7) McDonald's stock currently sells for $103. It's expected earnings per share are $5.50. The average P/E ratio for the industry is 24. If investors expected the same growth rate and risk for McDonald's as for an average firm in the same industry, it's stock price would

  1. A) stay about the same.
  2. B) rise.
  3. C) fall.
  4. D) there is not enough information.

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

8) If the ROE on a new investment is less than the firm's required rate of return

  1. A) the investment increases the firm's value.
  2. B) the investment leaves the firm's value unchanged.
  3. C) the effect on the firm's value is unpredictable.
  4. D) the investment reduces the firm's value.

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

9) Zorba's is a small chain of restaurants whose stock is not publicly traded. The average P/E ratio for similar restaurant chains is 16.5; the P/E ratio for the S&P 500 Index is 15.2. This year's earnings were $1.21 per share and next year's earnings are forecasted at $1.46 per share. A reasonable price for a share of Zorba's stock is

  1. A) $24.09.
  2. B) $19.96.
  3. C) $20.23.
  4. D) $16.50.

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

10) Apple stock is now selling for $460 per share. The P/E ratio based on current earnings is 10.98 and the P/E ratio based on expected earnings is 10.16. The expected growth rate in Apples earnings must be

  1. A) 2.39%.
  2. B) 8.07%.
  3. C) -7.5%.
  4. D) 5.5%.

Answer: B

Diff: 3

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

11) The P/E ratio is the market price of a share of stock divided by book equity per share.

Answer: FALSE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

12) The higher a firm's P/E ratio, the more optimistic investors feel about the firm's growth prospects.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

13) P/E ratios found in published sources or on the internet are always computed by dividing the next period's expected earnings into the current price of the stock.

Answer: FALSE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

14) The higher the investor's required rate of return, the higher the P/E ratio will be.

Answer: FALSE

Diff: 2

AACSB: 3. Analytic thinking


Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

15) Walmart's current earnings per share of $5.02 are expected to grow at a rate of 17% per year for the next few years. Using a P/E ratio of 13.46, what is a reasonable value for a share of Walmart Stock.

Answer: A reasonable value for Walmart would be $5.02(1.17)(13.46)=$79.06 per share.

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

16) RAH Inc. is not publicly traded, but the P/E ratios of it's 4 closest competitors are 15, 15.3, 15.7, and 16.5. RAH's current earnings per share are $1.50. They are expected to grow at 6% for the next few years. What is a reasonable price for a share of RAH stock?

Answer: An appropriate P/E ratio would be an average of the 4 competitors:

(15 + 15.3 + 15.7 + 16.5)/4 = 15.625. A reasonable price would be $1.50(1.06)(15.625) = $24.84.

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.2 Use the price-to-earnings ratio to value common stock.

Keywords: price/earnings ratio

Principles: Principle 3: Cash Flows Are the Source of Value

10.3 Preferred Stock

1) UVP preferred stock pays $5.00 in annual dividends. If your required rate of return is 13%, how much will you be willing to pay for one share?

  1. A) $38.46
  2. B) $26.26
  3. C) $65.46
  4. D) $46.38

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

2) Green Corp.'s preferred stock is selling for $20.83. If the company pays $2.50 annual dividends, what is the expected rate of return on its stock?

  1. A) 8.33%
  2. B) 12.00%
  3. C) 2.50%
  4. D) 20.00%

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

3) Sacramento Light & Power issued preferred stock in 1998 that had a par value of $85. The preferred stock pays a dividend of 5.75%. Investors require a rate of return of 6.50% today on this stock. What is the value of the preferred stock today? Round to the nearest $1.

  1. A) $100
  2. B) $85
  3. C) $75
  4. D) $16

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

4) Which of the following statements is true?

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

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

5) Which of the following statements concerning preferred stock is correct?

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

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

6) World Wide Interlink Corp. has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with an annual dividend of $5 per share. The stock will have a par value of $30. If investors' required rate of return on this investment is currently 20%, what should the preferred stock's market value be?

  1. A) $10
  2. B) $15
  3. C) $20
  4. D) $25

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

7) Davis Gas & Electric issued preferred stock in 1985 that had a par value of $50. The stock pays a dividend of 7.875%. Assume that shares are currently selling for $62.50. What is the preferred stockholder's expected rate of return? Round to the nearest 0.01%.

  1. A) 6.30%
  2. B) 7.88%
  3. C) 10.25%
  4. D) 5.02%

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

8) Murky Pharmaceuticals has issued preferred stock with a par value of $100 and a 5% dividend. The investors' required yield is 10%. What is the value of a share of Murky preferred?

  1. A) $100
  2. B) $75
  3. C) $50
  4. D) $25

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

9) Edison Power and 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

  1. A) preferred shareholders may cast all their votes for a single director.
  2. B) preferred shareholders must receive dividends totaling $8.00 per share.
  3. C) preferred shareholders must receive $2.00 per share.
  4. D) will not necessarily receive any dividend.

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

10) Which of the following provisions is unique to preferred stockholders and usually NOT available to common stockholders?

  1. A) Cumulative dividends feature
  2. B) Voting rights
  3. C) Fixed dividend
  4. D) Both A and C

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

11) Piercing Publishers recently issued preferred stock with a fixed annual dividend of $3.00 per share. Investors require a 5% return on similar preferred stock issues. The stock is currently selling for $65. Is the stock a good buy?

  1. A) Yes, as it is undervalued $5.
  2. B) Yes, as it is undervalued $10.
  3. C) No, as it is overvalued $5.
  4. D) No, as it is overvalued $10.

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: New question

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

12) Tri State Pickle Company preferred stock pays a perpetual annual dividend of 2 1/2% of its par value. Par value of TSP preferred stock is $100 per share. If investors' required rate of return on this stock is 15%, what is the value of per share?

  1. A) $37.50
  2. B) $15.00
  3. C) $16.67
  4. D) $6.00

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

13) Petrified Forest Skin Care, Inc. pays an annual perpetual dividend of $1.70 per share. If the stock is currently selling for $21.25 per share, what is the expected rate of return on this stock.

  1. A) 36.13%
  2. B) 12.5%
  3. C) 8.0%
  4. D) 13.6%

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

14) Horizon Communications stock pays a fixed annual dividend 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

  1. A) Horizon's dividend decreased by 6 cents.
  2. B) The value of Horizon's preferred increased by $3.00.
  3. C) The value of Horizon's preferred decreased by $5.00.
  4. D) The value of Horizon's preferred increased by $5.00.

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

15) The required rate of return on TKF preferred has fallen from 5.75% at the time of issue to the present rate of 5%. The stock now sells for $115. What was the original price?

  1. A) $75.61
  2. B) $132.25
  3. C) $114
  4. D) $100

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: New question

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

16) Preferred stock is similar to a bond in which of the following ways?

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

Answer: B

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

17) Solitron Manufacturing Company preferred stock is selling for $14. If it has a yearly dividend of $1, what is your expected rate of return if you purchase the stock at its market price (round your answer to the nearest .1%).

  1. A) 25.0%
  2. B) 14.2%
  3. C) 7.1%
  4. D) 9.3%

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

18) An decrease in the ________ will increase the value of preferred stock.

  1. A) expected rate of return
  2. B) life of the investment
  3. C) dividend paid
  4. D) both A and C

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

19) Texon's preferred stock sells for $85 and pays $11 each year in dividends. What is the required rate of return?

Answer: Required rate of return = = 0.129

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

20) What is the value of a preferred stock that pays a $2.10 dividend to an investor with a required rate of return of 6% (round your answer to the nearest $1)?

  1. A) $35
  2. B) $23
  3. C) $17
  4. D) $21

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Revised

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

21) Which of the following formulas is appropriate to find the value of preferred stock with a fixed dividend?

  1. A) Value of preferred stock = Annual Preferred Stock Dividend (1 + growth rate)/Market's Required Yield on Preferred Stock
  2. B) Value of preferred stock = Annual Preferred Stock Dividend (1 + growth rate)/Market's Required Yield on Preferred Stock - growth rate
  3. C) Value of preferred stock = Annual Preferred Stock Dividend/Market's Required Yield on Preferred Stock
  4. D) Value of preferred stock = Annual Preferred Stock Dividend/Investor's Required Yield on Preferred Stock

Answer: C

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

22) An issue of preferred stock currently sells for $52.50 per share and pays a constant annual expected dividend of $2.25 per share. The expected return on this security is

  1. A) 4.29%.
  2. B) 0.04%.
  3. C) 8.33%.
  4. D) 13.33%.

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

23) Expected cash flow for a preferred stock primarily consists of

  1. A) dividend payments.
  2. B) changes in the price of the stock.
  3. C) interest payments.
  4. D) both A and B.

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

24) Preferred stock is similar to common stock in that

  1. A) it has no fixed maturity date.
  2. B) the nonpayment of dividends can bring on bankruptcy.
  3. C) dividends are limited in amount.
  4. D) both carry voting rights.

Answer: A

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

25) Profitable companies often prefer to issue debt rather than preferred stock because

  1. A) debt creates less risk for the company.
  2. B) interest payments are fixed but preferred shareholders expect dividends to grow.
  3. C) preferred shares dilute the voting rights of common shareholders but bonds do not.
  4. D) interest on debt is deductible for tax purposes, but preferred dividends are not.

Answer: D

Diff: 2

AACSB: 3. Analytic thinking

Question Status: New question

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

26) In the event of bankruptcy, preferred stockholders and common stockholders have the same claim on the firm's assets.

Answer: FALSE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

27) A company may issue multiple classes of preferred stock.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

28) The cumulative dividend feature is necessary to protect the rights of preferred stockholders.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

29) Preferred stock cannot be retired.

Answer: FALSE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

30) To determine the value of a share of preferred stock, the discount rate used is the annual dividend percent.

Answer: FALSE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

31) The value of preferred shares is affected by changes in interest rates.

Answer: TRUE

Diff: 2

AACSB: 3. Analytic thinking

Question Status: New question

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

32) Miller/Hershey's preferred stock is selling at $54 on the market and pays an annual dividend of $4.20 per share.

  1. What is the expected rate of return on the stock?
  2. If an investor's required rate of return is 9%, what is the value of the stock for that investor?
  3. Considering the investor's required rate of return, does this stock seem to be a desirable investment?

Answer: 

  1. R = D/V

R = $4.20/54

R = 7.78%

  1. V = D/R

V = $4.20/.09

V = $46.66

  1. No, it is not a desirable investment.

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

33) Discuss two reasons why preferred stock would be viewed as less risky than common stock to investors.

Answer: Preferred stockholders are paid before common stockholders in the event of bankruptcy. Common stockholders, as the residual owners of a corporation, would receive any monies remaining after bondholder and preferred stock claims are satisfied. Preferred dividends are paid before common stock dividends in the normal course of business. In the event that a preferred dividend is not paid, it accumulates and dividends in arrears must be paid before any common stock dividends can be declared. Common shareholders take the risk that they will not receive dividends. The magnitude of the cash flows from preferred is also known where it is not known for common stock. Because cash flows are more certain, preferred stock would be considered less risky to the investor.

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

34) Determine the rate of return on a preferred stock that costs $50 and pays a $6 per share dividend.

Answer: 

K = Div = 6 = 12%

Vg 50

Diff: 2

AACSB: 3. Analytic thinking

Question Status: Previous edition

Objective: 10.3 Identify the basic features and characteristics and features of preferred stock and value preferred shares.

Keywords: preferred stock

Principles: Principle 3: Cash Flows Are the Source of Value

10.4 The Stock Market

1) An example of a primary market transaction is

  1. A) a new issue of stock by Evergreen Solar.
  2. B) a purchase of Microsoft stock on Nasdaq.
  3. C) Target repurchasing some its own stock from an investor.
  4. D) a sale of IBM stock on the NYSE.

Answer: A

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

2) The largest market stock exchange in the U.S. is

  1. A) NYSE.
  2. B) Nasdaq.
  3. C) AMEX.
  4. D) the CBOT.

Answer: A

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Revised

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

3) Which of the following companies is most likely to trade on the New York Stock Exchange?

  1. A) Dell
  2. B) Genzyme Transgenics
  3. C) Coca Cola
  4. D) Tata Motors

Answer: C

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

4) Which of the following exchanges has the strictest listing requirements?

  1. A) AMEX
  2. B) Nasdaq
  3. C) NYSE
  4. D) OTC

Answer: C

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

5) A small, newly listed technology company is most likely to be listed on

  1. A) AMEX.
  2. B) NYSE.
  3. C) Nasdaq National Markets.
  4. D) Nasdaq Capital Markets.

Answer: D

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

6) Listing requirements for the New York Stock Exchange include

  1. A) profitability.
  2. B) market value.
  3. C) breadth of ownership.
  4. D) all of the above.

Answer: D

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

7) A block trade is a trade involving 10,000 or more shares by a single holder.

Answer: TRUE

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

8) The NASDAQ trading floors are located in New York City.

Answer: FALSE

Diff: 2

AACSB: 6. Reflective thinking

Question Status: New question

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

9) Large, established technology companies such as Apple, Dell, Intel and Microsoft all trade on the NYSE.

Answer: FALSE

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

10) Trading on the Nasdaq is done electronically and does not require a physical location.

Answer: TRUE

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

11) In addition to stocks in individual companies, the AMEX conducts trading in such securities as ETFs and options.

Answer: TRUE

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

12) Describe the major differences between the organized exchanges such as the NYSE and electronic networks such as Nasdaq.

Answer: The organized exchanges such as the New York Stock Exchange have a physical location and a trading floor where buyers and sellers of securities can meet face to face. An increasing percentage of NYSE and AMEX trades is, however, executed electronically. Nasdaq is an electronically linked network of traders that post bid and ask prices (the prices they are willing to pay or accept for securities) and the quantities they are willing to purchase or sell. There is no physical trading floor. Although companies trading on Nasdaq tend to be smaller and younger than those traded on the NYSE, Nasdaq listings do include some very large companies such as Microsoft and Apple.

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

13) Distinguish between primary stock market transactions and secondary stock market transaction.

Answer: When a company issues stock to the public for the first time, the event is known as an IPO or Initial Public Offering. Subsequent to the IPO, trading in the company's stock takes place on one of the major exchanges such as the NYSE or Nasdaq. In the great majority of these transactions, investors buy stock from other investors who wish to sell it, rather than directly from the company that issued it.

Diff: 2

AACSB: 6. Reflective thinking

Question Status: Previous edition

Objective: 10.4 List the secondary markets for common stock.

Keywords: stock markets

Principles: Principle 4: Market Prices Reflect Information

1.The accumulated value of an annuity will exactly double if the amount of time is exactly doubled, everything else equal.

False

2.At 5.95 percent compounded annually, how many years will it take for $1,000 to double?

8

3.You are considering buying some stock in Continental Grain. Which of the following are examples of non-diversifiable risks?
I. Risk resulting from a general decline in the stock market. II.Risk resulting from a possible increase in income taxes. III.Risk resulting from an explosion in a grain elevator owned by Continental. IV. Risk resulting from a pending lawsuit against Continental.
I and II

4.Which of the following statements is true?
.
None of the above.

5.Common stock cannot be worth less than its book value.

True

6.Cary's Company bonds have a 12% coupon rate. Interest is paid semi-annually. The bonds have a par value of $1,000 and will mature 8 years from now. Compute the value of the bonds if investors' required rate of return is 8%.

$894.06

7.The less risky the bond (or the higher the bond rating) the lower the yield to maturity on the bond, all other things being equal.
True

8.The sum of the present values of an investment's expected future cash flows is known as the investment's intrinsic value.
True


9.All of the following affect the value of a bond except:

the maturity date of the bond

10.If you have $20,000 in an account earning 8 percent annually, what constant amount could you withdraw each year and have nothing remaining at the end of 5 years?
$5,009

11.A disadvantage of junk bonds is that they do not provide a coupon payment, and only make a par value payment at maturity.

False

12.The expected cash flow of an investment takes the condition of the economy into consideration.

False

  1. Finance theory suggests that the current market value of a bond is based upon which of the following?

    The sum of the present value of the bond's interest payments and the present value of the principal.

14.One characteristic of an annuity is that the payment amount is the same during each period.

False

15.Assume that WhirledCom has an issue of 15-year $1,000 par value bonds that pay 6% interest, semiannually. Further assume that today's required rate of return on these bonds is 9%. How much would these bonds sell for today? Round off to the nearest $1.

$756

16.If a firm were to experience financial insolvency, the legal system provides an order of hierarchy for the payment of claims. Assume that a firm has the following outstanding securities: mortgage bonds, common stock, debentures, and preferred stock. Rank the order in which investors that own mortgage bonds would have their claim paid?

Third.


17.How can investors reduce the risk associated with an investment portfolio without having to accept a lower expected return?

.
Purchase stocks that have exceptionally high standard deviations.

18.If a bond's rating declines, then so does its price, everything else equal.

False

19.If you expect NoDiv Corporation to sell for $75 per share in three years while paying no dividends along the way, if your required rate of return is 16% per year, how much is the stock worth today?
$42.68

20.The appropriate measure for risk according to the capital asset pricing model is:
the standard deviation of a firm's cash flows
alpha
the coefficient of variation of a firm's cash flows
none of the above

21.The intrinsic value should necessarily be above the market value in order to make it desirable in the eyes of an investor.
True

22.The present value of a future sum of money increases as the number of years before the payment is received increases.
True

23.You borrow $25,000 to be repaid in 12 monthly installments of $2,292.00. The annual interest rate is closest to:

24 percent.

24.All other things being equal, the future value of an investment will increase if:

all of the above

  1. The yield to maturity on a bond:

    is the expected rate of return on the bond

26.The present value of a $100 perpetuity discounted at 5% is $2,000.
True

27.You purchased 1,000 shares of Oliver Inc. common stock one year ago for $50 per share. You decided to take your profit today by selling at $55.00 per share. What is your holding period return?
10.0%

28.What is the value of a bond that matures in 20 years, makes an annual coupon payment of $40, and has a par value of $1,000? Assume a required rate of return of 10%, and round your answer to the nearest $10.


$490

29.Which of the following is/are true:
The Beta of a U.S. Treasury Bill is zero

The Beta of the market is one

The estimate of Beta for a given stock will vary from analyst to analyst depending on the time period used, and the market portfolio used to estimate Beta. All of the above are true

Correct Answer: All of the above are true

30.Which type of value is shown on the firm's balance sheet?

book value

31.A firm can increase the growth rate of common stockholders' investment in the firm by retaining more earnings or increasing return on equity.

True

32.Which of the following is the slope of the security market line?
security market line

beta

33.iSaga, whose common stock is currently selling for $12 per share, is expected to pay a $1.80 dividend, and sell for $14.40 one year from now. What are the dividend yield, growth rate, and total rate of return, respectively?

10% 5% 15%

  1. Which of the following is true regarding common stock?

All of the above.



60) Which of the following is not a function of functional area information systems?

A. provides analysis capabilities to middle level managers and staff
B. supports the managerial tasks of planning, organizing, and controlling operations
C. provides information to managers in the functional areas
D. provides information mainly in the form of reports
E. provides data from business events to the corporate database

61) Geocoding is __________.

A. programming spatially oriented databases
B. encrypting spatial information
C. integrating maps with spatially oriented databases and other databases
D. accessing geographical information
E. integrating organizational transactions with spatially oriented databases

62) _____ provides users with a view of what is happening, where _____ addresses why it is happening.

A. Multidimensional data analysis, data mining
B. Data mining, multidimensional data analysis
C. Multidimensional data analysis, structured query language
D. Data mining, expert system
E. Multidimensional data analysis, neural networks
63) A stock with a beta greater than 1.0 has returns that are _____ volatile than the market, and a stock with a beta of less than 1.0 exhibits returns which are _____ volatile than those of the market portfolio.

A. less, less
B. more, less
C. more, more
D. less, more

64) Which of the following is most consistent with the hedging principle in working capital management?

A. Fixed assets should be financed with short-term notes payable.
B. Inventory should be financed with preferred stock.
C. Accounts receivable should be financed with short-term lines of credit.
D. Borrow on a floating rate basis to finance investments in permanent assets.

65) The common stockholders are most concerned with:

A. the spread between the return generated on new investments and the investor’s required rate of return.
B. the size of the firm’s beginning earnings per share.
C. the percentage of profits retained.
D. the risk of the investment.

66) PepsiCo calculates unlevered betas for each peer group in order to:

A. eliminate different financial risks.
B. eliminate competitive factors.
C. eliminate different business risks.
D. eliminate judgment factors.

67) Tri State Pickle Company preferred stock pays a perpetual annual dividend of 2 1/2% of its par value. Par value of TSP preferred stock is $100 per share. If investors’ required rate of return on this stock is 15%, what is the value of per share?

A. $37.50
B. $6.00
C. $15.00
D. $16.67

68) According to the hedging principle, permanent assets should be financed with _____ liabilities.

A. permanent
B. fixed
C. spontaneous
D. current

69) Which of the following best represents operating income?

A. Income after financing activities
B. Income from discontinued operations
C. Earnings before interest and taxes
D. Income from capital gains

70) Petrified Forest Skin Care, Inc. pays an annual perpetual dividend of $1.70 per share. If the stock is currently selling for $21.25 per share, what is the expected rate of return on this stock?

A. 36.13%
B. 13.6%
C. 12.5%
D. 8.0%

71) Which of the following best represents the stream of income that is available to common stockholders?

A. Net profit after tax and after preferred dividend payments
B. Operating profit
C. Earnings before interest and taxes
D. Gross profit

72) An increase in future value can be caused by an increase in the __________.

A. annual interest rate and number of compounding periods
B. rate of return
C. starting value
D. dividends paid
E. original amount invested

73) At what rate must $400 be compounded annually for it to grow to $716.40 in 10 years?

A. 6%
B. 8%
C. 5%
D. 7%

74) Exchange rate risk:

A. arises from the fact that the spot exchange rate on a future date is a random variable.
B. doesn’t affect trades made in US Dollars.
C. applies only to certain types of domestic businesses.
D. has been phased out due to recent international legislation.

75) Which of the following represents an attempt to measure the earnings of the firm’s operations over a given time period?

A. Balance sheet
B. Quarterly statement
C. Cash flow statement
D. Income statement

 

  1. the t-bill return is used in the CAPM model as the risk rate?

true or false

  1. total risk equals systematic risk plus unsystematic risk?

true or false

  1. a perpetuity is an investment that continues forever but pays a different dollar amount each year?

true or false

  1. the same underlying formula is used for computing both the future value and present value?

true or false

  1. if you invest $750 every six months at 8 percent compounded semi-annually, how much would you accumlate at the end of 10 years?

a:$10,065 b:$10,193 c:$22,334 d:$21,731

FIN 100 Principles of Finance Part 1

FIN 100 Principles of Finance Part 2

FIN 100 Principles of Finance Part 3

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