Question 1

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.

Accepted Answer

This statement is true. Proxies can be used to give one party (such as a shareholder) the authority to vote shares of common stock on behalf of another party (such as a company's board of directors). This can be important in situations where there is a proxy fight or other dispute over control of a firm.

Question 2

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.

Accepted Answer

According to the nonconstant growth model, the discount rate used to find the present value of cash flows during the initial growth period may be different from the discount rate used in the subsequent constant growth period. However, the model assumes that the discount rate remains constant during each period.

Question 3

a firm's expected growth rate increased then its required rate of return would

Accepted Answer

An increase in a firm's expected growth rate can affect the required rate of return in various ways depending on investor perceptions, risk factors, and market conditions, leading to it possibly increasing, decreasing, or remaining constant.

Question 4

a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.

Accepted Answer

This statement correctly describes the two necessary conditions for a stock to be in equilibrium.

Question 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.

Accepted Answer

Founders' shares have more voting power per share than other classes of common stock, giving the founders greater control over the company.

Question 6

Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the value of its operations.

Accepted Answer

Discounting projected free cash flows at the weighted average cost of capital (WACC) helps to determine the present value of all future cash flows generated by the company's operations. The WACC takes into account the cost of equity and debt financing and represents the minimum return that the company needs to earn on its investments. By discounting future cash flows at this rate, it takes into account the time value of money and provides a present value estimate of the company's operations.

Question 7

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.

Accepted Answer

This statement is true. Classified stock can be used to create different classes of common stock with varying voting rights, allowing companies to raise equity capital while retaining voting control. This can be particularly useful for start-up firms that want to maintain control while still raising funds.

Question 8

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.

Accepted Answer

From an investor's perspective, preferred stock has a fixed dividend and priority over common stock in case of liquidation, making it less risky than common stock but more risky than bonds. For the issuing firm, bonds are the most risky due to the obligation to pay interest, preferred stock is next due to fixed dividends, and common stock is least risky as dividends are not obligatory.

Question 9

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.

Accepted Answer

This statement is true. Preemptive rights give current stockholders the first option to purchase new shares, which helps protect their ownership and value in the company.

Question 10

conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.

Accepted Answer

For a stock to be in equilibrium, both conditions must hold: the stock's market price must equal its intrinsic value, and the expected return must equal the required return for the marginal investor.

Question 11

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.

Accepted Answer

Preferred stock dividends are not guaranteed in the same way bond interest payments are, and they do not typically increase annually like common stock dividends might. Preferred dividends are set at a fixed rate and can be suspended by the company in financial distress.

Question 12

a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value.

Accepted Answer

This is known as the principle of equilibrium, where the market price will eventually move towards the intrinsic value as a result of the actions of rational investors.

Question 13

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

Accepted Answer

Total return on a share of stock takes into account both the dividend yield and any changes in the stock's price, not just commissions paid when buying or selling.

Question 14

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

Accepted Answer

When a new stock is brought to market, the marginal investor (the investor who is willing to buy or sell at the current price) determines the price at which the stock will trade. This is because the price in the market is set by supply and demand, and the price will continue to adjust until the marginal investor is satisfied with the price.

Question 15

a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

Accepted Answer

This is the principle of equilibrium in finance, known as the Capital Asset Pricing Model (CAPM). If the expected return is higher than the required return, it implies that the stock is underpriced, and investors will buy it until the price is bid up and the expected return is reduced to match the required return.

Question 16

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.

Accepted Answer

The answer of According to the basic DCF stock valuation...

Question 17

Which of the following statements is CORRECT?

Accepted Answer

The stock valuation model P0 = D1/(rs - g) can be used even if dividends are expected to decline at a constant rate, as long as rs > g.

Question 18

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.

Accepted Answer

This is because the cash flows associated with common stock are contingent on the company's performance and the dividends it chooses to pay out, while the cash flows associated with bonds are determined by a contractual agreement between the issuer and bondholders.

Question 19

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.

Accepted Answer

The constant growth DCF model used to evaluate the prices of common stocks assumes a perpetuity of dividends that grow at a constant rate. This is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities that have a fixed rate of return. Therefore, the statement is true.

Question 20

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.

Accepted Answer

The statement about preemptive rights is incorrect. Preemptive rights give existing shareholders the right to purchase any newly issued shares of stock in order to maintain their ownership percentage. The correct definition of the term for the scenario described would be "proxy access," which is the ability of shareholders to include candidates for director in the company's proxy materials. Without proxy access, dissident shareholders would have to mount their own proxy solicitation campaign in order to nominate candidates for the board of directors.

Quiz 5: Stocks