CFIN 5th Edition Besley Test Bank

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Chapter 07 Stocks Equity Characteristics and Valuation

TRUEFALSE

1. A call provision gives the issuing corporation the right to call in the preferred stock for
redemption.

(A) True

(B) False

Answer : (A)

2. A call provision included in a sinking fund adds a maturity option to a preferred stock issue.

(A) True

(B) False

Answer : (A)

3. According to the convertibility provision, a common stock can be converted to a certain number of
shares of preferred stock at the conversion price.

(A) True

(B) False

Answer : (B)

4. A common stock of a firm will have a maturity period of 10 years.

(A) True

(B) False

Answer : (B)

5. A firm undertakes stock repurchase only if the price of its stock is overvalued.

(A) True

(B) False

Answer : (B)

6. A stock's par value is equal to the market value of the stock on the last day of the fiscal year for a
firm.
(A) True

(B) False

Answer : (B)

7. A proxy fight is an attempt by a group to overthrow the current management team and take
control of a business by soliciting stockholders' proxies.

(A) True

(B) False

Answer : (A)

8. American depository receipts (ADRs) are foreign stocks listed on a domestic exchange.

(A) True

(B) False

Answer : (B)

9. If we view P/E ratios as measures of payback, all else equal, higher earnings multipliers are
better.

(A) True

(B) False

Answer : (B)

10. Stock prices move opposite changes in cash flows expected from the stock in the future, but they
move in the same direction as changes in rates of return.

(A) True

(B) False

Answer : (B)

11. Changes in stock prices occur because investors change the rates of return they require to
invest in stocks and/or the expectations about the cash flows associated with stocks change.

(A) True

(B) False

Answer : (A)
MULTICHOICE

12. When do firms get the right to redeem a preferred stock?​

(A) ​By paying accumulated dividends

(B) ​By issuing the stock at par value

(C) ​By incorporating a call provision

(D) ​By providing voting rights

(E) ​By including a preemptive right

Answer : (C)

13. The amount in excess of par value that a company must pay when it repurchases a security is
known as the _____.​

(A) call premium​

(B) ​preemptive price

(C) ​cumulative dividend

(D) ​participating dividend

(E) ​growth stock

Answer : (A)

14. Which of the following is included in the call provision of a preferred stock?​

(A) Preferred stockholders can elect the members of the board of directors and also vote on
corporate issues.​

(B) ​Preferred stockholders have priority over common stockholders with regard to assets of the firm.

(C) ​Preferred stockholders have the right to receive preferred dividends previously not paid, to be
disbursed before any common stock dividends can be paid.

(D) ​Preferred stock can be redeemed by incorporating a maturity option to a preferred stock issue.

(E) ​Preferred stock can participate with the common stock in sharing the firm's earnings.

Answer : (D)

15. Which of the following is considered a hybrid security?​

(A) ​Corporate bonds

(B) ​Preferred stock

(C) Founders' shares​

(D) ​Foreign equity

(E) ​Growth stock

Answer : (B)

16. Which of the following is a feature of a preferred stock?​

(A) Preferred stockholders have priority over debt holders, with regard to earnings and assets of the
firm.​

(B) ​Preferred stockholders can elect the members of the board of directors and also vote on
corporate issues.

(C) ​The firm has no obligation, contractual or implied, to pay preferred stock dividends.

(D) ​Preferred stockholders have the right to receive shares of new stock issue in proportion to their
current ownership holdings.

(E) ​Preferred stockholders have a higher priority claim to distributions made by the firm than
common stockholders.

Answer : (E)

17. Which of the following securities is eligible for a cumulative dividend?

(A) Growth stock

(B) Preferred stock

(C) Classified stock

(D) Common stock

(E) Founders' stock

Answer : (B)

18. Which of the following securities has the highest priority with regard to earnings and assets of a
firm?

(A) Corporate bonds

(B) Preferred stock

(C) Common stock

(D) American depository receipts (ADRs)

(E) Foreign stocks

Answer : (A)

19. Which of the following provisions will call for the repurchase and retirement of a given
percentage of the preferred stock each year?​

(A) Participation​

(B) ​Cumulative dividends

(C) ​Sinking fund

(D) ​Preemptive right

(E) ​Call provision

Answer : (C)

20. According to the convertibility provision, a preferred stock can be converted into a _____.​

(A) ​common stock

(B) ​corporate bond

(C) ​nonvoting stock

(D) ​cumulative stock

(E) ​participating stock

Answer : (A)

21. Which of the following securities can be converted into common stock?

(A) Proxy stocks

(B) Growth stocks

(C) Preemptive stocks

(D) Founders' shares

(E) Preferred stocks

Answer : (E)

22. A preferred stock can be exchanged for a certain number of shares of common stock at the _____.​
(A) par value​

(B) ​conversion price

(C) ​discount rate

(D) ​capital gain rate

(E) ​premium price

Answer : (B)

23. Which of the following types of stocks pay its investors a fixed amount of dividends?

(A) Preemptive stocks

(B) Growth stocks

(C) Common stocks

(D) Preferred stocks

(E) Founders' shares

Answer : (D)

24. A protective feature on a preferred stock that requires preferred dividends previously not paid to
be disbursed before any common stock dividends can be paid is called _____.​

(A) par value​

(B) ​voting rights

(C) ​cumulative dividends

(D) ​sinking fund

(E) ​preemptive right

Answer : (C)

25. Which of the following is true about the payment of dividends by a firm?​

(A) ​Dividends are paid only to the bondholders of the firm

(B) ​Common stockholders have priority over preferred stockholders with regard to dividends

(C) ​Preferred stocks will pay accumulated dividends only once i.e. at the time of maturity

(D) ​Growth stocks pay little or no dividends and instead retain most of their earnings each year

(E) ​Common stockholders will receive a fixed amount of dividend every year
Answer : (D)

26. Which of the following is true about a growth stock?​

(A) ​It pays a fixed amount of dividends every year.

(B) ​It has sole voting rights but generally pays out only restricted dividends (if any) for a specified
number of years.

(C) ​It pays pay large and relatively constant dividends each year.

(D) ​It pays cumulative dividends at the time of maturity.

(E) ​It generally pays little or no dividends so as to retain earnings to help fund developmental
opportunities.

Answer : (E)

27. Stocks that produce returns that are based primarily on dividends are traditionally called _____.

(A) preemptive stocks

(B) income stocks

(C) growth stocks

(D) founders' stocks

(E) classified stocks

Answer : (B)

28. How can a preferred stock incorporate a maturity provision with the preferred stock issue?

(A) By including a call provision

(B) By including a cumulative dividends provision

(C) By including a preemptive right

(D) By including a participating provision

(E) By including a voting provision

Answer : (A)

29. When will a company repurchase shares of its common stock in the financial markets?

(A) When the price of the firm's stock is overvalued

(B) When the management wants to increase the ownership control of the outside investors
(C) When the firm has excess cash but no good investment opportunities

(D) When the common stockholders are last to receive proceeds from the liquidation

(E) When the returns on the firm's stocks are generated by capital gains

Answer : (C)

30. What action would the management take if it wants to gain more ownership control of the firm?​

(A) ​Issue more growth stocks

(B) ​Solicit and get stockholders' proxies

(C) ​Repay a portion of the loan

(D) ​Repurchase shares of common stock

(E) ​Pay cumulative dividends to preferred stocks

Answer : (D)

31. What is the other name for par value of a preferred stock?​

(A) ​Liquidation value

(B) ​Interest

(C) ​Preference value

(D) ​Cumulative value

(E) ​Hybrid value

Answer : (A)

32. The preferred dividend is generally stated as a percentage of the _____.​

(A) market value of the share

(B) ​net sales

(C) ​call premium

(D) ​par value

(E) ​sinking fund

Answer : (D)

33. Which of the following represents the minimum legal financial obligation of a common
stockholder if a firm is liquidated and additional funds are needed to repay its debt?

(A) The redemption value of the common stock

(B) The par value of the common stock

(C) The earnings per share of the common stock

(D) The interest obligation per share of the common stock

(E) The market value per share of the common stock

Answer : (B)

34. A firm has 1,000 shares of common stock outstanding with a par value of $15 per share. Upon
liquidation, the firm has insufficient funds and requires an additional $5,000 to repay its creditors.
Which of the following statements is true about the shareholders' financial obligation?

(A) If the share is purchased for $8, then the stockholders are obligated pay $2 per share to the
creditors.

(B) If the share is purchased for $20, then the stockholders are obligated pay an interest of $15 per
share to the firm.

(C) If the share is purchased for $15, then the stockholders are obligated to pay $15 per share to the
bondholders.

(D) If the share is purchased for $12, then the stockholders are obligated pay a dividend of $3 per
share to the firm.

(E) If the share is purchased for $10, then the stockholders are obligated to contribute $5 per share
to the firm.

Answer : (E)

35. Which of the following is a nonvoting stock?​

(A) Common stock​

(B) ​Preferred stock

(C) ​Founders' shares

(D) ​Preemptive stock

(E) ​Growth stock

Answer : (B)

36. Stock owned by the organizers of the firm who will have full voting rights is:​
(A) ​preferred stock.

(B) ​common equity.

(C) ​founders' shares.

(D) ​convertible equity.

(E) ​retained earnings.

Answer : (C)

37. A shareholder can transfer the right to vote to a second party, by means of an instrument known
as _____.​

(A) ​arbitrage

(B) ​allotment

(C) ​consortium

(D) ​rationing

(E) ​proxy

Answer : (E)

38. Common stockholders have the right to _____.

(A) vote for the changes in a firm's charter

(B) convert their stock into a bond

(C) receive the cash distributions before preferred stockholders

(D) receive the par value of shares on liquidation

(E) receive cumulative dividends

Answer : (A)

39. Shareholders exert control of the management of the firm by:​

(A) ​running the daily operations of the firm.

(B) ​directly replacing management with themselves.

(C) ​buying shares in an IPO at a discounted price.

(D) ​electing board members who can replace the management.

(E) ​buying shares in a second firm at a substantially reduced price.

Answer : (D)

40. Scubapro Corporation currently has 500,000 shares outstanding and plans to issue 200,000
more shares in a seasoned equity offering. The current shareholders have preemptive rights on any
new issue of stock by Scubapro Corporation. How many shares of stocks would an investor with
20,000 shares, who exercises his preemptive rights on the new stock issue, have the right to buy?

(A) 200,000 shares

(B) 120,000 shares

(C) 20,000 shares

(D) 12,000 shares

(E) 8,000 shares

Answer : (E)

41. Certificates representing ownership in stocks of foreign companies, which are held in a trust
bank located in the country the stock is traded are called _____.​

(A) ​certificates of ownership

(B) ​foreign stock funds

(C) ​mutual funds

(D) ​American depository receipts

(E) ​investment bankers

Answer : (D)

42. In international markets, excluding stocks sold in the United States, what is a stock that is
traded in a country other than the issuing company's home country called?​

(A) ​American depository receipts

(B) ​Yankee stock

(C) ​Euro stock

(D) ​Class A stock

(E) ​Preferred stock

Answer : (C)

43. What is the risk of investing money in American depository receipts (ADRs)?​
(A) ​Risks associated with the corporations in which the investments are made

(B) ​ADRs are not foreign stocks

(C) ​Inability to take funds such as dividends out of the country

(D) ​Risk of translation of value into domestic terms

(E) ​Risk of translation of information into domestic terms

Answer : (A)

44. Which of the following is considered as a Euro stock?

(A) A German company selling stock in the United States

(B) A Japanese company selling stock in Japan

(C) A U.S. company selling stock in the U.S.

(D) A German company selling stock in Japan

(E) A Japanese company selling stock in the United States

Answer : (D)

45. If a German company sells its stock in the United States, it is termed as _____.​

(A) founders' stock​

(B) ​Yankee stock

(C) ​income stock

(D) ​growth stock

(E) ​Euro stock

Answer : (B)

46. Nahanni Treasures Corporation is planning a new common stock issue of five million shares to
fund a new project. The increase in shares will bring the number of shares outstanding to 25 million.
Nahanni's long-term growth rate is 6 percent, and its current required rate of return is 12.6 percent.
The firm just paid a $1.00 dividend and the stock sells for $16.06 in the market. On the
announcement of the new equity issue, the firm's stock price dropped. Nahanni estimates that the
company's growth rate will increase to 6.5 percent with the new project, but since the project is
riskier than average, the firm's required return on stock will increase to 13.5 percent. Using the
DDM constant growth model, what is the change in the equilibrium stock price?

(A) -$1.77
(B) -$1.06

(C) -$0.85

(D) -$0.66

(E) -$0.08

Answer : (C)

47. When using the Dividend Discount Model, assuming that growth (g) will remain constant, under
which of the following circumstances will the dividend yield be equal to the required return on a
common stock (rs)?​

(A) ​g = 0

(B) ​g > 0

(C) ​g < 0

(D) ​g = rs

(E) ​g > rs

Answer : (A)

48. If the expected rate of return on a stock exceeds the required rate, it means that _____​

(A) ​the stock is experiencing a supernormal growth.

(B) ​the stock should be sold.

(C) ​the company is not trying to maximize the price per share.

(D) ​the stock is a good buy.

(E) ​the dividends are not declared.

Answer : (D)

49. Alpha's preferred stock currently has a market price equal to $80 per share. If the dividend paid
on this stock is $6 per share, what is the required rate of return investors are demanding from
Alpha's preferred stock?​

(A) ​7.5%

(B) ​13.3%

(C) ​6.0%

(D) ​$6.00
(E) ​$13.33

Answer : (A)

50. The constant growth Dividend Discount Model (DDM) may be written as _____.​

(A) ​r0 = D0/(P0 + g)

(B) ​P0 = D0/(rs + g)

(C) ​P0 = D0/(rs − g)

(D) ​P0 = D1/(rs - g)

(E) ​r0 = D0/(P0 - g)

Answer : (D)

51. A share of perpetual preferred stock pays an annual dividend of $6 per share. If investors
require a 12 percent rate of return, what should be the price of this preferred stock?​

(A) $57.25​

(B) ​$50.00

(C) ​$62.38

(D) ​$46.75

(E) ​$41.64

Answer : (B)

52. A share of a preferred stock pays a quarterly dividend of $2.50. If the price of this preferred
stock is currently $50, what is the simple annual rate of return?​

(A) ​12%

(B) ​18%

(C) ​20%

(D) ​23%

(E) ​28%

Answer : (C)

53. A share of a preferred stock pays a dividend of $0.50 each quarter. If you are willing to pay
$20.00 for this preferred stock, what is your simple (not effective) annual rate of return?​
(A) 8%​

(B) ​6%

(C) ​12%

(D) ​14%

(E) ​10%

Answer : (E)

54. The last dividend on Spirex Corporation's common stock was $4.00, and the expected growth
rate is 10 percent. If you require a rate of return of 20 percent, what is the highest price you should
be willing to pay for this stock?

(A) ​$38.50

(B) ​$40.00

(C) ​$45.69

(D) ​$44.00

(E) ​$50.00

Answer : (D)

55. You are trying to determine the appropriate price to pay for a share of common stock. If you
purchase this stock, you plan to hold it for 1 year. At the end of the year you expect to receive a
dividend of $5.50 and to sell the stock for $154. The appropriate rate of return for this stock is 16
percent. What should the current price of this stock be?

(A) $150.22

(B) $162.18

(C) $137.50

(D) $98.25

(E) $175.83

Answer : (C)

56. A share of common stock has a current price of $82.50 and is expected to grow at a constant
rate of 10 percent. If you require a 14 percent rate of return, what is the current dividend on this
stock?​

(A) ​$2.81
(B) ​$3.00

(C) ​$4.29

(D) ​$4.75

(E) ​$6.13

Answer : (B)

57. A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50,
and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of
return, how much should you be willing to pay for this stock?

(A) $67.81

(B) $22.49

(C) $58.15

(D) $31.00

(E) $43.97

Answer : (E)

58. On January 1, 2016, the price of a stock is $42.50, whereas on December 31, 2016, the price of
the stock is $48.78. Determine the capital gain yield of the stock.

(A) 13.25%

(B) 14.78%

(C) 15.14%

(D) 16.33%

(E) 17.49%

Answer : (B)

59. What is the formula to calculate P/E ratio?​

(A) ​Market price per share ÷ Book value per share

(B) ​Earnings available to common stockholders (EAC) ÷ Number of shares

(C) ​Common dividends ÷ Number of shares

(D) ​Market price per share ÷ Earnings per share

(E) ​Average cost of funds × Invested capital

Answer : (D)

60. The P/E ratio gives an indication of _____.

(A) a firm's debt position

(B) a stock's dividend yield

(C) the payback period of a stock

(D) the par value of a stock

(E) the maturity value of a stock

Answer : (C)

61. What does a P/E ratio of 10 indicate?​

(A) ​It would take 10 years for an investor to recover his or her initial investment.

(B) ​The firm will pay a dividend of $10 per share.

(C) ​The value of the stock will be 10 times the initial investment at the time of maturity.

(D) ​A stock's value will increase by 10 percent every year.

(E) ​An investor would receive 10 percent of the total earnings of the firm, at the time of liquidation.

Answer : (A)

62. Which of the following is true about the P/E ratio of a firm?​

(A) ​The higher the P/E ratio, the less investors are willing to pay for each dollar earned by the firm.

(B) ​If a firm's P/E ratio is 8, then, it would take 8 years for an investor to double his or her initial
investment.

(C) ​The appropriate value of P/E ratio is multiplied with EPS to estimate the stock price.

(D) ​If a company's P/E ratio is too high relative to that of similar firms, its earnings have not been
fully captured in the existing stock value.

(E) ​If the firm's P/E ratio is too low relative to that of similar firms, it means that the market has
overvalued its current earnings.

Answer : (C)

63. Which of the following is determined by decreasing a firm's after-tax operating income by the
costs associated with both the debt and the equity issued by the firm?
(A) A firm's price earnings ratio

(B) A firm's expected capital gains yield

(C) A firm's intrinsic value of stock

(D) A firm's nonconstant growth of stock

(E) A firm's economic value added

Answer : (E)

64. Considering the economic value added (EVA) of a firm, which of the following should increase
the firm's value?​

(A) ​EVA = 0

(B) ​EVA > 0

(C) ​EVA < 0

(D) ​EVA > EPS

(E) ​P/E ratio > EVA

Answer : (B)

65. In the EVA equation, the _____ is subtracted from the after-tax operating income to determine
the economic value added.​

(A) ​marginal tax

(B) ​operating cash flows

(C) ​current intrinsic value

(D) ​average cost of funds

(E) ​total capital invested

Answer : (D)

66. A firm has an EBIT of $22 million, total invested capital of $74 million, and the average cost of
funds of 12%. The firm has a marginal tax rate of 35% and 4.2 million shares of the firm are
outstanding. What is the EVA of the firm?​

(A) ​$4.83 million

(B) ​$5.42 million

(C) ​$6.33 million

(D) ​3.61 million

(E) ​$7.97 million

Answer : (B)

67. The EVA of a firm is $6.25 million and the firm has 2.78 million outstanding shares. What is the
maximum amount of dividend that can be paid to shareholders?​

(A) $1.65​

(B) ​$2.25

(C) ​$3.12

(D) ​$3.89

(E) ​$4.41

Answer : (B)

68. Which of the following is true about the change in a stock price?​

(A) ​If investors demand higher returns to invest in stocks, then prices should increase.

(B) ​If investors demand lower returns to invest in stocks, then prices should fall.

(C) ​If investors demand higher returns to invest in stocks, then prices should fall.

(D) ​If investors expect their investments to generate lower future cash flows, then prices should
increase.

(E) ​If investors expect their investments to generate higher future cash flows, then prices should fall.

Answer : (C)

69. The current expected value of a stock is $32. If investors demand a higher rate of return of 10%
instead of the 8% rate of return, what will the impact on the stock price of the firm be?​

(A) The stock price will increase by 10%.​

(B) ​The stock price will not be affected by the change in the rate of return.

(C) ​The stock price will increase to $35.

(D) ​The stock price will reduce to zero.

(E) ​The stock price will decrease.

Answer : (E)
70. ​On January 3, 2016, the stock price of a firm was $25 and on January 4, 2016, it reduced to $19.
Which of the following is a probable reason for the decrease in the stock price?

(A) ​A boom in the economy

(B) ​Reduction in the cost of debt

(C) ​Increased rate of return

(D) ​Higher future cash flows

(E) ​Increased company's growth rate

Answer : (C)