Fundamentals of Corporate Finance 3rd Edition Parrino Test Bank

Fundamentals of Corporate Finance 3rd
Edition Parrino Test Bank

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Fundamentals of Corporate Finance 3e Test Bank
Chapter 9: Stock Valuation
Format: True/False
Learning Objective: LO 1
Level of Difficulty: Easy
Bloomcode: Knowledge
AASCB: Analytic
IMA: Corporate Finance
AICPA: Industry/Sector Perspective
1. Equity securities are certificates of ownership of a corporation.
A) True
B) False
Ans: A
Format: True/False
Bloomcode: Comprehension
AASCB: Analytic
AICPA: Measurement
2. The stocks owned by households represent about 35% of the total value of all corporate equity.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
3. A large number of investors in equities actually own through pension or retirement funds.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
4. Companies raise capital in secondary markets by issuing new securities.
A) True
B) False
Copyright © 2015 John Wiley & Sons, Inc. 9-1
Ans: B
Format: True/False
AASCB: Analytic
AICPA: Measurement
5. An active secondary market for debt or equity securities makes raising new capital less expensive
for firms.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
6. For investors, the function of secondary markets is to provide marketability for the securities they
own at a fair price.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
7. Secondary market transactions in the United States mostly take place over the counter and not in
exchanges.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic

8. In terms of market capitalization (total stock value) of the firms listed, the NYSE is the largest in
the world and NASDAQ is the second largest.
A) True
B) False
Ans: A
Format: True/False
Level of Difficulty: Medium
AASCB: Analytic
9. Direct search markets provide the best price information.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic
10. Direct search is the least efficient type of secondary market.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
11. For a commission fee less than the cost of direct search, brokers give investors an incentive to make
use of the information by hiring them.
A) True
B) False
Ans: A
Format: True/False

AASCB: Analytic
12. A broker market eliminates the need for time-consuming search for a fair deal by buying and
selling immediately from its inventory of securities.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic
13. NASDAQ is the best-known example of a direct market.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic
14. In an auction market, buyers and sellers confront each other directly and bargain over price.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
15. The New York Stock Exchange is the best-known example of an auction market.
A) True
B) False
Ans: A

Format: True/False
AASCB: Analytic
16. The common stockholders of a company have unlimited liability.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic
AICPA: Measurement
17. Preferred stockholders are not guaranteed any dividend payments and have the lowest-priority
claim on the firm’s assets in the event of bankruptcy.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic
AICPA: Measurement
18. Preferred dividend payments are fixed obligations of the firm, similar to the interest payments on
corporate bonds.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic
AICPA: Measurement
19. The market considers preferred stock to be a debt security because the dividend payment is a fixed
contractual obligation and has credit ratings like bonds.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic
AICPA: Measurement
20. Valuation of common and preferred stock is done using a different valuation formula than that used
for bonds.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
21. In the general dividend-valuation model, the price of a share of stock is the present value of all
expected future dividends.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
22. For a company that has no growth, dividends stay constant over time.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
23. A fast growing company will pay constant dividends over a period of time.
A) True
B) False
Ans: B
Format: True/False
AASCB: Analytic
AICPA: Measurement
24. The constant-growth stock has dividends growing at a constant rate over time.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
25. The constant-growth dividend model tells us that the current price of a share of stock is the next
period dividend divided by the difference between the discount rate and the dividend growth rate.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
26. Whenever the constant-growth rate for dividends exceeds the required rate of return on the common
stock, the constant-growth model provides invalid solutions.
A) True
B) False
Ans: A
Format: True/False

AASCB: Analytic
AICPA: Measurement
27. The value of a supernormal growth stock is the present value of the mixed growth dividend
payments and the present value of the constant-growth dividend payments.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
28. Failure to pay a preferred dividend signals to the market that the firm is in serious financial trouble.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
29. Preferred stock with no fixed maturity can be valued as a perpetuity.
A) True
B) False
Ans: A
Format: True/False
AASCB: Analytic
AICPA: Measurement
30. The bond valuation model can be used to value perpetual preferred stocks.
A) True
B) False
Ans: B

Format: Multiple Choice

AASCB: Analytic
AICPA: Measurement
31. The stocks owned by ––––– represent about 35 percent of the total value of all corporate equity.
A) mutual funds.
B) pension funds.
C) foreign investors.
D) households.
Ans: D

AASCB: Analytic
32. Which of the following statements is true about secondary markets?
A) In secondary markets, outstanding shares of stock are bought and sold among investors.
B) Most secondary market transactions directly affect the capital of the firm that issues the securities.
C) An active secondary market causes firms to sell their new debt or equity issues at a higher
transaction cost of funds.
D) All of the above statements are true
Ans: A

AASCB: Analytic
33. Which of the following statements is true about secondary markets in the United States?
A) In terms of market capitalization (total stock value) of the firms listed, the NASDAQ is the largest
in the world and the NYSE is the second largest.
B) NASDAQ is an OTC (over-the-counter) market.
C) Firms listed on the NASDAQ tend to be, on average, larger in size, and their shares trade more
frequently than those traded on NYSE.
D) In the United States, most secondary market transactions are done over the counter.
Ans: B

AASCB: Analytic
34. Which of the following statements is NOT true about secondary markets?
A) In terms of market capitalization (total stock value) of the firms listed, the NASDAQ is the largest
in the world and the NYSE is the second largest.
B) NASDAQ is the second-largest stock market in the United States.
C) Firms listed on the NYSE tend to be, on average, larger in size and their shares trade more
frequently than those traded on NASDAQ.
D) In the United States, most secondary market transactions are done on one of the many stock
exchanges.
Ans: A

AASCB: Analytic
35. In comparison to the NYSE,
A) NASDAQ has less company listed.
B) total share volume is lower on the NASDAQ.
C) firms listed on the NASDAQ tend to be smaller.
D) NASDAQ firms exceed NYSE listed firms in total capitalization.
Ans: C

AASCB: Analytic
36. Direct search markets are characterized by:
A) complete price information.
B) extensive broker and dealer participation.
C) private placement transactions and sale of common stock of small private companies.
D) a high level of efficiency.
Ans: C

AASCB: Analytic


37. The least efficient of all the different types of secondary markets is the:
A) auction market.
B) direct search market.
C) dealer market.
D) broker market.
Ans: B

AASCB: Analytic
38. Which of the following statements is NOT true about broker markets?
A) Brokers bring buyers and sellers together to earn a fee, called a commission.
B) Brokers’ extensive contacts provide them with a pool of price information that individual investors
could not economically duplicate themselves.
C) Investors have an incentive to hire a broker because what they charge as a commission is less than
the cost of direct search.
D) Brokers can guarantee an order because they have an inventory of securities.
Ans: D

AASCB: Analytic
39. In brokered markets:
A) the commission charged by brokers is a lower cost to buyers and sellers than the cost of direct
search.
B) buyers and sellers are brought together for a commission.
C) brokers build a pool of price information through their extensive contacts.
D) All of the above are true of broker markets.
Ans: D

AASCB: Analytic
40. Which of the following statements is true about dealer markets?
A) NYSE is the best-known example of a dealer market.

B) A dealer market involves time-consuming search for a fair deal.
C) The advantage of a dealer over a brokered market is that brokers cannot guarantee that an order will
be executed promptly, while dealers can, because they have an inventory of securities.
D) All of the above are true of dealer markets.
Ans: C

AASCB: Analytic
41. Dealer markets are characterized by:
A) no time-consuming search for a fair deal.
B) a guarantee of order fulfillment because the dealer holds an inventory of securities.
C) improved market efficiency because dealers provide continuous bid and ask prices for securities.
D) All of the above characterize dealer markets.
Ans: D

AASCB: Analytic
42. Which of the following statements is NOT true about auction markets?
A) In an auction market, buyers and sellers confront each other directly and bargain over price.
B) The participants can only communicate orally in auction markets.
C) The New York Stock Exchange is the best-known example of an auction market.
D) The auctioneer in an auction market is the specialist, who is designated by the exchange to
represent orders placed by public customers.
Ans: B

AASCB: Analytic
AICPA: Measurement
43. Which of the following statements is NOT true about common stock?
A) Common-stock holders have the right to vote on the election of the board of directors of their
company.
B) Common stock is considered to have no fixed maturity.
C) Owners of common stock are guaranteed dividend payments by the firm.

D) Common-stock holders have limited liability toward the obligations of the corporation.
Ans: C

AASCB: Analytic
AICPA: Measurement
44. Which of the following statements is true about common stock?
A) Common stock is considered to have a fixed maturity.
B) Owners of common stock are guaranteed dividend payment by the firm.
C) Owners of common stock have the lowest-priority claim on the firm’s assets in the event of
bankruptcy.
D) Common-stock holders have unlimited liability toward the obligations of the corporation.
Ans: C

AASCB: Analytic
45. Which of the following is NOT a widely known stock market index?
A The Dow Jones Industrial Average
)
B The OTQ Composite Index
)
C The New York Stock Exchange Index
)
D) The Standard and Poor’s 500 Index
Ans: B

AASCB: Analytic
AICPA: Measurement
46. Which of the following statements is NOT true about preferred stock?
A) Preferred stock represents ownership in the firm.
B) Preferred stockholders are not eligible for guaranteed dividend payments by the firm.
C) Preferred stock dividends are paid by the issuer with after-tax dollars.
D) Preferred stock holders have limited voting privileges relative to common-stock owners.
Ans: B

AASCB: Analytic
AICPA: Measurement
47. Which of the following statements is NOT true about preferred stock?
A) Preferred dividend payments are paid by the issuer with after-tax dollars.
B) Preferred dividends are tax deductible just like the interest on bonds.
C) Preferred stock holders have limited voting privileges relative to common-stock owners.
D) Preferred stocks are generally viewed as perpetuities because they have no fixed maturity.
Ans: B

AASCB: Analytic
AICPA: Measurement
48. Owners of preferred stock:
A) have limited voting rights.
B) usually receive fixed dividend payments.
C) are given priority treatment over common stock with respect to dividends payments, and the claims
against the firm’s assets in the event of bankruptcy or liquidation.
D) All of the above statements are true.
Ans: D

AASCB: Analytic
AICPA: Measurement
49. Preferred stock is sometimes treated like a debt security because:
A) legally preferred stock is a debt security.
B) preferred dividend payments are similar to bond interest payments and are fixed in nature
regardless of the firm’s earnings.
C) preferred dividends are deductible from taxable income just like interest payments on bonds.
D) preferred stock holders receive a residual value and not a stated value.
Ans: B


AASCB: Analytic
AICPA: Measurement
50. Which of the following statements is true?
A) Preferred stockholders are considered to be the true owners of public corporations.
B) Dividends paid to preferred stockholders are not fixed.
C) Preferred stockholders do not typically have voting rights.
D) Preferred stock can never be converted to common stock.
Ans C
:

AASCB: Analytic
AICPA: Measurement
51. Applying the valuation procedure to common stocks is more difficult than applying it to bonds
because:
A) the size and timing of the dividend cash flows are less certain than the coupon payments for bonds.
B) common stocks have no final maturity date.
C) unlike the rate of return, or yield, on bonds, the rate of return on common stock is not directly
observable.
D) All of the above are true.
Ans: D


Bloomcode: Application
AASCB: Analytic
AICPA: Measurement
52. Assume that you are considering the purchase of a stock which will pay dividends of $4.50
during the next year. Further assume that you will be able to sell the stock for $85.00 one
year from today and that your required rate of return is 15 percent. How much would you
be willing to pay for the stock today? (Round off to the nearest $0.01)
A) $89.50
B) $65.37
C) $94.10
D) $77.83
Ans: D
Feedback:
D1 + P1 $4.50 + $85.00 $89.50
P0 = = = = $77.82
1+ R 1 + 0.15 1.15

AASCB: Analytic
AICPA: Measurement
53. Which of the following statements is NOT true about the general dividend valuation model?
A) The model does not assume any specific pattern for future dividends, such as a constant growth
rate.
B) It makes a specific assumption about when the share of stock is going to be sold in the future.
C) The model calls for forecasting an infinite number of dividends for a stock.
D) The price of a share of stock is the present value of all expected future dividends.
Ans: B


AASCB: Analytic
AICPA: Measurement
54. Which of the following statements is true about the general dividend valuation model?
A) It implies that the underlying value of a share of stock is determined by the market’s
expectations of the future dividends that the firm will generate.
B) It implies that the value of a firm’s common stock can be determined only if the expected
future dividends are infinite.
C) It implies that the value of a growth stock can be determined by forecasting the future
price of the stock.
D) The model cannot be used to calculate the value of a common stock unless the dividends
exceed the firm’s expected growth rate.
Ans: A

AASCB: Analytic
AICPA: Measurement
55. Which of the following statements is true about growth stocks?
A) These are stocks of firms that grow their sales at above-average rates and are expected to do so for a
length of time.
B) These are stocks of firms that grow their earnings at above-average rates and are expected to do so
for a length of time.
C) They generally pay dividends during their fast growth phase.
D) None of the above.
Ans: B

AASCB: Analytic
AICPA: Measurement
56. Which of the following are the three simplifying assumptions that cover most stock growth
patterns?
A) Dividends remain constant over time, dividends grow at a constant rate, and dividends are equal to
zero.
B) Dividends have a zero-growth rate, dividends grow at a varying rate, and dividends are equal to
zero.
C) Dividends remain constant over time, dividends grow at a constant rate, and dividends have a
mixed growth pattern.

Ans: C

AASCB: Analytic
AICPA: Measurement
57. Which of the following statements is NOT true about zero-growth stocks?
A) Dividend payment pattern remains constant over time.
B) The cash flow pattern resembles a perpetuity with a constant cash flow.
C) Dividend pattern for common stock of a company shows growth over time.
D) There is no growth in dividends over time.
Ans: C

AASCB: Analytic
AICPA: Measurement
58. Which of the following statements is NOT true about constant-growth stocks?
A) Cash dividend remains constant over time.
B) Mature companies with a history of stable growth show this pattern.
C) Dividends grow at a constant rate from one period to the next forever.
D) Far distant-dividends have a very small present value and add little to the stock’s price.
Ans: A

AASCB: Analytic
AICPA: Measurement
59. The constant-growth dividend model will provide invalid solutions when:
A) the growth rate of the stock exceeds the required rate of return for the stock.
B) the growth rate of the stock is less than the required rate of return for the stock.
C) the growth rate of the stock is equal to the risk-free rate.
Ans: A


AASCB: Analytic
AICPA: Measurement
60. Cortez, Inc., is expecting to pay out a dividend of $2.50 next year. After that it expects its dividend
to grow at 7 percent for the next four years. What is the present value of dividends over the next
five-year period if the required rate of return is 10 percent? (Do not round intermediate calculations.
Round final answer to two decimal places.)
A) $10.76
B) $9.80
C) $11.88
D) $11.50
Ans: A
Feedback:
Expected dividends for Cortez, Inc., and their present value:
D2 = D1(1 + g) = $2.50(1 + 0.07) = $2.675
D3 = D2(1 + g) = $2.675(1.07) = $2.862
D4 = D3(1 + g) = $2.862(1.07) = $3.063
D5 = D4(1 + g) = $3.063(1.07) = $3.277
Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4) + PV(D5)
$2.50 $2.675 $2.862 $3.063 $3.277
= + + + +
(1.10 ) (1.10 ) 2 (1.10 ) 3 (1.10 ) 4 (1.10 ) 5
= $2.27 + $2.21 + $2.15 + $2.09 + $2.03
= $10.76

AASCB: Analytic
AICPA: Measurement
61. Next year Jenkins Traders will pay a dividend of $3.00. It expects to increase its dividend by $0.25
in each of the following three years. If their required rate of return is 14 percent, what is the present
value of their dividends over the next four years? (Do not round intermediate calculations. Round
final answer to two decimal places)
A) $13.50
B) $9.72
C) $12.50
D) $11.63
Ans: B
Feedback:
Expected dividends for Jenkins Traders and their present value:
D1 = $3.00; D2 = $3.25; D3 = $3.50; D4 = $3.75
Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4)

$3.00 $3.25 $3.50 $3.75

= + 2
+ 3
+
(1.14 ) (1.14 ) (1.14 ) (1.14 ) 4
= $2.63 + $2.50 + $2.36 + $2.22
= $9.72

AASCB: Analytic
AICPA: Measurement
62. Kleine Toymakers is introducing a new line of robotic toys, which it expects to grow their earnings
at a much faster rate than normal over the next three years. After paying a dividend of $2.00 last
year, it does not expect to pay a dividend for the next three years. After that Kleine plans to pay a
dividend of $4.00 in year 4 and then increase the dividend at a rate of 10 percent in years 5 and 6.
What is the present value of the dividends to be paid out over the next six years if the required rate
of return is 15 percent?(Do not round intermediate calculations. Round final answer to two decimal
places.)
A) $13.24
B) $12.00
C) $6.57
D) $10.24
Ans: C
Feedback:
Expected dividends for Kleine Toymakers and their present value:
D0 = $2.00; D1 = D2 = D3 = $0
D4 = $4.00
D5 = D4(1 + g) = $4.00(1.10) = $4.40
D6 = D5(1 + g) = $4.40(1.10) = $4.84
Present value of the dividends = PV(D1) + PV(D2) +…………+ PV(D6)
$4.00 $4.40 $4.84
= $0 + $0 + $0 + 4
+ 5
+
(1.15) (1.15) (1.15)6
= $0 + $0 + $0 + 2.29 + $2.19 + $2.09
= $6.57

AASCB: Analytic
AICPA: Measurement
63. Givens, Inc., is a fast growing technology company that paid a $1.25 dividend last week. The
company’s expected dividend growth rates over the next four years are as follows: 25 percent, 30
percent 35 percent, and 30 percent. The company then expects to settle down to a constant-growth
rate of 8 percent annually. If the required rate of return is 12 percent, what is the present value of
the dividends over the fast growth phase? (Do not round intermediate calculations. Round final
answer to two decimal places.)
A) $1.25
B) $6.46
C) $8.37
D) $7.23
Ans: D
Feedback:
Expected dividends for Givens, Inc., and their present value:

D0 = $1.25
D1 = D0(1 + g) = $1.25(1.25) = $1.563
D2 = D1(1 + g) = $1.563(1.30) = $2.031
D3 = D2(1 + g) = $2.031(1.35) = $2.742
D4 = D3(1 + g) = $2.742(1.30) = $3.565
Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4)
$1.563 $2.031 $2.742 $3.565
= + + +
(1.12 ) (1.12 ) 2 (1.12 ) 3 (1.12 ) 4
= $1.40 + $1.62 + $1.95 + $2.27
= $7.23

AASCB: Analytic
AICPA: Measurement
64. Jacob Suppliers has not paid out any dividend in the last three years. It does not expect to pay
dividends in the next two years either as it recovers from an economic slowdown. Three years from
now it expects to pay a dividend of $2.50 and then $3.00 in the following two years. What is the
present value of the dividends to be received over the next five years if the discount rate is 15
percent?( Do not round intermediate calculations. Round final answer to two decimal places.)
A) $4.85
B) $5.37
C) $5.50
D) $6.14
Ans: A
Feedback:
Expected dividends for Jacobs Suppliers and their present value:
D0 = D1 = D2 = $0; D3 = $2.50; D4 = $3.00; D5 = $3.00
Present value of the dividends = PV(D1) + PV(D2) +…………+ PV(D5)
$2.50 $3.00 $3.00
= $0 + $0 + 3
+ 4
+
(1.15) (1.15) (1.15)5
= $0 + $0 + $1.64 + $1.72 + $1.49
= $4.85


AASCB: Analytic
AICPA: Measurement
65. Xinhua Manufacturing Company has been generating stable revenues but sees no growth in it for
the foreseeable future. The company’s last dividend was $3.25, and it is unlikely to change the
amount paid out. If the required rate of return is 12 percent, what is the stock worth today? (Round
the final answer to two decimal places.)
A) $39.00
B) $3.69
C) $27.08
D) $21.23
Ans: C
Feedback:
D0 = $3.25; g = 0; R = 12%
D $3.25
P0 = = = $27.08
R 0.12

AASCB: Analytic
AICPA: Measurement
66. Zephyr Electricals is a company with no growth potential. Its last dividend payment was $4.50, and
it expects no change in future dividends. What is the current price of the company’s stock given a
discount rate of 9 percent?
A) $40.50
B) $50.00
C) $45.00
D) $500.00
Ans: B
Feedback:
D0 = $4.50; g = 0; R = 9%
D $4.50
P0 = = = $50.00
R 0.09

AASCB: Analytic
AICPA: Measurement
67. Metasteel Limited Co. has a stable sales track record, but does not expect to grow in the next
several years. Its last annual dividend was $5.75. If the required rate of return on similar
investments is 18 percent, what is the current stock price? (Round the answer to two decimal
places.)
A) $103.50
B) $13.50
C) $39.30
D) $31.94
Ans: D
Feedback:
D0 = $5.75; g = 0; R = 18%
D $5.75
P0 = = = $31.94
R 0.18

AASCB: Analytic
AICPA: Measurement
68. Ambassador Corp. sells household cleaners producing a revenue stream that has remained
unchanged in the last few years. The firm does not expect any change in its sales or earnings in the
next several years. The stock is currently selling at $46.88. If the required rate of return is 16
percent, what is the dividend paid by this company? (Round the answer to two decimal places.)
A) $2.93
B) $4.65
C) $6.89
D) $7.50
Ans: D
Feedback:
P0 = $46.88; g = 0; R = 16%
D D
P0 = = 0 = $46.88
R 0.16
D0 = $46.88  0.16 = $7.50

AASCB: Analytic
AICPA: Measurement
69. A communications company pays annual dividends of $8.50 with no possibility of it changing in
the next several years. If the firm’s stock is currently selling at $60.71, what is the required rate of
return? (Round to nearest whole number.)

A) 14%
B) 16%
C) 13%
D) 15%
Ans: A
Feedback:
P0 = $60.71; g = 0; D0 = $8.50
D $8.50
P0 = $60.71 = =
R R
$8.50
R= = 14%
$60.71

AASCB: Analytic
AICPA: Measurement
70. You are interested in investing in a company that expects to grow steadily at an annual rate of 6
percent for the foreseeable future. The firm paid a dividend of $2.30 last year. If your required rate
of return is 10 percent, what is the most you would be willing to pay for this stock? (Round to the
nearest dollar.)
A) $58
B) $61
C) $23
D) $24
Ans: B
Feedback:
D0 = $2.30; g = 6%; R = 10%
D1 D (1 + g )
P0 = = 0
R−g R−g
$2.30(1.06) $2.438
= = = $60.95
0.10 − 0.06 0.04
=$61.00

AASCB: Analytic
AICPA: Measurement
71. Johnson Corporation has just paid a dividend of $4.45. The company has forecasted a growth rate
of 8 percent for the next several years. If the appropriate discount rate is 14 percent, what is the
current price of this stock? (Round to the nearest dollar.)
A) $74
B) $32
C) $80
D) $60
Ans: C
Feedback:
D0 = $4.45; g = 8%; R = 14%

D1 D (1 + g )
P0 = = 0
R−g R−g
$4.45(1.08) $4.806
= = = $80.10
0.14 − 0.08 0.06
=$80.00

Level of Difficulty: Hard
AASCB: Analytic
AICPA: Measurement
72. Ryder Supplies has its stock currently selling at $63.25. The company is expected to grow at a
constant rate of 7 percent. If the appropriate discount rate is 17 percent, what is the expected
dividend, a year from now? (Round the answer to two decimal places.)
A) $4.43
B) $3.25
C) $10.75
D) $6.33
Ans: D
Feedback:
P0 = $63.25; g = 7%; R = 17%
D1
P0 =
R−g
D1 = P0 ( R − g )
= $63.25(0.17 − 0.07) = $6.325

AASCB: Analytic
AICPA: Measurement
73. Prior, Inc., is expected to grow at a constant rate of 9 percent. If the company’s next dividend is
$2.75 and its current price is $37.35, what is the required rate of return on this stock? (Do not
round intermediate calculations. Round final answer to the nearest percent.)
A) 13%
B) 16%
C) 20%

D) 21%
Ans: B
Feedback:
D1 = $2.75; P0 = $37.35; g = 9%
D1
P0 =
R−g
$2.75
$37.35 =
R − 0.09
$37.35( R − 0.09) = $2.75
− 3.3615 − 2.75 = −37.35R
6.1115
R= = 16.4%
37.35

AASCB: Analytic
AICPA: Measurement
74. A company is growing at a constant rate of 8 percent. Last week it paid a dividend of $3.00. If the
required rate of return is 15 percent, what is the price of the stock three years from now? (Do not
round intermediate calculations. Round final answer to two decimal places.)
A) $58.31
B) $46.29
C) $51.02
D) $42.83
Ans: A
Feedback:
R = 15%; D0 = $3.00; g= 8%
D4 D 0 (1 + g ) 4
P3 = =
R−g R−g
3.00(1.08) 4
= = $58.31
0.15 − 0.08


AASCB: Analytic
AICPA: Measurement
75. Which of the following is the most typical example of a zero-growth dividend stock?
A) The common stock of a firm in the biotechnology industry.
B) The preferred stock of a utility company.
C) The common stock of a firm in the health care industry.
D) The common stock of a firm in the information technology industry.
Ans: B

AASCB: Analytic
AICPA: Measurement
76. The constant growth dividend model would be useful to determine the value of all, but which of
the following firms?
A) A firm whose earnings and dividends are declining at a fairly steady rate.
B) A firm whose sales, profits, and dividends are growing at an annual average compound
rate of 5 percent.
C) A firm whose earnings and dividends are growing at a fairly steady rate.
D) A firm whose expected sales, profits, and dividends are flat.
Ans: D

AASCB: Analytic
AICPA: Measurement
77. Starskeep, Inc., is a fast growing technology company. The firm projects a rapid growth of 40
percent for the next two years and then a growth rate of 20 percent for the following two years.
After that, the firm expects a constant-growth rate of 8 percent. The firm expects to pay its first
dividend of $1.25 a year from now. If your required rate of return on such stocks is 20 percent,
what is the current price of the stock? (Do not round intermediate calculations. Round final answer
to two decimal places.)
A) $15.63
B) $4.70
C) $30.30
D) $22.68
Ans: A
Feedback:
g1 = g2 = 40%, g3 = g4 = 20%, g = 8%, D1 = $1.25, R = 20%

D1 = $1.25, D2 = $1.25(1.40) = $1.75, D3 = $1.75(1.20) = $2.10
D4 = $2.10(1.20) = $2.52, D5 = $2.52(1.08) = $2.722
D5 $2.722
P4 = = = $22.68
R − g 0.20 − 0.08
D1 D2 D3 D4 P4
P0 = + + + +
(1 + R ) (1 + R )
1 2
(1 + R ) 3
(1 + R ) 4
(1 + R ) 4
$1.25 $1.75 $2.10 ($2.52 + 22.68)
P0 = + 2
+ +
1.20 (1.20) (1.20) 3 (1.20) 4
P0 = $1.04 + $1.22 + $1.22 + 12.15
P0 = $15.63

AASCB: Analytic
AICPA: Measurement
78. BioSci, Inc., a biotech firm has forecast the following growth rates for the next three years: 30
percent, 25 percent, and 20 percent. The company then expects to grow at a constant rate of 7
percent for the next several years. The company paid a dividend of $2.00 last week. If the required
rate of return is 16 percent, what is the market value of this stock? (Do not round intermediate
calculations. Round final answer to two decimal places.)
A) $51.03
B) $36.86
C) $56.12
D) $46.37
Ans: B
Feedback:
g1 = 30%; g2 = 25%, g4 = 20%, g = 7%, D0 = $2.00, R = 16%
D1 = $2.00(1.30) = $2.60, D2 = $2.60(1.25) = $3.25, D3 = $3.25(1.20) = $3.90
D4 = $3.90(1.07) = $4.173;
D4 $4.173
P3 = = = $46.37
R − g 0.16 − 0.07
D1 D2 D3 P3
P0 = + + +
(1 + R ) 1
(1 + R ) 2
(1 + R) 3
(1 + R ) 3
$2.60 $3.25 ($3.90 + 46.37)
P0 = + +
1.16 (1.16) 2 (1.16) 3
P0 = $2.24 + $2.42 + $32.20
P0 = $36.86


AASCB: Analytic
AICPA: Measurement
79. Grant, Inc., is a fast growth stock and expects to grow at a rate of 25 percent for the next four years.
It will then settle to a constant-growth rate of 10 percent. The first dividend will be paid out in year
3 and will be equal to $5.00. If the required rate of return is 18 percent, what is the current price of
the stock? (Do not round intermediate calculations. Round final answer to two decimal places.)
A) $85.94
B) $97.19
C) $50.59
D) $65.68
Ans: C
Feedback:
g1-4 = 25%; g = 10%; D3 = $5.00; R = 18%
D4 = D3 (1.25) = $5.00(1.25) = $6.25; D5 = $6.25(1.10) =$6.875
D5 $6.875
P4 = = = $85.94
R − g 0.18 − 0.10
D1 D2 D3 D + P4
P0 = + + + 4
(1 + R ) (1 + R ) 2
(1 + R ) 3
(1 + R ) 4
$5.00 ($6.25 + $85.94)
P0 = 0 + 0 + +
(1.18) 3 (1.18) 4
P0 = $3.04 + $47.55 = $50.59

AASCB: Analytic
AICPA: Measurement
80. Stag Corp. will pay dividends of $4.75, $5.25, $5.75, and $7 for the next four years. Thereafter, the
company expects its growth rate to be at a constant rate of 7 percent. If the required rate of return is
15 percent, what is the current market price of the stock? (Do not round intermediate calculations.
Round final answer to two decimal places.)
A) $69.41
B) $93.63
C) $57.54
D) $80.29
Ans: A
Feedback:
D1 = $4.75; D2 = $5.25; D3 = $5.75; D4 = $7; g = 7%; R = 15%
D5 $7(1.07)
P4 = = = $93.63
R − g 0.15 − 0.07
D1 D2 D3 D4 P4
P0 = + + + +
(1 + R) (1 + R) 2
(1 + R) 3
(1 + R) 4
(1 + R) 4
$4.75 $5.25 $5.75 ($7 + $93.63)
P0 = + 2
+ +
1.15 (1.15) (1.15) 3 (1.15) 4
P0 = $4.13 + $3.97 + $3.78 + $57.53 = $69.41

AASCB: Analytic
AICPA: Measurement
81. Lincoln, Inc. expects to pay no dividends for the next four years. It has projected a growth rate of
35 percent for the next four years. After four years, the firm will grow at a constant rate of 6
percent. Its first dividend to be paid in year 5 will be worth $4.25. If your required rate of return is
20 percent, what is the stock worth today? (Do not round intermediate calculations. Round final
answer to two decimal places.)
A) $14.64
B) $32.18
C) $36.43
D) $21.82
Ans: A
Feedback:
gconstant = 6%; R = 20%; D5 = $4.25; D1 – D4 = 0
PV (D1) + PV(D2) + PV(D3) + PV(D4) = 0
D5 $4.25
P4 = = = $30.36
R − g 0.20 − 0.06
P4 $30.36 $30.36
P0 = PV of dividends + = 0+ = = $14.64
(1 + R) 4
(1.20)4 2.0736


AASCB: Analytic
AICPA: Measurement
82. Suppose a firm’s expected dividends for the next three years are as follows: D1 = $1.10, D2 =
$1.20, and D3 = $1.30. After three years, the firm’s dividends are expected to grow at
5.00 percent per year. What should the current price of the firm’s stock (P0) be today if
investors require a rate of return of 12.00 percent on the stock? (Do not round
intermediate calculations. Round off final answer to the nearest $0.01)
A) $61.30
B) $10.10
C) $16.74
D) $24.12
Ans: C
Feedback:
D1 D2 D3 Dt $1.10 $1.20 $1.30 $19.50
P0 = + + + = + + +
(1 + R )1
(1 + R )2
(1 + R )3
(1 + R )t
1.12 (1.12)2
(1.12)3 (1.12)3
P 0 = $0.98 + $0.96 + $0.93 + $13 .88 = $16 .74 =$16.74

AASCB: Analytic
AICPA: Measurement
83. Which of the following statements is true?
A) In order for the constant growth dividend model to properly value a firm’s common
stock, R must be greater than g.
B) From a practical perspective, the growth rate in the constant growth dividend model must
be greater than the sum of the long-term rate of inflation and the long-term real
growth rate of the economy.
C) In order for the constant growth dividend model to properly value a firm’s common
stock, g must be greater than R.
D) The constant growth dividend model can be used effectively to value the common shares
of a mixed growth stock.
Ans: A

AASCB: Analytic
AICPA: Measurement
84. Ajax Company has issued perpetual preferred stock with a par of $100 and a dividend of 5.5
percent. If the required rate of return is 7.75 percent, what is the stock’s current market price?
(Round off to the two decimal places.)
A) $12.90
B) $70.97
C) $53.27
D) $62.14
Ans: B
Feedback:
D = 5.5% ($100) = $5.50; R = 7.75%
D $5.50
P0 = = = $70.97
R 0.0775

AASCB: Analytic
AICPA: Measurement
85. The National Bank of Columbia has issued perpetual preferred stock with a $100 par value. The
bank pays a quarterly dividend of $1.40 on this stock. What is the current price of this preferred
stock given a required rate of return of 8.5 percent? (Round off to two decimal places.)
A) $23.06
B) $65.88
C) $37.57
D) $43.25
Ans: B
Feedback:
Quarterly dividend = $1.40
Required rate of return = R = 8.5%
(1.40  4)
P0 = = $65.88
0.085

AASCB: Analytic
AICPA: Measurement
86. The preferred stock of Acme International is selling currently at $110.35. If your required rate of
return is 9.75 percent, what is the dividend paid by this stock? (Round off to the two decimal
places.)
A) $9.75
B) $11.32
C) $10.76
D) $8.53
Ans: C
Feedback:
P0 = $110.35; R = 9.75%
D D
P0 = $110.35 = =
R 0.0975
D = $110.35  0.0975
= $10.76

AASCB: Analytic
AICPA: Measurement
87. Each quarter, Transam, Inc., pays a dividend on its perpetual preferred stock. Today, the stock is
selling at $83.45. If the required rate of return for such stocks is 10.5 percent, what is the quarterly
dividend paid by the firm? (Do not round intermediate calculations. Round final answer to two
decimal places.)
A) $8.76
B) $10.50
C) $2.19
D) $2.63
Ans: C
Feedback:
P0 = $83.45; R = 10.5%
D D
P0 = $83.45 = =
R 0.105
D = $83.45  0.105
= $8.76
Annual dividend = $8.76, Quarterly dividend = $8.76 /4 = $2.19

AASCB: Analytic
AICPA: Measurement
88. The Columbia Consumer Products Co. has issued perpetual preferred stock with a $100 par value.
The firm pays a quarterly dividend of $2.60 on this stock. What is the current price of this preferred
stock given a required rate of return of 12.5 percent?
A) $47.25
B) $80.00
C) $20.80
D) $83.20
Ans: D
Feedback:
Quarterly dividend = $2.60
Required rate of return = R = 12.5%
(2.60  4)
P0 = = $83.20
0.125

AASCB: Analytic
AICPA: Measurement
89. Which of the following statements about preferred stock is FALSE?
A) Preferred stock has a higher-priority claim on the firm’s assets than the common stock.
B) Failure to pay dividends on preferred stocks will result in a default.
C) Preferred stock has a lower-priority claim on the firm’s assets than the firm’s creditors in
the event of default.
D) Preferred stock typically pays a fixed dividend.
Ans: B

AASCB: Analytic
AICPA: Measurement
90. Durango Water Works has an outstanding issue of preferred stock that has a par (maturity
value) of $75.00. The stock, which pays a quarterly dividend of $1.10, will be retired by
the firm in 20 years. If the preferred stock is currently selling for $68.00, what is the
preferred stock’s yield-to-maturity? (Round off to the nearest 0.01%)
A) 6.72%
B) 5.64%
C) 4.28%
D) 7.73%
Ans: A
Feedback:
N = 20 × 4 = 80
PV = –$68.00
PMT = $ 1.10
FV = $75.00
Solve for i = 1.68% × 4 = 6.72%
Format: Essay

AASCB: Analytic
91. Discuss the significance of an active secondary market to both issuers of securities and to investors.
Ans: Most secondary market transactions do not directly affect the firm which issues the securities. The
presence of a secondary market does, however, affect the issuer indirectly. Simply put, investors
will pay a premium price for primary securities that have an active secondary market because most
investors do not hold securities forever. Thus, the marketability provided by secondary markets is
an important service to the issuers. Financial managers are well aware of the importance of
secondary markets for the sale of their firm’s primary securities, and as a result, they encourage
investment banking firms to establish secondary markets for their securities. The presence of an
active secondary market allows firms to sell their new debt or equity issues at a lower funding cost
than firms selling similar securities that have no secondary market. From an investor’s perspective,
the function of secondary markets is to provide marketability for the shares of securities they own
at a fair price.
Format: Essay
Bloomcode: Analysis
AASCB: Analytic
92. How do the secondary markets for securities differ across the four types of markets?
Ans: The direct search markets are the farthest from our ideal of complete price information and are
those markets in which buyer and seller must seek each other out directly. Securities are bought and
sold so infrequently that no third party, such as a broker or dealer, has an incentive to serve the
market. The sale of common stock of small private companies and private placement transactions
are good examples of direct search markets. This is the least efficient type of secondary market.
In broker markets, brokers bring buyers and sellers together to earn a fee, called a commission. Brokers
have extensive contacts, who provide them with a pool of price information that individual
investors could not economically duplicate themselves. Investors have an incentive to make use of
the information by hiring brokers because what brokers charge them as a commission is less than
the cost of direct search.
In dealer markets, market efficiency is improved by dealers providing continuous bidding (selling or
buying) for the security with the help of an inventory of securities that they hold and use to make a
profit. The advantage of a dealer over a brokered market is that brokers cannot guarantee that an
order will be executed promptly, while dealers can because they have an inventory of securities.
NASDAQ is the best-known example of a dealer market in the United States.
In an auction market, buyers and sellers confront each other directly and bargain over price. The New
York Stock Exchange is the best-known example of an auction market and is also the most efficient
equity market in the United States. In the NYSE, the auction for a security takes place at a specific
location on the floor of the exchange, called a post. The auctioneer in this case is the specialist, who
is designated by the exchange to represent orders placed by public customers.
Format: Essay

Bloomcode: Analysis
AASCB: Analytic
AICPA: Measurement
93. Differentiate the characteristics of common and preferred stocks.
Ans:
Characteristic Common Stock Preferred Stock
Represents basic ownership claim in a Represents ownership interest in the
Ownership of firm
corporation. corporation.
Common stockholders can vote on all
important matters that affect the
The preferred stockholders have no
life of the company, such as to
voting privileges in those
Voting rights elect the board of directors,
matters affecting day-to-day
approve the capital budget, or
running the firm.
vote on a proposed merger or
acquisition.
Common stockholders enjoy limited
liability that is their losses are
Liability of owners Limited
limited to the original value of
their investment in the firm.
Preferred stock holders are given
priority treatment over
Have the lowest-priority claim on the common stockholders with
Claim on assets firm’s assets in the event of respect to dividends payments
bankruptcy. and the claims against the
firm’s assets in the event of
bankruptcy or liquidation.
Owners of common stock are not Preferred dividend payments take
Dividends guaranteed any dividend precedence over common
payments dividends.
Preferred stocks are legally classified
Common stocks are perpetuities in the as perpetuities because they
Maturity sense that they have no maturity. have no maturity. Although
some type of preferred stock
might have a maturity date.

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Chapter 9: Stock Valuation

AICPA: Industry/Sector Perspective

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IMA: Corporate Finance

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A) NYSE is the best-known example of a dealer market.

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C) Owners of common stock are guaranteed dividend payments by the firm.

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D) None of the above.

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$3.00 $3.25 $3.50 $3.75

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Expected dividends for Givens, Inc., and their present value:

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D0 = $4.45; g = 8%; R = 14%