Quiz 2: Bond Valuation BFM 114: 1T

Stock Valuation Prof. JRB Ramos

Name: Cyra Niña C. de Lemos

True or False
1. Cumulative preferred stocks are preferred stocks for which all passed (unpaid) dividends
in arrears must be paid in additional shares of preferred stock prior to the payment of
dividends to common stockholders. False
2. The number of authorized shares of common stock can be greater than or lesser than
the number of outstanding shares of common stock. False
3. The value of an asset is determined by discounting the expected cash flows back to its
present value, using the rate of return on the market portfolio as a discount rate. False
4. A bond with long maturity has less ʺinterest rate riskʺ than a bond with short maturity
when all other features, coupon interest rate, par value, and interest payment
frequency are the same. False
5. In valuing preference shares, a potential investor needs to put into consideration the
corporate tax rate in determining the minimum stock price to pay. False
6. Generally speaking, preference shares do not participate in the normal earnings of a
corporation. True
7. The doctrine of piercing the veil generally makes corporate shareholder liable to
corporation’s acts. True
8. Dilution of ownership occurs when a new stock issue results in each present stockholder
having a larger number of shares and, thus, a claim to a larger part of the firmʹs earnings
than previously. False
9. The cost of preferred stock financing is generally higher than that of common stock
financing. False
10. The decision point of bond refunding is comparing the market value of the bond versus
the stream of costs associated with issuance of new bond. False
Multiple Choices: Theories
1. The yield to maturity of a bond is
A) the discount rate in a present value equation that equates the historical price of the
bond with the present value of the future debt service obligations
B) the average annual rate of return an investor expects to receive from buying and
holding the bond in his desired holding period
C) equal to the coupon rate if the bond sells at par value
D) All of the above

2. A ________ is a complex and lengthy legal document stating the conditions under which
a bond has been issued.
A) bond debenture
Quiz 2: Bond Valuation BFM 114: 1T
Stock Valuation Prof. JRB Ramos

B) warrant
C) sinking fund
D) bond indenture
3. The purpose of a restrictive debt covenant that requires maintaining a minimum level of
net working capital is to
A) Protect the lender by controlling the risk and marketability of the borrower’s
security investment alternative
B) Limit the amount of fixed-payment obligations
C) Ensure a cash shortage does not cause an inability to meet current obligations
D) Prevent liquidation of assets through large salary increases to key employees
4. Which bond trading process will expose issuing firm with the greatest amount of risk?
A) Firm commitment underwriting
B) Best Efforts underwriting
C) Competitive Sale
D) Negotiated Sale

5. For an investor who plans to purchase a bond maturing in one year, the primary
consideration should be
A) Interest Rate Risk
B) Credit Quality Risk
C) Coupon Rate
D) Yield to Maturity

6. AAA Corporation has the following capital structure

Debenture bonds P10,000,000
Preference Shares 1,000,000
Ordinary Share 39,000,000
The financial leverage of AAA Corporation would increase as a result of
A) Financing its investment with higher percentage of bonds
B) Splitting debt and equity capital component by P25M-P25M
C) Issuing ordinary shares and using the proceeds to retire preference shares
D) Issuing lower cost ordinary shares and using the proceeds to retire debenture bonds
7. Which of the following statements properly describes an advantage of ordinary shares
over long term bonds as a source of financing?
A) There is much lower underwriting and issuance costs with ordinary shares and
financing flexibility is maintained.
B) There is less liquidity risk with ordinary shares and financing flexibility is maintained
C) Ordinary share is less costly and liquidity risk is less
D) Ordinary share is less costly and current owners retain control
Quiz 2: Bond Valuation BFM 114: 1T
Stock Valuation Prof. JRB Ramos

8. The pre-emptive right

A) gives the holders of preference shares first option receive dividends
B) gives bondholders first right to claim assets in liquidation
C) Gives preference holders to have minority representation in the Board of Directors
D) gives the holders of ordinary shares first option to buy additional ordinary shares
9. In the Gordon model, the value of the common stock is the
A) net value of all assets which are liquidated for their exact accounting value.
B) actual amount each common stockholder would expect to receive if the firmʹs assets
are sold, creditors and preferred stockholders are repaid, and any remaining money is
divided among the common stockholders.
C) present value of a non-growing dividend stream.
D) present value of a constant, growing dividend stream.

10. Which of the following would most likely not increase primary earnings per share
A) Treasury Shares purchase
B) Conversion of convertible bonds
C) Decrease in fixed costs
D) Increase in sales performance
Problems:
The WINTERFELL CORPORATION has been very successful in the past four years. Over these
years, it paid common stock dividend of P7.50 in the first year, P8.44 in the second year, P9.50
in the third year, and its most recent dividend was P10.69. The company wishes to continue this
dividend growth indefinitely. What is the value of the company’s stock if the required rate of
return is 16 percent? Do not round off during the computation. Express final answers at
absolute numbers (no decimal places)
1.

Table 7.2
Year Dividends (Pesos)
2019 13
2018 11.61
2017 10.37
2016 9.10
2015 7.98
2014 7.00
CASTERLY ROCK owns stock in a company which has paid the annual dividends shown in
Table 7.2
2. Calculate the annual dividend growth (Round off to absolute value. No decimals)
Quiz 2: Bond Valuation BFM 114: 1T
Stock Valuation Prof. JRB Ramos

3. Calculate estimated dividend for 2020. (Answer at nearest two decimal places)
4. Calculate the price of stock needed to be paid if investor’s IRR is 19% using Gordon
Model. (Answer at nearest two decimal places)

5. RIVERLANDS issued bonds bearing a coupon rate of 12 percent, pay coupons

semiannually, have 3 years remaining to maturity, and are currently priced at $940 per
bond. What is the yield to maturity? (Use 60%-40% weight to market value and par
value approach. Express answers in two decimal places).
6. DORNE paid P2.00 per share in common stock dividends last year. The companyʹs policy
is to allow its dividend to grow at 5 percent for 4 years and then the rate of growth
changes to 3 percent per year from year five and on. What is the value of the stock if the
required rate of return is 8 percent? (Express dividends per year at nearest 2 decimal
places and PVF factors at nearest 3 decimal places. Round off final answer at nearest
two decimal places.

ANSWERS:
1. 56
2. 13%
3. 15
4. 46
5. 14.54%
6. 30