STOCKS VALUATION REVIEWER

Instructions: Write the true if the statement is CORRECT, write false if the statement is
INCORRECT.
(LOW LEVEL)

1. The 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.

2. If 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.

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

4. If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is
generally set equal to the required rate on bonds of equal risk.

5. A call provision gives bondholders the right to demand, or "call for," repayment of a bond.
Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get
the principal amount back and reinvest it elsewhere at higher rates.

6. "Restrictive covenants" are designed primarily to protect bondholders by constraining the actions
of managers. Such covenants are spelled out in bond indentures.

7. 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.

8. From 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.

9. Treasury stock is a company’s own stock that has been reacquired and retired.

10. Stock splits and large stock dividends have the same effect on a company’s retained earnings and
total stockholders’ equity.

Instructions: Write the letter of your answer before the number.

( LOW LEVEL )

1. The preemptive right is important to shareholders because it

a. allows managers to buy additional shares below the current market price.
b. will result in higher dividends per share.

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 c. is included in every corporate charter.
d. protects the current shareholders against a dilution of their ownership interests.
e. protects bondholders, and thus enables the firm to issue debt with a relatively low interest
rate.

2. Companies can issue different classes of common stock. Which of the following statements
concerning stock classes is CORRECT?

a. All common stocks fall into one of three classes: A, B, and C.

b. All common stocks, regardless of class, must have the same voting rights.
c. All firms have several classes of common stock.
d. All common stock, regardless of class, must pay the same dividend.
e. Some class or classes of common stock are entitled to more votes per share than other
classes.

3. Which of the following represents the total number of shares that a corporation may issue under
the terms of its charter?
a. authorized shares
b. issued shares
c. unissued shares
d. outstanding shares

4. Which of the following statements is CORRECT?

a. Preferred stockholders have a priority over bondholders in the event of bankruptcy to the
income, but not to the proceeds in a liquidation.
b. The preferred stock of a given firm is generally less risky to investors than the same
firm’s common stock.
c. Corporations cannot buy the preferred stocks of other corporations.
d. Preferred dividends are not generally cumulative.
e. A big advantage of preferred stock is that dividends on preferred stocks are tax deductible
by the issuing corporation.

5. Which of the following statements is CORRECT?

a. A major disadvantage of financing with preferred stock is that preferred stockholders

typically have supernormal voting rights.
b. Preferred stock is normally expected to provide steadier, more reliable income to
investors than the same firm’s common stock, and, as a result, the expected after-tax yield on the
preferred is lower than the after-tax expected return on the common stock.
c. The preemptive right is a provision in all corporate charters that gives preferred
stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.
d. One of the disadvantages to a corporation of owning preferred stock is that 70% of the
dividends received represent taxable income to the corporate recipient, whereas interest income
earned on bonds would be tax free.
e. One of the advantages to financing with preferred stock is that 70% of the dividends paid
out are tax deductible to the issuer.

6. Which of the following statements is CORRECT?

a. If a company has two classes of common stock, Class A and Class B, the stocks may pay
different dividends, but under all state charters the two classes must have the same voting rights.

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 b. The preemptive right gives stockholders the right to approve or disapprove of a merger
between their company and some other company.
c. The preemptive right is a provision in the corporate charter that gives common
stockholders the right to purchase (on a pro rata basis) new issues of the firm's common stock.
d. The stock valuation model, P0 = D1/(rs - g), cannot be used for firms that have negative
growth rates.
e. The stock valuation model, P0 = D1/(rs - g), can be used only for firms whose growth rates
exceed their required returns.

7. Which of the following best describes a possible result of treasury stock transactions by a
corporation?
a. May increase but not decrease retained earnings.
b. May increase net income if the cost method is used.
c. May decrease but not increase retained earnings.
d. May decrease but not increase net income.

8. Which of the following features of preferred stock makes the security more like debt than an
equity instrument?
a. Participating
b. Voting
c. Redeemable
d. Noncumulative

9. An entry is not made on the

a. date of declaration.
b. date of record.
c. date of payment.
d. An entry is made on all of these dates.

10. Cash dividends are paid on the basis of the number of shares
a. authorized.
b. issued.
c. outstanding.
d. outstanding less the number of treasury shares.

11. Which dividends do not reduce stockholders' equity?

a. Cash dividends
b. Stock dividends
c. Property dividends
d. Liquidating dividends

12. A feature common to both stock splits and stock dividends is

a. a transfer to earned capital of a corporation.
b. that there is no effect on total stockholders' equity.
c. an increase in total liabilities of a corporation.
d. a reduction in the contributed capital of a corporation.

13. What effect does the issuance of a 2-for-1 stock split have on each of the following?
Par Value per Share Retained Earnings
a. No effect No effect
b. Increase No effect

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 c. Decrease No effect
d. Decrease Decrease

14. Dividends are not paid on

a. noncumulative preferred stock.
b. nonparticipating preferred stock.
c. treasury common stock.
d. Dividends are paid on all of these.

15. A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return
is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock's current
price?

a. $17.39
b. $17.84
c. $18.29
d. $18.75
e. $19.22

16. A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the
constant growth rate is g = 4.0%. What is the current stock price?

a. $23.11
b. $23.70
c. $24.31
d. $24.93
e. $25.59

17. Gay Manufacturing is expected to pay a dividend of $1.25 per share at the end of the year (D1 =
$1.25). The stock sells for $32.50 per share, and its required rate of return is 10.5%. The
dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected
growth rate?

a. 6.01%
b. 6.17%
c. 6.33%
d. 6.49%
e. 6.65%

18. The Morrissey Company's bonds mature in 7 years, have a par value of $1,000, and make an
annual coupon payment of $70. The market interest rate for the bonds is 8.5%. What is the
bond's price?
a. $923.22
b. $946.30
c. $969.96
d. $994.21
e. $1,019.06

19. D. J. Masson Inc. recently issued noncallable bonds that mature in 10 years. They have a par
value of $1,000 and an annual coupon of 5.5%. If the current market interest rate is 7.0%, at what
price should the bonds sell?

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 a. $829.21
b. $850.47
c. $872.28
d. $894.65
e. $917.01

20. Quigley Inc.'s bonds currently sell for $1,080 and have a par value of $1,000. They pay a $100
annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,125. What is
their yield to maturity (YTM)?
a. 8.56%
b. 9.01%
c. 9.46%
d. 9.93%
e. 10.43%

21. Garvin Enterprises’ bonds currently sell for $1,150. They have a 6-year maturity, an annual
coupon of $85, and a par value of $1,000. What is their current yield?
a. 7.39%
b. 7.76%
c. 8.15%
d. 8.56%
e. 8.98%

22. Moerdyk Corporation's bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par
value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What
is the bond’s price?
a. 1,063.09
b. 1,090.35
c. 1,118.31
d. 1,146.27
e. 1,174.93

23. O'Brien Ltd.'s outstanding bonds have a $1,000 par value, and they mature in 25 years. Their
nominal yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of
$850. What is the bond's nominal (annual) coupon interest rate?
a. 6.27%
b. 6.60%
c. 6.95%
d. 7.32%
e. 7.70%

24. Whited Inc.'s stock currently sells for $35.25 per share. The dividend is projected to increase at a
constant rate of 4.75% per year. The required rate of return on the stock, rs, is 11.50%. What is
the stock's expected price 5 years from now?

a. $40.17
b. $41.20

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 c. $42.26
d. $43.34
e. $44.46

25. Francis Inc.'s stock has a required rate of return of 10.25%, and it sells for $57.50 per share. The
dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-end
dividend, D1?

a. $2.20
b. $2.44
c. $2.69
d. $2.96
e. $3.25

PROBLEM SOLVING. 4 POINTS EACH

(HIGH LEVEL)
PROBLEM 1
Using the following table, what is the present value of $5,000 to be received 5 years, if the market rate is
10% compounded annually?

Periods 5% 6% 7% 10% 12%

1 .95238 .94340 .93458 .90909
2 .90703 .89000 .87344 .82645
3 .86384 .83692 .81630 .75132
4 .82270 .79209 .76290 .68301
5 .78353 .74726 .71299 .62092
6 .74622 .70496 .66634 .56447
7 .71068 .66506 .62275 .51316
8 .67684 .62741 .58201 .46651
9 .64461 .59190 .54393 .42410
10 .61391 .55840 .50835 .38554

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PROBLEM 2
Use the following tables to calculate the present value of a $20,000 7%, 5 year bond that pays $1,400
($20,000  7%) interest annually, if the market rate of interest is 7%

Present Value of $1 at Compound Interest

Periods 5% 6% 7% 10% 12%
1 .95238 .94340 .93458 .90909
2 .90703 .89000 .87344 .82645
3 .86384 .83692 .81630 .75132
4 .82270 .79209 .76290 .68301
5 .78353 .74726 .71299 .62092
6 .74622 .70496 .66634 .56447
7 .71068 .66506 .62275 .51316
8 .67684 .62741 .58201 .46651
9 .64461 .59190 .54393 .42410
10 .61391 .55840 .50835 .38554

Present Value of Annuity of $1 at Compound Interest

Periods 5% 6% 7% 10% 12%
1 .95238 .94340 .93458 .90909 .89286
2 1.85941 1.83339 1.80802 1.73554 1.69005
3 2.72325 2.67301 2.62432 2.48685 2.40183
4 3.54595 3.46511 3.38721 3.16987 3.03735
5 4.32948 4.21236 4.10020 3.79079 3.60478
6 5.07569 4.91732 4.76654 4.35526
7 5.78637 5.58238 5.38929 4.86842
8 6.46321 6.20979 5.97130 5.33493
9 7.10782 6.80169 6.51523 5.75902
10 7.72174 7.36009 7.02358 6.14457

PROBLEM 3
The Francis Company is expected to pay a dividend of D 1 = $1.25 per share at the end of the year, and
that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is
1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company's current
stock price?

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PROBLEM 4
The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a
constant rate of 5.50% per year in the future. The company's beta is 1.15, the market risk premium is
5.00%, and the risk-free rate is 4.00%. What is the company's current stock price, P0?

PROBLEM 5
On January 1, 2011, Piper Co. issued ten-year bonds with a face value of $1,000,000 and a stated interest
rate of 10%, payable semiannually on June 30 and December 31. The bonds were sold to yield 12%.
Table values are:
Present value of 1 for 10 periods at 10% .386
Present value of 1 for 10 periods at 12% .322
Present value of 1 for 20 periods at 5% .377
Present value of 1 for 20 periods at 6% .312
Present value of annuity for 10 periods at 10% 6.145
Present value of annuity for 10 periods at 12% 5.650
Present value of annuity for 20 periods at 5% 12.462
Present value of annuity for 20 periods at 6% 11.470

Calculate the issue price of the bonds.

PROBLEM 6
Consider a share that sells for P50. The business enterprise is expected to pay a P3 cash dividend at the
end of the year, and the share’s market price at the end of the year is expected to be P55 a share.
Compute the expected return.

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PROBLEM 7
Seiko Business Enterprise earned 2,500,000 in 2011. Of this amount, it decided that 20 percent would be
used to buy treasury shares. Currently, there are 400,000 shares outstanding. Market price per share is P18.
The business enterprise can use 500,000 to buy back 25,000 shares through a tender offer to shareholders
of P20 per share. The offer price of P20 is higher than the current market price of P18 because the business
enterprise feels its buyback will drive up the price of existing shares as a function of the law of supply and
demand.

a. Compute the earnings per share.

b. Compute the current P/E multiple.

c. Compute the earnings per share after treasury share is acquired.

d. The expected market price, assuming the P/E ratio (multiple) remains the same, is:

PROBLEM 8
A firm has had the indicated earnings per share over the last three years:

Year EPS

2003 $3.00
2002 2.00
2001 1.00

If the firm’s dividend policy was based on a fixed dollar payout policy of 50 cents per share plus an extra
dividend equal to 75 percent of earnings per share above $1.00, determine the annual dividend for each
year.

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PROBLEM 9
Tangshan Mining has 100,000 shares outstanding and just declared a 3-for-2 stock split. Before the
announcement, the firm’s shares were trading at $50.00 per share. After the stock dividend, the firm’s
shares should trade at _________ per share.

PROBLEM 10
Urlacher Digital’s stock is trading at $120 a share. The company plans to announce a 3-for-2 stock split.
The stock split is expected to increase the company’s market capitalization by 5 percent. What is the
expected stock price after the stock split is completed?

END

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