Chapter 10

Financial Management: Principles & Applications, 13e (Titman)
Chapter 10 Stock Valuation
1) P. Noel Company's common stock has just paid a $2.00 dividend. If investors believe that the
expected rate of return on P. Noel is 14% and that dividends will grow at the rate of 5% per year
for the foreseeable future, what is the value of a share of P. Noel stock?
A) $15.00
B) $22.22
C) $23.33
D) $40.00
Answer: C
Diff: 2
AACSB: 3. Analytic thinking skills
Question Status: New question
Objective: 10.1 Identify the basic characteristics and features of common stock and use the
discounted cash flow model to value common shares.
Keywords: common stock
Principles: Principle 3: Cash flows are the source of value
2) The expected rate of return on a share of common stock whose dividends are growing at a
constant rate (g) is which of the following?
A) (D1 + g)/Vc
B) D1/Vc + g
C) D1/g
D) D1/Vc
Answer: B
Diff: 2
Question Status: Previous edition
1
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3) Green Company's common stock is currently selling at $24.00 per share. The company
recently paid dividends of $1.92 per share and projects growth at a rate of 4%. At this rate, what
is the stock's expected rate of return?
A) 4.08%
B) 8.00%
C) 12.00%
D) 8.80%
Answer: C
Diff: 2
4) Common stockholders are essentially

A) creditors of the firm.
B) managers of the firm.
C) owners of the firm.
D) all of the above.
Answer: C
Diff: 2
5) Butler, Inc.'s return on equity is 17% and management retains 75% of earnings for investment
purposes. Based on this information, what will be the firm's growth rate?
A) 4.25%
B) 22.67%
C) 44.12%
D) 12.75%
Answer: D
Diff: 2
2
6) If a company has a return on equity of 25% and wants a growth rate of 10%, how much of
ROE should be retained?
A) 40%
B) 50%
C) 60%
D) 70%
Answer: A
Diff: 2
7) ________ gives minority shareholders more power to elect a member to the board of directors.
A) Preemptive right
B) Majority voting
C) Proxy fights
D) Cumulative voting
Answer: D
Diff: 2
Question Status: Revised
8) You are evaluating the purchase of Cellars, Inc. common stock that just paid a dividend of
$1.80. You expect the dividend to grow at a rate of 12% for the next three years. You plan to
hold the stock for three years and then sell it. You estimate that a required rate of return of 17.5%
will be adequate compensation for this investment. Calculate the present value of the expected
dividends.
A) $4.91
B) $5.40
C) $9.80
D) $6.80
Answer: A
Diff: 2
3
9) You are evaluating the purchase of Charbridge, Inc. common stock which currently pays no
dividend and is not expected to do so for many years. Because of rapidly growing sales and
profits, you believe the stock will be worth $51.50 in 3 years. If your required rate of return is
16%, what is the stock worth today?
A) $59.74
B) $51.25
C) $32.99
D) $0.00 because stocks that do not pay dividends have no value.
Answer: C
Diff: 3
10) CEOs naming friends to the board of directors and paying them more than the norm is an
example of the
A) agency problem.
B) preemptive right.
C) majority voting feature.
D) proxy fights.
Answer: A
Diff: 2
Principles: Principle 5. Individuals respond to incentives.
11) Evidence that agency costs exists

A) because they are shown in footnotes to the financial statements.
B) because stock prices increase when an underperforming CEO is unexpectedly replaced.
C) because underperforming CEO's are frequently voted out by shareholders.
D) because management often pursues risky but profitable opportunities rather than safer, less
profitable opportunities.
Answer: B
Diff: 1
4
12) Evidence exists that directors
A) aggressively represent the interests of shareholders.
B) are quick to replace or reduce the compensation of underperforming CEOs.
C) often represent the interests of the managers who nominated them for directorships.
D) are vigilant in requiring that the firm's assets be used efficiently.
Answer: C
Diff: 2
13) Frost Corporation's recent earnings per share were $12.90. Their dividend payout ratio is
20%. Earnings are expected to grow at an average of 6% per year and the company's policy is to
maintain the same payout ratio. If investors are requiring a 12% rate of return on this stock, what
will they be willing to pay for one share?
A) $21.50
B) $22.75
C) $43.00
D) $45.58
Answer: D
Diff: 2
14) Fris B. Corporation stock is currently selling for $42.86. It is expected to pay a dividend of
$3.00 at the end of the year. Dividends are expected to grow at a constant rate of 3% indefinitely.
Compute the required rate of return on FBC stock.
A) 10%
B) 33%
C) 7%
D) 4.3%
Answer: A
Diff: 2
5
15) You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend
of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a
required rate of return of 17.5% will be adequate compensation for this investment. Assuming
that your analysis is correct, what is the most that you would be willing to pay for the common
stock if you were to purchase it today? Round to the nearest $.01.
A) $36.65
B) $91.23
C) $51.55
D) $74.82
Answer: A
Diff: 2
16) A stock currently sells for $63 per share, and the required return on the stock is 10%.
Assuming a growth rate of 5%, calculate the stock's last dividend paid.
A) $1
B) $3
C) $5
D) $7
Answer: B
Diff: 2
17) A decrease in the ________ will cause an increase in common stock value.
A) growth rate
B) required rate of return
C) last paid dividend
D) both B and C
Answer: B
Diff: 2
6
18) Acme Consolidated has a return on equity of 12%. If Acme distributes 60% of earnings as
dividends, then we would expect the common shareholders' investment in the firm and the value
of the common stock to grow by
A) 4.80%.
B) 7.20%.
C) 12%.
D) 6%.
Answer: A
Diff: 2
19) An investor is contemplating the purchase of common stock at the beginning of this year and
to hold the stock for one year. The investor expects the year-end dividend to be $2.00 and
expects a year-end price for the stock of $40. If this investor's required rate of return is 10%, then
the value of the stock to this investor is
A) $36.36.
B) $38.18.
C) $33.06.
D) $34.88.
Answer: B
Diff: 2
7
20) Nicholas Inc. just paid a $2.00 dividend on its common stock and expects to continue
growing dividends at an average rate of 5% each year, from now to infinity. If the required rate
of return for this stock is 9% and it is currently selling for $54.50 per share, the stock
A) selling for exactly its intrinsic value.
B) there is not information to determine if the stock is overpriced or underpriced.
C) underpriced.
D) overpriced.
Answer: D
Diff: 2
21) An issue of common stock currently sells for $40.00 per share, has an expected dividend to
be paid at the end of the year of $2.00 per share, and has an expected growth rate to infinity of
5% per year. The expected rate of return on this security is
A) 5%.
B) 10.25%.
C) 13.11%.
D) 10%.
Answer: D
Diff: 2
22) Common shareholders have a claim on the company's assets

A) at any time, equal to the value of their shares.
B) only after the claims of debtholders and preferred shareholders have been satisfied.
C) after the claims of the preferred shareholders have been satisfied, but before the debt holders.
D) never. Common shareholders have no claim on the company's assets.
Answer: B
Diff: 2
8
23) KDP's most recent dividend was $2.00 per share and is selling today in the market for $70.
The dividend is expected to grow at a rate of 7% per year for the foreseeable future. If the market
return is 10% on investments with comparable risk, should you purchase the stock?
A) No, because the stock is overpriced $1.33.
B) No, because the stock is overpriced $3.33.
C) Yes, because the stock is underpriced $1.33.
D) Yes, because the stock is underpriced $3.33.
Answer: C
Diff: 2
24) When a company has an initial public offering

A) the previous owner of the shares will bet the money and the buyer will get the shares.
B) the proceeds of the sale will not affect the company's balance.
C) the proceeds of the sale will increase the company's equity.
D) the proceeds of the sale will become a liability payable to the shareholders.
Answer: C
Diff: 2
25) You are considering the purchase of Miller Manufacturing, Inc.'s common stock. The stock
is selling for $21.00 per share. The next dividend is expected to be $2.10, and you expect the
dividend to keep growing at a constant rate. If the stock is returning 15%, calculate the growth
rate of dividends.
A) 3%
B) 5%
C) 8%
D) 10%
Answer: B
Diff: 2
9
26) ABC, Inc. just paid a dividend of $2. ABC expects dividends to grow at 10%. The return on
stocks like ABC, Inc. is typically around 12%. What is the most you would pay for a share of
ABC stock?
A) $100
B) $110
C) $120
D) $130
Answer: B
Diff: 2
27) Marjen, Inc. just paid a dividend of $5. Marjen stock currently sells for $73.57. The return on
stocks like Marjen, Inc. is around 10%. What is the implied growth rate of dividends.
A) 1%
B) 3%
C) 5%
D) 7%
Answer: B
Diff: 3
28) Which investor incurs the greatest risk?

A) Mortgage bondholder
B) Preferred stockholder
C) Common stockholder
D) Debenture bondholder
Answer: C
Diff: 1
10
29) What allows common stockholders the right to cast a number of votes equal to the number of
directors being elected?
A) The majority voting provision
B) The casting feature
C) The cumulative voting provision
D) The proxy method
Answer: C
Diff: 2
30) The shareholder can cast all votes for a single candidate or split them among various
candidates through
A) proxy fights.
B) cumulative voting.
C) call provisions.
D) majority voting.
Answer: B
Diff: 2
31) If a company has issued preferred stock

A) the common shareholders will have weaker voting rights.
B) preferred shareholders will be allowed to choose one or more members of the board of
directors.
C) dividends on preferred stock will be higher than the common dividends.
D) preferred dividends will have to be paid before the company can pay dividends on common
stock.
Answer: D
Diff: 1
11
32) You are considering the purchase of Wahoo, Inc. The firm just paid a dividend of $4.20 per
share. The stock is selling for $115 per share. Security analysts agree with top management in
projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your
required rate of return for stocks of this type is 17.5%. If you were to purchase and hold the stock
for three years, what would the expected dividends be worth today?
A) $12.60
B) $9.21
C) $17.12
D) $15.55
E) $11.46
Answer: E
Diff: 2
33) A share of common stock just paid a dividend of $3.25 per share. The expected long-run
growth rate for this stock is 18%. If investors require a rate of return of 24%, what should the
price of the stock be?
A) $57.51
B) $62.25
C) $71.86
D) $63.92
Answer: D
Diff: 2
12
34) Common stockholders expect greater returns than bondholders because
A) they have no legal right to receive dividends.
B) they bear greater risk.
C) in the event of liquidation, they are only entitled to receive any cash that is left after all
creditors are paid.
D) all of the above.
Answer: D
Diff: 2
35) WSU Inc. is a young company that does not yet pay a dividend. You believe that the
company will begin to pay dividends 5 years from now, and that the company will then be worth
$50 per share. If your required rate of return on this risky stock is 20%, what is the stock worth
today?
A) $40
B) $10
C) $20.09
D) $0.00
Answer: C
Diff: 2
36) Common stockholders are essentially creditors of the firm.

Answer: FALSE
Diff: 1
13
37) Common stock represents a claim on residual income.
Answer: TRUE
Diff: 2
38) The growth rate of future earnings is determined by return on equity and the profit-retention
rate.
Answer: TRUE
Diff: 2
39) The stockholder's expected rate of return consists of a dividend yield and interest.
Answer: FALSE
Diff: 2
40) When bankruptcy occurs, the claims of the common shareholders may go unsatisfied.
Answer: TRUE
Diff: 2
14
41) Cumulative voting allows a shareholder to cast all of his or her votes for one director rather
than voting on each director separately.
Answer: TRUE
Diff: 2
42) The expected rate of return implied by a given market price equals the required rate of return
for investors at the margin.
Answer: TRUE
Diff: 2
43) Stock valuation is more precise than bond valuation as stock cash flows are more certain.
Answer: FALSE
Diff: 2
44) The stock valuation model D1/(Rc - g) requires Rc > G.

Answer: TRUE
Diff: 2
15
45) Is the following common stock priced correctly? If no, what is the correct price?
Price = $26.25
Required rate of return = 13%
Dividend year 0 = $2.00
Dividend year 1 = $2.10
Answer: Growth rate = = 5%
Vcs = 2.10 /(.13-.05)= $26.25

The stock is priced correctly.
Diff: 2
46) The common stock of Cranberry, Inc. is selling for $26.75 on the open market. A dividend of
$3.68 is expected to be distributed, and the growth rate of this company is estimated to be 5.5%.
If Richard Dean, an average investor, is considering purchasing this stock at the market price,
what is his expected rate of return?
Answer:
R = (D/V) + g
R = ($3.68/$26.75) + .055
R = 19.26%
Diff: 2
16
47) Tannerly Worldwide's common stock is currently selling for $48 a share. If the expected
dividend at the end of the year is $2.40 and last year's dividend was $2.00, what is the rate of
return implicit in the current stock price?
Answer:
Rc = 2.40/48 + (2.40 - 2.00)/2.00
= .05 + .20
= 25%
Diff: 2
48) Draper Company's common stock paid a dividend last year of $3.70. You believe that the
long-term growth in the dividends of the firm will be 8% per year. If your required return for
Draper is 14%, how much are you willing to pay for the stock?
Answer: P0 = = = $66.60
Diff: 2
49) Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1
and grows at a rate of 5%.
Answer: Kcs = + 5% = 10% + 5% = 15%
Diff: 2
17
50) You are considering the purchase of AMDEX Company stock. You anticipate that the
company will pay dividends of $2.00 per share next year and $2.25 per share the following year.
You believe that you can sell the stock for $17.50 per share two years from now. If your required
rate of return is 12%, what is the maximum price that you would pay for a share of AMDEX
Company stock?
Answer: Vc = $2.00 PVIF12%,1 + $19.75 PVIF12%,2
= ($2.00)(.893) + ($19.75)(.797)
= $17.53
Diff: 2
51) You can purchase one share of Sumter Company common stock for $80 today. You expect
the price of the common stock to increase to $85 per share in one year. The company pays an
annual dividend of $3.00 per share. What is your expected rate of return for Sumter stock?
Answer: $80.00 = +
$80.00 (1 + R) = $88.00
(1 + R) = = $1.10
R = .10
Diff: 2
52) If a stock has a much higher than normal P/E ratio, investors probably expect
A) slow growth in earnings.
B) rapid growth in earnings.
C) large increases in the price of the stock.
D) a declining stock price
Answer: B
Diff: 2
Objective: 10.2 Use the price-to-earnings ratio to value common stock.
Keywords: price/earnings ratio
18
53) Which of the following factors will influence a firm's P/E ratio?
A) The investors' required rate of return
B) Firm investment opportunities
C) General market conditions
D) All of the above
Answer: D
Diff: 2
54) The P/E ratio is calculated by dividing

A) the current stock price by stockholders' equity.
B) total assets by net income.
C) the current stock price by earnings per share.
D) the current stock price by operating cash flow per share.
Answer: C
Diff: 2
55) The GAP's most recent earnings per share were $1.75. Analysts forecast next year's earnings
per share at $1.88. If the appropriate P/E ratio is 15, a share of GAP stock should be valued at
A) $28.20.
B) $26.25.
C) $27.23.
D) $8.57.
Answer: A
Diff: 2
19
56) The retail analyst at Morgan-Sachs values stock of the GAP at $38.00 per share. They are
using the average industry "forward" P/E ratio of 17. Their forecasted earnings per share for next
year is
A) $0.54.
B) $1.50.
C) $2.24
D) There is not enough information calculate earnings per share.
Answer: C
Diff: 2
57) Home Depot stock is currently selling for $136 per share. Next year's dividend is expected to
be $3.31; next year's earnings per share are expected to be $6.55. Home Depot's P/E ratio is
A) .048.
B) 22.03.
C) 20.75
D) 41.08
Answer: C
Diff: 2
58) McDonald's stock currently sells for $123. It's expected earnings per share are $5.12. The
average P/E ratio for the industry is 24. If investors expected the same growth rate and risk for
McDonald's as for an average firm in the same industry, it's stock price would
A) stay about the same.
B) rise.
C) fall.
D) there is not enough information.
Answer: A
Diff: 2
20
59) If the ROE on a new investment is less than the firm's required rate of return
A) the investment increases the firm's value.
B) the investment leaves the firm's value unchanged.
C) the effect on the firm's value is unpredictable.
D) the investment reduces the firm's value.
Answer: D
Diff: 2
60) Zorba's is a small chain of restaurants whose stock is not publicly traded. The average P/E
ratio for similar restaurant chains is 16.5; the P/E ratio for the S&P 500 Index is 15.2. This year's
earnings were $1.21 per share and next year's earnings are forecasted at $1.46 per share. A
reasonable price for a share of Zorba's stock is
A) $24.
B) $20.
C) $18.
D) $16.
Answer: A
Diff: 2
61) Apple stock is now selling for $115 per share. The P/E ratio based on current earnings is
13.77 and the P/E ratio based on expected earnings is 12.29. The expected growth rate in Apples
earnings must be
A) 1.48%.
B) 12.1%.
C) -10.3%.
D) 10.3%.
Answer: B
Diff: 3
21
62) The P/E ratio is the market price of a share of stock divided by book equity per share.
Answer: FALSE
Diff: 2
63) The higher a firm's P/E ratio, the more optimistic investors' feel about the firm's growth
prospects.
Answer: TRUE
Diff: 2
64) P/E ratios found in published sources or on the internet are always computed by dividing the
next period's expected earnings into the current price of the stock.
Answer: FALSE
Diff: 2
65) The higher the investor's required rate of return, the higher the P/E ratio will be.
Answer: FALSE
Diff: 2
22
66) Walmart's current earnings per share of $4.60 are expected to grow only at a rate of 2% per
year for the next few years. Using a P/E ratio of 15, what is a reasonable value for a share of
Walmart Stock.
Answer: A reasonable value for Walmart would be $4.60(1.02)(15)=$70.38 per share.
Diff: 2
67) RAH Inc. is not publicly traded, but the P/E ratios of it's 4 closest competitors are 15, 15.3,
15.7, and 16.5. RAH's current earnings per share are $1.50. They are expected to grow at 6% for
the next few years. What is a reasonable price for a share of RAH stock?
Answer: An appropriate P/E ratio would be an average of the 4 competitors
(15+15.3+15.7+16.5)/4=15.625. A reasonable price would be $1.50(1.06)(15.625)=$24.84.
Diff: 2
68) UVP preferred stock pays $5.00 in annual dividends. If your required rate of return is 13%,
how much will you be willing to pay for one share?
A) $38.46
B) $26.26
C) $65.46
D) $46.38
Answer: A
Diff: 2
Objective: 10.3 Identify the basic features and characteristics and features of preferred stock
and value preferred shares.
Keywords: preferred stock
23
69) Green Corp.'s preferred stock is selling for $20.83. If the company pays $2.50 annual
dividends, what is the expected rate of return on its stock?
A) 8.33%
B) 12.00%
C) 2.50%
D) 20.00%
Answer: B
Diff: 2
70) Sacramento Light & Power issued preferred stock in 1998 that had a par value of $85. The
preferred stock pays a dividend of 5.75%. Investors require a rate of return of 6.50% today on
this stock. What is the value of the preferred stock today? Round to the nearest $1.
A) $100
B) $85
C) $75
D) $16
Answer: C
Diff: 2
71) Which of the following statements is true?

A) Preferred stockholders are entitled to dividends before common stockholders can receive
dividends.
B) Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not pay
back the investment.
C) The market value of preferred stock, like bonds, will usually fluctuate in value primarily as
the result of market rates of interest.
D) All of the above.
Answer: D
Diff: 2
24
72) Which of the following statements concerning preferred stock is correct?
A) Preferred stock generally is more costly to the firm than common stock.
B) Most issues of preferred stock have a cumulative feature.
C) Preferred dividend payments are tax-deductible.
D) Preferred stock is a riskier form of capital to the firm than bonds.
Answer: B
Diff: 2
73) World Wide Interlink Corp. has decided to undertake a large project. Consequently, there is a
need for additional funds. The financial manager plans to issue preferred stock with an annual
dividend of $5 per share. The stock will have a par value of $30. If investors' required rate of
return on this investment is currently 20%, what should the preferred stock's market value be?
A) $10
B) $15
C) $20
D) $25
Answer: D
Diff: 2
74) Davis Gas & Electric issued preferred stock in 1985 that had a par value of $50. The stock
pays a dividend of 7.875%. Assume that shares are currently selling for $62.50. What is the
preferred stockholder's expected rate of return? Round to the nearest 0.01%.
A) 6.30%
B) 7.88%
C) 10.25%
D) 5.02%
Answer: A
Diff: 2
25
75) Murky Pharmaceuticals has issued preferred stock with a par value of $100 and a 5%
dividend. The investors' required yield is 10%. What is the value of a share of Murky preferred?
A) $100
B) $75
C) $50
D) $25
Answer: C
Diff: 2
76) Edison Power and Light has an outstanding issue of cumulative preferred stock with an
annual fixed dividend of $2.00 per share. It has not paid the preferred dividend for the last 3
years, but intends to pay a dividend on the common stock in the coming year. Before Edison can
pay a dividend on the common stock
A) preferred shareholders may cast all their votes for a single director.
B) preferred shareholders must receive dividends totaling $8.00 per share.
C) preferred shareholders must receive $2.00 per share.
D) will not necessarily receive any dividend.
Answer: B
Diff: 2
77) Which of the following provisions is unique to preferred stockholders and usually NOT
available to common stockholders?
A) Cumulative dividends feature
B) Voting rights
C) Fixed dividend
D) Both A and C
Answer: D
Diff: 2
26
78) Piercing Publishers recently issued preferred stock with a fixed annual dividend of $3.00 per
share. Investors require a 5% return on similar preferred stock issues. The stock is currently
selling for $65. Is the stock a good buy?
A) Yes, as it is undervalued $5.
B) Yes, as it is undervalued $10.
C) No, as it is overvalued $5.
D) No, as it is overvalued $10.
Answer: C
Diff: 2
79) Tri State Pickle Company preferred stock pays a perpetual annual dividend of 2 1/2% of its
par value. Par value of TSP preferred stock is $100 per share. If investors' required rate of return
on this stock is 15%, what is the value of per share?
A) $37.50
B) $15.00
C) $16.67
D) $6.00
Answer: C
Diff: 2
80) Petrified Forest Skin Care, Inc. pays an annual perpetual dividend of $1.70 per share. If the
stock is currently selling for $21.25 per share, what is the expected rate of return on this stock.
A) 36.13%
B) 12.5%
C) 8.0%
D) 13.6%
Answer: C
Diff: 2
27
81) Horizon Communications stock pays a fixed annual dividend of $3.00. Because of lower
inflation, the market's required yield on this preferred stock has gone from 12% to 10%. As a
result
A) Horizon's dividend decreased by 6 cents.
B) the value of Horizon's preferred increased by $3.00.
C) the value of Horizon's preferred decreased by $5.00.
D) the value of Horizon's preferred increased by $5.00.
Answer: D
Diff: 2
82) The required rate of return on TKF preferred has fallen from 5.75% at the time of issue to the
present rate of 5%. The stock now sells for $115. What was the original price?
A) $75.61
B) $132.25
C) $114
D) $100
Answer: D
Diff: 2
83) Preferred stock is similar to a bond in the following way

A) Preferred stock always contains a maturity date.
B) Both investments provide a fixed income.
C) Both contain a growth factor similar to common stock.
D) None of the above.
Answer: B
Diff: 2
28
84) From the issuing firm's point of view, one advantage of preferred stock over bonds is
A) preferred dividends are a deductible expense for tax purposes.
B) preferred voting privileges concentrate power in the hands of managers and major
shareholders.
C) a dividend payment can be skipped without triggering bankruptcy.
D) all of the above
Answer: C
Diff: 2
85) A decrease in the ________ will increase the value of preferred stock.
A) expected rate of return
B) life of the investment
C) dividend paid
D) both A and C
Answer: A
Diff: 2
86) National Grit's preferred stock has a par value of $100, sells for $85 and pays $11 each year
in dividends. What is the required rate of return?
A) 12.9 %
B) 11%
C) 1.29%
D) 8.5%
Answer: A
Diff: 2
29
87) What is the value of a preferred stock that pays a $2.10 dividend to an investor with a
required rate of return of 6% (round your answer to the nearest $1)?
A) $35
B) $23
C) $17
D) $21
Answer: A
Diff: 2
88) Which of the following formulas is appropriate to find the value of preferred stock with a
fixed dividend?
A) Value of preferred stock = Annual Preferred Stock Dividend (1+ growth rate)/Market's
Required Yield on Preferred Stock
B) Value of preferred stock = Annual Preferred Stock Dividend (1+ growth rate)/Market's
Required Yield on Preferred Stock - growth rate
C) Value of preferred stock = Annual Preferred Stock Dividend/Market's Required Yield on
Preferred Stock
D) Value of preferred stock = Annual Preferred Stock Dividend/Investor's Required Yield on
Preferred Stock
Answer: C
Diff: 2
30
89) An issue of preferred stock currently sells for $52.50 per share and pays a constant annual
expected dividend of $2.25 per share. The expected return on this security is
A) 4.29%.
B) 0.04%.
C) 8.33%.
D) 13.33%.
Answer: A
Diff: 2
90) Expected cash flow for a preferred stock primarily consists of

A) dividend payments .
B) changes in the price of the stock.
C) interest payments.
D) both A and B.
Answer: A
Diff: 2
91) Preferred stock is similar to common stock in that

A) it has no fixed maturity date.
B) the nonpayment of dividends can bring on bankruptcy.
C) dividends are limited in amount.
D) both carry voting rights.
Answer: A
Diff: 2
31
92) Profitable companies often prefer to issue debt rather than preferred stock because
A) debt creates less risk for the company.
B) interest payments are fixed but preferred shareholders expect dividends to grow.
C) preferred shares dilute the voting rights of common shareholders but bonds do not.
D) interest on debt is deductible for tax purposes, but preferred dividends are not.
Answer: D
Diff: 2
93) In the event of bankruptcy, preferred stockholders and common stockholders have the same
claim on the firm's assets.
Answer: FALSE
Diff: 2
94) A company may issue multiple classes of preferred stock.

Answer: TRUE
Diff: 2
95) The cumulative dividend feature is necessary to protect the rights of preferred stockholders.
Answer: TRUE
Diff: 2
32
96) Typical preferred stock is values as a perpetual annuity.
Answer: TRUE
Diff: 2
97) In order to determine the value of a share of preferred stock, the discount rate used is the
annual dividend percent.
Answer: FALSE
Diff: 2
98) The value of preferred shares is affected by changes in interest rates.

Answer: TRUE
Diff: 2
33
99) Miller/Hershey's preferred stock is selling at $54 on the market and pays an annual dividend
of $4.20 per share.
a. What is the expected rate of return on the stock?
b. If an investor's required rate of return is 9%, what is the value of the stock for that investor?
c. Considering the investor's required rate of return, does this stock seem to be a desirable
investment?
Answer:
a. R = D/V
R = $4.20/54
R = 7.78%
b. V = D/R
V = $4.20/.09
V = $46.66
c. No, it is not a desirable investment.
Diff: 2
100) Discuss two reasons why preferred stock would be viewed as less risky than common stock
to investors.
Answer: Preferred stockholders are paid before common stockholders in the event of
bankruptcy. Common stockholders, as the residual owners of a corporation, would receive any
monies remaining after bondholder and preferred stock claims are satisfied. Preferred dividends
are paid before common stock dividends in the normal course of business. In the event that a
preferred dividend is not paid, it accumulates and dividends in arrears must be paid before any
common stock dividends can be declared. Common shareholders take the risk that they will not
receive dividends. The magnitude of the cash flows from preferred is also known where it is not
known for common stock. Because cash flows are more certain, preferred stock would be
considered less risky to the investor.
Diff: 2
34
101) Determine the rate of return on a preferred stock that costs $50 and pays a $6 per share
dividend.
Answer:
K = Div = 6 = 12%
Vg 50
Diff: 2
35

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Chapter 10

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Financial Management: Principles & Applications, 13e (Titman)

Chapter 10 Stock Valuation

4) Common stockholders are essentially

11) Evidence that agency costs exists

22) Common shareholders have a claim on the company's assets

24) When a company has an initial public offering

28) Which investor incurs the greatest risk?

31) If a company has issued preferred stock

36) Common stockholders are essentially creditors of the firm.

44) The stock valuation model D1/(Rc - g) requires Rc > G.

Vcs = 2.10 /(.13-.05)= $26.25

54) The P/E ratio is calculated by dividing

71) Which of the following statements is true?

83) Preferred stock is similar to a bond in the following way

90) Expected cash flow for a preferred stock primarily consists of

91) Preferred stock is similar to common stock in that

94) A company may issue multiple classes of preferred stock.

98) The value of preferred shares is affected by changes in interest rates.

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