Common Stock Chapter 7

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Questions and Answers

Which of the following is not a characteristic of common stock?

has no maturity date

considered a permanent form of long-term financing

is a residual form of ownership

has claims on assets prior to those of preferred stock (correct)

Stockholders' equity includes all of the following except:

Treasury stock (correct)

Contributed capital in excess of par

Retained earnings

Common stock at par

The market value of common stock is primarily based on

the firm's future earnings (correct)

total assets

book value

retained earnings

Common stockholders have a number of general rights, including all of the following except:

management rights (B) Signup and view all the answers

The book value of an asset represents

the historic acquisition cost of the asset (A) Signup and view all the answers

In a reverse stock split

the number of shares are decreased (C) Signup and view all the answers

Which of the following is not an advantage of common stock financing?

involves relatively high flotation costs (C) Signup and view all the answers

A change in the market price of an asset will occur as a result of changes in:

investors' required rates of return and their expected returns from the asset (B) Signup and view all the answers

In the constant-growth dividend valuation model, the required rate of return must be ______ the dividend growth rate in order for the formula price to be meaningful.

greater than (C) Signup and view all the answers

In the constant-growth dividend valuation model, the required rate of return on a common stock can be shown to be equal to the sum of the dividend yield plus:

Price appreciation yield (C) Signup and view all the answers

The valuation of common stock is considerably more complicated than the valuation of bonds or preferred stocks because:

The returns can be in annual cash payments or price appreciation, and they are normally expected to grow and not remain constant (D) Signup and view all the answers

In the valuation of common stock, the simple annuity and perpetuity formulas used in the valuation of bonds and preferred stock are not generally applicable because:

Common stock dividends are normally expected to grow over time, rather than being constant as are payments on most bonds and most preferred stock. (D) Signup and view all the answers

One of the assumptions of the constant growth dividend valuation model is that

the required rate of return is greater than the dividend growth rate (A) Signup and view all the answers

The most important factor to be considered in the valuation of a closely held firm is

earnings capacity (A) Signup and view all the answers

Stockholders' equity equals

both preferred stock and common equity (A) Signup and view all the answers

A common stock's book value is calculated

on the basis of balance sheet figures (C) Signup and view all the answers

From an accounting standpoint, stock dividends involve a transfer from the

retained earnings account (B) Signup and view all the answers

Which one of the following is not a reason a firm may decide to repurchase its own stock?

disposition of excess warrants (B) Signup and view all the answers

The returns investors receive from holding common stocks may be in two forms. They are

cash dividend payments and capital gains (C) Signup and view all the answers

The constant growth dividend valuation model does not hold when

g is greater than ke (A) Signup and view all the answers

If the general level of interest rates in the economy moves up, then investors will require a rate of return on securities, and, in general, stock prices should , ceteris paribus.

higher, decline (B) Signup and view all the answers

If competition in an industry increases, the future growth potential should

decrease (B) Signup and view all the answers

The zero growth dividend valuation model is used when a firm's future dividends are expected to remain constant, ______

forever (B) Signup and view all the answers

When evaluating a firm based on price/earnings multiples, the evaluator must determine the price/earnings multiple for

firms in the same industry (B) Signup and view all the answers

A firm that wishes to raise additional equity capital by selling a portion of the existing owners' stock while maintaining control of the firm should consider a ______.

separate class of nonvoting stock (A) Signup and view all the answers

A firm may use a stock repurchase ______

as part of a financial restructuring and to dispose of excess cash (A) Signup and view all the answers

In the constant growth dividend valuation model, the required rate of return on a common stock is equal to the sum of the ______

capital gains yield and dividend yield (C) Signup and view all the answers

In the constant growth dividend valuation model, it is assumed that the ______

firm's future dividend payments are expected to grow at a constant rate forever (C) Signup and view all the answers

An arrangement whereby an investment banker agrees to purchase an entire new issue of securities is called ______

underwriting (D) Signup and view all the answers

The difference between the selling price to the public of a new issue and the net the issuing firm actually receives is known as the ______

underwriting spread (A) Signup and view all the answers

All of the following are advantages of private security placements (over a public offering) except ______

lower interest rates (D) Signup and view all the answers

A firm may sell its common stock directly to its existing stockholders through a ______

rights offering (D) Signup and view all the answers

Direct issuance costs are ______

all of these are correct (C) Signup and view all the answers

In marketing a new security issue, the investment banker assumes the risk of not being able to sell the security at a favorable price in each of the following cases except:

a best efforts offering (A) Signup and view all the answers

An investment banker is generally thought to be qualified to advise a corporation on a variety of matters, including all the following except:

the firm's new product marketing decisions (A) Signup and view all the answers

In addition to direct costs, there are other costs associated with new security offerings. These other costs include all of the following except:

the cost of overpricing (B) Signup and view all the answers

Which of the following are reasons why large multinational corporations may sell equity in international markets rather than selling stock only in the country in which they are domiciled?

Global equity offerings result in higher price per share. (B) Signup and view all the answers

The P/E ratio indicates

how much investors are willing to pay for $1 of current earnings (B) Signup and view all the answers

Common stock dividends normally are paid

quarterly (A) Signup and view all the answers

In stock quotations, the last column, showing the net change, indicates the net change in

the closing price from the previous day's close (B) Signup and view all the answers

Many preferred stocks are treated as____in determining their values.

Convertible securities (C) Signup and view all the answers

When a stock is split 2 for 1, then the____ figure on the firm's balance sheet is cut in half.

par value (B) Signup and view all the answers

The rights of stockholders to share equally on a per share basis in any distributions of corporate earnings is known as ____.

dividend rights (D) Signup and view all the answers

____ result in what is known as treasury stock.

Stock repurchases (B) Signup and view all the answers

Listed below are some of the responsibilities of investment bankers. Which of the following is NOT one of them?

They directly influence the objectives and direction of the company. (C) Signup and view all the answers

The zero growth method is used to value

preferred stock (D) Signup and view all the answers

The book value per share of common stock is calculated by dividing by the number of shares outstanding

total common stockholders' equity (D) Signup and view all the answers

All of the following are ways that securities are offered to the public in a public offering EXCEPT:

Securities are sold through excess-market pricing (C) Signup and view all the answers

In a liquidation of a firm due to bankruptcy, which of the following usually gets paid last?

common stockholders (C) Signup and view all the answers

The returns from most common stocks are

positively correlated with each other (A) Signup and view all the answers

Common stockholders’ claim on assets is considered after which of the following:

Preferred Stockholders (B) Signup and view all the answers

In valuing a company that sells products and services,____ is the most important factor in the valuation of closely held firms.

profit (B) Signup and view all the answers

Of the following common stock rights, which allows common stockholders to buy more shares of common stock in order to retain their pro-rata share of ownership in the company?

preemptive rights (B) Signup and view all the answers

Stock splits are:

a sign that the company wants to get its stock price to a more desirable trading level. (C) Signup and view all the answers

All of the following are reasons that companies hold treasury stock EXCEPT:

to comply with SEC regulations that a certain amount of company shares must be kept by the company. (A) Signup and view all the answers

Study Notes

Common Stock Characteristics, Valuation, and Issuance

Common stock has no maturity date
It's considered permanent long-term financing
Stockholders' equity includes common stock at par, contributed capital in excess of par, and retained earnings, but not treasury stock.
Book value per share is calculated by dividing total common stockholder's equity by number of shares outstanding.
Market value is primarily based on the firm's future earnings.
Common stockholders have voting rights, asset rights, and dividend rights, but not management rights.
Reverse stock splits decrease the number of shares.
In a reverse stock split, the market value does not decrease, and par value does not decrease.
A disadvantage of common stock financing is high flotation costs.

Valuation of Common Stock

The valuation of common stock is more complex than that of bonds or preferred stock.
Common stock returns can take two forms: annual cash payments and price appreciation.
These returns are generally expected to grow, not remain constant.
Many preferred stocks are treated as perpetuities in determining their values.
Investors buy common stock for different reasons than they buy bonds or preferred stock.
Constant growth dividend valuation models require the required rate of return to be greater than the dividend growth rate.
In the constant growth dividend valuation model, the required rate of return is equal to the sum of the dividend yield and the price appreciation yield.

Repurchasing Stock

Repurchasing stock can be used as a future corporate need.
Repurchasing stock can be used as a financial restructuring strategy.

Additional Information

An arrangement where an investment banker agrees to purchase an entire new issue of securities is called underwriting.
The difference between selling price to the public vs the net price for the company is called the underwriting spread.
A group of underwriters who share responsibility for selling a security issue is called a purchasing syndicate.
Private security placements have reduced flotation costs, and greater flexibility, and save time when compared to public offerings.
Investing firms assume risk for best efforts offerings.
Direct costs of issuing securities include the cost of incentives and possible decline in stock price.
A procedure that allows a company to file a registrar statement with the SEC and later sell stock increments is a shelf registration.
The general level of interest rates moving up will cause investors to require a higher rate of return, which will result in a decline in stock prices.
If competition in an industry increases, future growth prospects will decrease.
The zero growth dividend valuation model assumes that firm's future dividends will remain constant leading to a constant firm value.

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Description

This quiz covers the fundamental characteristics of common stock, including its valuation and issuance. Learn about stockholder rights, market versus book value, and the implications of stock splits. Prepare to deepen your understanding of common stock as a long-term financing option.