CH8

Question 1

What does common stock represent?

Answer 1

Ownership in a company with voting rights and claim to future earnings.

Question 2

Who has control in a corporation?

Answer 2

Shareholders → Elect board of Directors → Appoint Managers.

Question 3

What is the principal-agent problem?

Answer 3

Managers may act in their own interest instead of maximizing shareholder value.

Question 4

What is a proxy fight?

Answer 4

A battle where an outside group tries to take control by getting shareholders’ votes.

Question 5

What are dual-class shares?

Answer 5

Some stocks have more voting power (super-voting) or none at all (restricted voting).

Question 6

What is the preemptive right? Corporate finance

Answer 6

The right to buy new shares before outsiders to prevent dilution.

Question 7

What is preferred stock?

Answer 7

A hybrid security that pays fixed dividends but lacks voting rights.

Question 8

Why do some firms use dual-class shares?

Answer 8

To allow founders or insiders to retain control over the company.

Question 9

What are the main stock types?

Answer 9

Common stock: Voting, dividends vary. Preferred stock: No voting, fixed dividends.

Question 10

Why might investors prefer growth stocks?

Answer 10

High potential price increase, reinvested earnings, minimal dividends.

Question 11

What determines a stock’s intrinsic value?

Answer 11

The present value of expected future cash flows (dividends, price appreciation).

Question 12

What does the Dividend Discount Model (DDM) assume?

Answer 12

That stock price = present value of future dividends.

Question 13

What’s the intrinsic value formula for constant growth stocks? DDM

Answer 13

P0 = D1 / (rs - g)

Question 14

What happens if the growth rate (g) is greater than required return (r_s)? On the DDM formula

Answer 14

The DDM breaks down (infinite stock price).

Question 15

What is the relationship between stock price and required return?

Answer 15

Higher rs → Lower stock price, and vice versa.

Question 16

What is the Free Cash Flow (FCF) method used for?

Answer 16

Valuing firms that do not pay dividends by estimating total firm value.

Question 17

What is the formula for firm value using FCF?

Answer 17

V = ∑ (FCFt / (1+WACC)^t)

Question 18

How do we find stock price from firm value?

Answer 18

Stock Price = (Firm Value - Debt) ÷ Shares Outstanding

Question 19

What is Market Multiple Valuation?

Answer 19

Comparing stock value using industry averages (P/E, EV/EBITDA, etc.).

Question 20

What’s a major weakness of market multiple valuation?

Answer 20

Hard to find perfect comparable firms, as ratios can vary widely.

Question 21

What is a dividend yield?

Answer 21

Dividend Yield = D1 / P0 (How much dividend income a stock pays relative to price).

Question 22

What is a capital gains yield?

Answer 22

Capital Gains Yield = (P1 - P0) / P0 (Stock price increase percentage).

Question 23

What is total expected return?

Answer 23

Total Return = Dividend Yield + Capital Gains Yield

Question 24

What happens to stock price if dividends increase?

Answer 24

Stock price rises, assuming all else stays constant.

Question 25

What type of stock pays little to no dividends?

Answer 25

Growth stocks (e.g., Amazon, Tesla).

Question 26

What’s the key difference between common and preferred stock?

Answer 26

Common stock: Voting rights, dividends vary. Preferred stock: No voting, fixed dividends.

Question 27

What is the formula for preferred stock valuation?

Answer 27

P0 = D / r (Like a perpetuity).

Question 28

Why are preferred stocks considered “hybrids”?

Answer 28

Like bonds: Fixed payments. Like stocks: No maturity date.

Question 29

Can a company delay preferred stock dividends?

Answer 29

Yes, but they must be paid before common stock dividends.

Question 30

Do preferred stocks get voting rights?

Answer 30

No, unless specified in special cases.

Question 31

What does the Efficient Market Hypothesis (EMH) state?

Answer 31

Stock prices instantly reflect all available information.

Question 32

What are the three forms of EMH?

Answer 32

Weak: Past prices don’t predict future. Semi-strong: All public info is priced in. Strong: Even insider info is priced in.

Question 33

What does EMH say about “beating the market”?

Answer 33

It’s impossible without insider information.

Question 34

What type of investing does EMH support?

Answer 34

Index funds & passive investing (because active trading doesn’t work long-term).

Question 35

Why do some investors reject EMH?

Answer 35

Markets can be irrational (bubbles, crashes).

Question 36

A stock just paid a $2 dividend, expects 5% growth, and has a required return of 10%. What is its price?

Answer 36

P0 = 2.10 / (0.10 - 0.05) = 42

Question 37

A stock's P/E ratio is 20 and its EPS is $3. What is its stock price?

Answer 37

P = P/E × EPS = 20 × 3 = 60

Question 38

What happens to the stock price if required return rises?

Answer 38

Stock price drops, as higher returns make it less attractive.

Question 39

A stock has a total expected return of 12%, dividend yield of 4%. What is the capital gains yield?

Answer 39

8% (Total return = Dividend Yield + Capital Gains Yield → 12% - 4%)

Question 40

What is the value of a preferred stock that pays a $5 dividend and has a required return of 8%?

Answer 40

P0 = 5 / 0.08 = 62.50

Question 41

Why are index funds popular?

Answer 41

They track the market without needing to “beat” it.

Question 42

How does the market react to new public information?

Answer 42

Prices adjust instantly (Semi-Strong EMH).

Question 43

What kind of stocks do risk-averse investors prefer?

Answer 43

Dividend stocks (stable returns, lower risk).

Question 44

What kind of stocks do risk-tolerant investors prefer?

Answer 44

Growth stocks (higher risk, higher return).

Question 45

What does a high P/E ratio indicate?

Answer 45

Investors expect strong future growth.

Question 46

What is a stock buyback?

Answer 46

A company repurchases its own shares, reducing supply & increasing price.

Question 47

What causes stock price bubbles?

Answer 47

Irrational speculation and overconfidence.

Question 48

What does it mean when a stock is “undervalued”?

Answer 48

Its intrinsic value > market price → Buy signal!

Question 49

What does it mean when a stock is “overvalued”?

Answer 49

Its intrinsic value < market price → Sell signal!

Question 50

Why are high-growth companies often unprofitable?

Answer 50

They reinvest earnings instead of paying dividends.

Question 51

for the firm value formula, the free cashflow that you put on top is it year 0? or year1?

Answer 51

year 1. if we are given the current free cashflow then we need to grow it to the next period and then use the growing perpetuity formula