chapter 7

Question 1

if you own a share of stock, you can receive cash in 2 ways

Answer 1

• company pays dividends
• you sell your shares, either to another investor in the market or back to the company

Question 2

price of stock is

Answer 2

PV of expected cash flows/dividends

Question 3

dividends leads to _____, while selling leads to _______

Answer 3

cash income, capital gains

Question 4

special circumstances for estimating stock value

Answer 4

1. dividend zero growth rate
2. dividend constant growth rate
3. dividend grows at non-constant rate

Question 5

zero growth dividend

Answer 5

firm pays constant forever, price is computed using perpetuity formula

Question 6

constant dividend growth

Answer 6

firm will increase dividend by constant percent every period

Question 7

supernormal dividend growth

Answer 7

not consistent initially, but settles down to constant growth

Question 8

zero growth dividend can be viewed as a

Answer 8

perpetuity

Question 9

Po =

Answer 9

D / R

Question 10

Do

Answer 10

dividend just paid

Question 11

Dt =

Answer 11

D(zero) * (1+g)^t

Question 12

dividend growth model can be used to

Answer 12

get stock price at any point in time

Question 13

dividend growth model =

Answer 13

D(t+1) / (R - g)

Question 14

constant growth model conditions

Answer 14

1. dividend expected to grow at g forever
2. stock price expected to grow at g forever
3. expected dividend yield is constant
4. expected capital gains yield is constant and equal to g
5. expected total return, R, must be > g

Question 15

dividend yield =

Answer 15

stock’s expected cash dividend / current price

Question 16

capital gains yield

Answer 16

dividend growth rate, or the rate at which the value of an investment grows

Question 17

for stocks that don’t pay dividends, we can value them using

Answer 17

price-earnings or price-sales ratio

Question 18

price at time =

Answer 18

benchmark PE ratio * earnings per share
OR
benchmark price-sales ratio * sales per share

Question 19

features of common stock: voting rights

Answer 19

• stockholders elect directors
• cumulative voting vs straight voting
• boards are often staggered
• proxy voting

Question 20

classes of common stock

Answer 20

founders shares, class A and class B shares

Question 21

cumulative voting

Answer 21

permits minority participation, a shareholder may cast all votes for one member of BoD

Question 22

straight voting

Answer 22

shareholder may cast all votes for each member of the BoD

Question 23

staggering boards 2 effects

Answer 23

• makes it more difficult for a minority shareholder to elect a director when there is cumulative voting
• makes takeover attempts less likely to be successful b/c it makes it more difficult to vote in a majority of new directors

Question 24

proxy voting

Answer 24

grant of authority by a shareholder to someone else to vote their shares

Question 25

other shareholder rights of common stock

Answer 25

- right to share proportionally in dividends paid - right to share proportionally in assets remaining after liabilities have been paid in a liquidation - the right to vote on stockholder matters of great importance - preemptive right

Question 26

preemptive right

Answer 26

a company that wishes to sell stock must first offer it to the existing shareholders before the general public

Question 27

dividends

Answer 27

paid to shareholders, represent return on capital contributed

Question 28

T/F: a firm can go bankrupt for not declaring dividends

Answer 28

false

Question 29

dividends and taxes

Answer 29

- not tax deductible for firm - taxed as ordinary income for individuals

Question 30

what dividends must be paid before dividends can be paid to common stockholders

Answer 30

preferred stock

Question 31

preferred stock features

Answer 31

- not a liability of the firm - can be deferred indefinitely - most preferred dividends are cumulative - generally does not carry voting rights

Question 32

primary vs secondary markets

Answer 32

primary is new issue market, secondary is existing shares traded among investors

Question 33

dealer

Answer 33

maintains an inventory and stands ready to buy or sell at any time

Question 34

broker

Answer 34

brings buyers and sellers together