Chapter 7 TB Flashcards
Unlike creditors, equity-holders are owners of the firm.
T or F?
TRUE
Unlike equity-holders, creditors are owners of the firm.
T or F?
FALSE
Unlike creditors, equity-holders are owners of the firm.
Holders of equity have claims on both income and assets that are secondary to the claims of creditors.
T or F?
TRUE
The tax deductibility of interest lowers the cost of debt financing.
T or F?
TRUE
Interest paid to bondholders is tax deductible.
T or F?
TRUE
Dividends paid to stockholders are tax deductible.
T or F?
FALSE
Which of the following is an advantage for a firm to issue common stock over long-term debt?
A) the cost of equity financing being less than the cost of debt financing
B) the primary claim of equityholders on income and assets in the event of liquidation
C) no maturity date on which the par value of the issue must be repaid
D) the tax deductibility of dividends which lowers the cost of equity financing
C
Which of the following is a difference between common stock and bonds?
A) Bondholders have a voice in management; common stockholders do not.
B) Bondholders have a senior claim on assets and income relative to stockholders.
C) Stocks have a stated maturity but bonds do not.
D) Dividend paid to stockholders is tax-deductible but interest paid to bondholders are not.
B
Holders of equity capital ________.
A) own the firm
B) receive interest payments
C) receive guaranteed income
D) have loaned money to the firm
A
Because equityholders are the last to receive any distribution of assets as a result of bankruptcy proceedings, they expect ________.
A) fixed dividend payments
B) greater returns from their investment than the return that bondholders expect
C) all profits to be paid out in dividends
D) warrants to be attached to the stock issue
B
If bankruptcy were to occur, ________ would have the first claim on assets.
A) preferred stockholders
B) unsecured creditors
C) equity stockholders
D) secured creditors
D
The market value of common stock is related to its par value because both are sensitive to the reactions of investors to new information.
T or F?
FALSE
Common stockholders are often referred to as residual claimants.
T or F?
TRUE
Common stock can be either privately owned by private investors or publicly owned by public investors.
T or F?
TRUE
The market value of common stock is completely unrelated to its par value.
T or F?
TRUE
The par value on a common stock is used as a basis for determining its fixed dividend.
T or F?
FALSE
The number of authorized shares of common stock is always greater than or equal to the number of outstanding shares of common stock.
T or F?
TRUE
The number of outstanding shares of common stock is always greater than or equal to the number of authorized shares of common stock.
T or F?
FALSE
Super-voting shares of common stock provide shareholders with more votes per share compared with ordinary shares of common stock.
T or F?
TRUE
Most investors pay taxes on dividends at the same rate at which their ordinary income is taxed.
T or F?
FALSE
Treasury stocks held within the corporation do not have voting rights but have a claim on assets in liquidation.
T or F?
FALSE
Regarding the tax treatment of payments to securities holders, it is true that ________.
A) interest and preferred stock dividends are not tax-deductible ,while common stock dividends are tax deductible
B) interest and preferred stock dividends are tax-deductible, while common stock dividends are not tax-deductible
C) common stock dividends and preferred stock dividends are tax-deductible, while interest is not tax-deductible
D) common stock dividends and preferred stock dividends are not tax-deductible, while interest is usually tax-deductible
D
Which of the following is true of outstanding shares?
A) A firm cannot sell more shares than the outstanding shares mentioned in the charter.
B) Authorized shares become outstanding shares when they are issued or sold to investors.
C) Outstanding shares are indicated in a firm’s corporate charter.
D) Outstanding shares are the shares repurchased by the firm.
B
Shares of stock currently owned by a firm’s shareholders are called ________.
A) authorized shares
B) issued shares
C) outstanding shares
D) treasury shares
C
If a firm has class A and class B common stock outstanding, it usually means that ________.
A) each class receives a different dividend
B) the par value of each class is different
C) the dividend paid to one of the classes is tax deductible by the corporation
D) the classes have different voting rights
D
Common stockholders expect to earn a return by receiving ________.
A) semiannual interest
B) fixed periodic payments
C) dividends
D) annual interest
C
The purpose of nonvoting common stock is to ________.
A) limit the voting power of the management
B) allow the minority interest to elect one director
C) raise capital without giving up any voting control
D) give preference on distribution of earnings to those shareholders who own the stock
C
A proxy statement gives shareholders the right ________.
A) of one vote for each share owned
B) to give up their vote to another party
C) to maintain their proportionate ownership in the corporation when new common stock is issued
D) to sell their share of stock at a premium
B
A proxy battle is the attempt by ________.
A) the creditors of a bankrupt corporation to seize assets of the corporation
B) the management to dismiss the board of directors for their incapability to manage the operations
C) a nonmanagement group to unseat the existing management and gain control of the firm
D) the employees to form trade unions to influence decisions on behalf of members
C
The attempt by a nonmanagement group to gain control of the management of a firm by soliciting a sufficient number of proxy votes is called a ________.
A) hostile takeover
B) bankruptcy proceeding
C) proxy battle
D) management buyout
C
In a ________, new shares are sold to the existing shareholders.
A) private placement
B) public offering
C) rights offering
D) direct placement
C
Treasury stock refers to the ________.
A) sale of stock at a price greater than the par value
B) stock issued by the US government
C) repurchase of outstanding stock
D) authorization of additional shares of stock by the board of directors
C
Which of the following is true of the issuance of nonvoting common stock?
A) It is issued in the event of a hostile takeover to preserve the interests of existing owners.
B) It helps the corporation to raise capital through the sale of common stock, without giving up its voting control.
C) It helps the existing stockholders to automatically transfer their voting rights to new stockholders without any legal proceeding.
D) It tends to result in the dilution of voting rights of current stockholders.
B
Which of the following is true of par value of a common stock?
A) It is determined on the basis of the stock’s market value.
B) It is an arbitrary value established for legal purposes in a firm’s corporate charter.
C) It indicates the market value at which the stock was originally sold.
D) It allows stockholders to purchase additional shares at a price below the market price.
B
________ allows stockholders to purchase additional shares at a price below the market price, in direct proportion to their number of owned shares.
A) A rights offering
B) Treasury stock
C) Preemptive rights
D) Proxy statements
A
Which of the following is true of a common stock?
A) It gives voting rights which permit determination of the amount of dividend receivable.
B) It gives claims on income and assets which are superior to the claims of creditors of the firm.
C) Dividends on common stock are fully tax-deductible.
D) There is no fixed dividend payment obligation for the company.
D
Stock rights provide the stockholder with ________.
A) the right to purchase additional shares in direct proportion to their number of owned shares
B) the right to elect the board of directors
C) cumulative voting privileges over the preference stockholders
D) the opportunity to receive extraordinary earnings
A
The preemptive right gives shareholders the right ________.
A) to caste one vote for each share owned at the annual meeting of the company
B) to give up their vote to another party if they do not attend the annual meeting
C) to maintain their proportionate ownership in the corporation when new common stock is issued
D) to sell their share of stock at a premium in the event of liquidation
C
Preferred stock is a special form of stock having a fixed periodic dividend that must be paid prior to payment of any interest to outstanding bonds.
T or F?
FALSE
In the case of liquidation, bondholders are paid before preferred stockholders, who in turn are paid before common stockholders.
T or F?
TRUE
In the case of liquidation, common stockholders are paid before preferred stockholders, who in turn are paid before bondholders.
T or F?
FALSE
Preferred stock has characteristics of debt since it provides a fixed periodic cash payment.
T or F?
TRUE
The amount of the claim of preferred stockholders in liquidation is normally equal to the market value of the preferred stock.
T or F?
FALSE
Cumulative preferred stocks are preferred stocks for which all passed (unpaid) dividends in arrears must be paid along with the current dividend prior to the payment of dividends to common stockholders.
T or F?
TRUE
Because preferred stock is a form of ownership and has no maturity date, its claims on income and assets are secondary to those of the firm’s creditors.
T or F?
TRUE
No-par preferred stock has no stated face value, but its annual dividend is stated as a percentage of the market value.
T or F?
FALSE
The market value of a preferred stock is not used to calculate dividend payments, but rather represents the value of the stock in the marketplace.
A preferred stockholder is sometimes referred to as a residual owner, since in essence he or she receives what is left—the residual—after all other claims on the firm’s income and assets have been satisfied.
T or F?
FALSE
An ordinary stockholder is sometimes referred to as a residual owner, since in essence he or she receives what is left—the residual—after all other claims on the firm’s income and assets have been satisfied.
A call feature is a feature that allows preferred stockholders to change each share into a stated number of shares of common stock.
T or F?
FALSE
A conversion feature is a feature that allows preferred stockholders to change each share into a stated number of shares of common stock.
Although preferred stock provides added financial leverage in much the same way as bonds, it differs from bonds in that the issuer can pass a dividend payment without suffering the consequences that result when an interest payment is missed on a bond.
T or F?
TRUE
Preferred stockholders are often referred to as residual claimants.
T or F?
FALSE
Common stockholders are often referred to as residual claimants.
Which of the following typically applies to common stock but not to preferred stock?
A) par value
B) dividend yield
C) legally considered as equity in the firm
D) voting rights
D
Which of the following is true of common stocks?
A) The common stock of a corporation can be either privately or publicly owned.
B) Firms often issue common stock with no par value.
C) Preemptive rights often result in a dilution of ownership.
D) A firm’s corporate charter indicates the rate at which dividends are paid.
A
Which of the following is true of equity?
A) equityholders do not have voting rights.
B) It does not mature, so repayment is not required.
C) It is a temporary form of financing for a firm.
D) Equity financing is obtained from creditors.
B
Equity capital can be raised through ________.
A) the money market
B) the NYSE bond market
C) the stock market
D) a private placement with an insurance company
C
Common stockholders are sometimes referred to as ________.
A) non preemptive right holders
B) managers
C) creditors
D) residual owners
D
Which of the following is true of common stock?
A) It is often considered quasi-debt due to fixed payment obligation.
B) It pays a fixed dividend.
C) It gives the holder voting rights which permit selection of the firm’s directors.
D) Its holders have priority over preferred stockholders in the event of liquidation of assets.
C
A proxy statement is a statement transferring ________.
A) the ownership of a bondholder to another party
B) the votes of a bondholder to the another party
C) the votes of a stockholder to another party
D) the ownership of a stockholder to another party
C
Which of the following is typically a feature of common stock?
A) Most common stocks are callable.
B) Most common stocks are cumulative.
C) Common stocks have a maturity value.
D) Common stocks may or may not pay dividends.
D
The claims of the equity-holders on a firm’s assets have priority over the claims of creditors because the equity-holders are the owners of the firm.
T or F?
FALSE
Preemptive rights allow common stockholders to maintain their proportionate ownership in the corporation when when the firm sells new shares of stock.
T or F?
TRUE
Stock rights allow stockholders to purchase additional shares of stock in direct proportion to the number of shares they own.
T or F?
TRUE
A common stockholder has no guarantee of receiving any cash inflows, but receives what is left after all other claims on the firm’s income and assets have been satisfied.
T or F?
TRUE
Preemptive rights allow existing shareholders to maintain voting control and protect themselves against the dilution of their ownership.
T or F?
TRUE
Treasury stock generally does not have voting rights, does not earn dividends, and does not have a claim on assets in liquidation.
T or F?
TRUE
Treasury stock is generally reclassified as class B common stock and has voting rights.
T or F?
FALSE
Dilution of ownership occurs when a new stock issue results in each present stockholder having a larger number of shares and, thus, a claim to a larger part of the firm’s earnings than previously.
T or F?
FALSE
ADRs are ________.
A) securities, backed by American depositary shares (ADSs), that permit U.S. investors to hold shares of non-U.S. companies and trade them in U.S. markets
B) securities, backed by Securities Exchange Commission (SEC), that permit all investors to hold shares of U.S. companies and trade them in U.S. markets
C) securities, backed by American depositary shares (ADSs), that permit non-U.S. investors to hold shares of U.S. companies and trade them in U.S. markets
D) securities, backed by Securities Exchange Commission (SEC), that permit U.S. investors to hold shares of non-U.S. companies and trade them in international markets
A
________ are promised a fixed periodic dividend that must be paid prior to paying any common stock dividends.
A) Preferred stockholders
B) Common stockholders
C) Bondholders
D) Creditors
A
Dividends in arrears that must be paid to the preferred stockholders before payment of dividends to common stockholders are ________.
A) cumulative
B) nonparticipating
C) participating
D) convertible
A
From a corporation’s point of view, a disadvantage of issuing preferred stock is ________.
A) that it increases financial leverage
B) that it has to give fixed payments as well as voting rights to the holders
C) its excellent merger security
D) that the dividends are not tax-deductible
D
Which of the following is a disadvantage of issuing preferred stock from the common stockholders’ perspective?
A) There is a seniority of preferred stockholder’s claim over common stockholders.
B) The preferred stockholders have superior voting rights in the selection of board of directors.
C) The preferred stockholders are always paid a higher proportion of dividend payments.
D) Issuance of preferred stocks will result in a higher risk, to the disadvantage of common stockholders.
A
The risk cost of preferred stock is ________.
A) lower than the cost of long-term debt
B) higher than the cost of common stock
C) higher than the cost of long-term debt and lower than the cost of common stock
D) lower than the cost of convertible long-term debt and higher than the cost of common stock
C
Preferred stock is characterized by ________.
A) voting rights
B) maturity date
C) quasi-debt nature
D) preemptive rights
C
A violation of preferred stock restrictive covenants usually permits preferred shareholders to ________.
A) force the company into bankruptcy
B) suit against the shareholders
C) force the retirement of the preferred stock at or above its par value
D) force the company to repurchase the shares at a stated amount below par
C
Which of the following is true of preferred stocks?
A) Preferred stock with a conversion feature allows holders to change each share into a stated number of shares of common stock.
B) Like bonds, preferred stocks are due for payment on a fixed maturity date along with interest.
C) Restrictive covenants of preferred stocks include provisions about listing of stocks on the securities exchange and determining the price of stock.
D) A firm’s bond indenture indicates how many authorized preferred shares and bonds it can issue.
A
Preferred stockholders ________.
A) do not have preference over common stockholders in the case of liquidation
B) have preference over bondholders in the case of liquidation
C) do not have preference over bondholders in the case of liquidation
D) have preference over creditors in the case of liquidation
C
Which of the following is usually a right of a preferred stockholder?
A) right to convert shares to common stock on demand
B) preemptive right to participate in the issuance of new common shares
C) right to receive dividend payments before any dividends are paid to common stockholders
D) right to sue company in bankruptcy proceedings if promised preferred dividends are not paid
C
Which of the following is typically a feature of preferred stocks?
A) They are settled prior to common stocks during liquidation.
B) They are mostly noncumulative in nature.
C) They are paid dividends that grow at a constant rate.
D) They carry voting rights and have maturity date.
A
Source of financing which places minimum constraints on the firm
CS or PS?
CS
Used by young firms receiving investment funds from venture capital firms
CS or PS?
PS
Potential dilution of earnings and voting power
CS or PS?
CS
Fixed financial obligation
CS or PS?
PS
Increases the firm’s borrowing power
CS or PS?
CS
May have cumulative and participating features
CS or PS?
PS
May be convertible into another type of security
CS or PS?
PS
Last to receive earnings or distribution of assets in the event of bankruptcy
CS or PS?
CS
Frequently includes a call feature
CS or PS?
PS
Which of the following is true of securities analysts?
A) They raise initial external equity finance privately for firms.
B) They are primarily involved in underwriting of securities.
C) They find prospective buyers for new stocks or bonds issue.
D) They use a variety of models and techniques to value stocks.
D
Investors purchase a stock when they believe that it is undervalued and sell when they feel that it is overvalued.
T or F?
TRUE
In an efficient market, the expected return and the required return are equal.
T or F?
TRUE
In an efficient market, stock prices adjust quickly to new public information.
T or F?
TRUE
In an inefficient market, stock prices adjust quickly to new public information.
T or F?
FALSE
In an efficient market, stock prices adjust quickly to new public information.
In an inefficient market, securities are typically in equilibrium, which means that they are fairly priced and that their expected returns equal their required returns.
T or F?
FALSE
In an efficient market, securities are typically in equilibrium, which means that they are fairly priced and that their expected returns equal their required returns.
In an efficient market, securities are typically in equilibrium, which means that they are fairly priced and that their expected returns equal their required returns.
T or F?
TRUE
To a buyer, an asset’s value represents the minimum price that he or she would pay to acquire it.
T or F?
FALSE
If the expected return is less than the required return, investors will sell the asset, because it is not expected to earn a return commensurate with its risk.
T or F?
TRUE
If the expected return were above the required return, investors would buy an asset, driving its price up and its expected return down.
T or F?
TRUE
Efficient-market hypothesis is the theory describing the behavior of a market in which securities are typically in equilibrium, security prices fully reflect all public information available and react swiftly to new information, and, because stocks are fairly priced, investors need not waste time looking for mispriced securities.
T or F?
TRUE
If a market is truly efficient, investors should not waste their time trying to find and capitalize on mispriced securities.
T or F?
TRUE
Behavioral finance is a growing body of research that anomalies that are not consistent with the efficient markets theory.
T or F?
TRUE
The constant growth model is an approach to dividend valuation that assumes a constant future dividend.
T or F?
FALSE
The constant growth model is an approach to dividend valuation that assumes that dividends grow at a constant rate indefinitely.
T or F?
TRUE
Rational buyers and sellers use their assessment of an asset’s risk and return to determine its value. Relative to this concept, which of the following is true?
A) To a buyer the asset’s value represents the minimum price that he or she would pay to acquire it.
B) To a seller the asset’s value represents the maximum sale price.
C) To a buyer the asset’s value represents the maximum price that he or she would pay to acquire it.
D) To a seller the asset’s value represents the price at which he acquired the asset.
C
According to the efficient market hypothesis, prices of actively traded stocks ________.
A) can be under- or overvalued in an efficient market
B) can only be undervalued in an efficient market
C) do not differ from their true values in an efficient market
D) can only be overvalued in an efficient market
C
If an asset’s expected return is less than its required return, rational investors will ________.
A) buy the asset, which will drive the price up and cause expected return to reach the level of the required return
B) sell the asset, which will drive the price down and cause the expected return to reach the level of the required return
C) sell the asset, which will drive the price up and cause the expected return to reach the level of the required return
D) buy the asset, since price is expected to increase
B
If the expected return is above the required return on an asset, rational investors will ________.
A) buy the asset, which will drive the price up and cause expected return to reach the level of the required return
B) buy the asset, which will drive the price down and cause the expected return to reach the level of the required return
C) sell the asset, which will drive the price up and cause the expected return to reach the level of the required return
D) sell the asset, since price is expected to decrease
A
Which of the following is true of efficient-market hypothesis?
A) Securities are typically in disequilibrium, meaning they are fairly priced and their expected returns are more than their required returns.
B) Insider trading scandals have proven that stocks are not fully and fairly priced; as a result, it would be worthwhile for investors should spend time searching for mispriced (over- or undervalued) stocks.
C) At any point in time, security prices fully reflect all internal information available about the firm and its securities, and these prices are insensitive to new information.
D) Since stocks are fully and fairly priced, it follows that investors should not waste their time trying to find and capitalize on miss-priced (undervalued or overvalued) securities.
D
Preferred stock is valued as if it were a ________.
A) fixed-income obligation
B) bond
C) perpetuity
D) common stock
C
The ________ is utilized to value preferred stock.
A) capital asset pricing model
B) arbitrage pricing model
C) zero-growth model
D) Black-Scholes model
C
In the Gordon model, the value of a common stock is the ________.
A) net value of all assets which are liquidated for their exact accounting value
B) actual amount each common stockholder would expect to receive if the firm’s assets are sold
C) present value of a non-growing dividend stream
D) present value of a constant growing dividend stream
D
The free cash flow valuation model can be used to determine the value of an entire company as the present value of its expected free cash flows discounted at the firm’s weighted average cost of capital.
T or F?
TRUE
The free cash flow valuation model is based on the same principle as the P/E valuation approach; that is, the value of a share of stock is the present value of future cash flows.
T or F?
FALSE
The free cash flow valuation model is based on the same principle as dividend valuation models; that is, the value of a share of stock is the present value of future cash flows.
T or F?
TRUE
In valuation of common stock, the price/earnings multiple approach usually produces higher valuations than the book or liquidation values since it considers expected earnings.
T or F?
TRUE
The common stock book value model ignores a firm’s expected earnings potential and generally lacks any true relationship to the firm’s value in the marketplace.
T or F?
TRUE
The liquidation value per share of common stock is the amount per share of common stock that would be received if all of a firm’s assets were sold for their accounting value and the proceeds remaining were divided among common stockholders.
T or F?
FALSE
The book value per share of common stock is the amount per share of common stock that would be received if all of a firm’s assets were sold for their accounting value and the proceeds remaining were divided among common stockholders.
The book value per share of common stock is the amount per share of common stock that would be received if all of a firm’s assets were sold for their accounting value and the proceeds remaining were divided among common stockholders.
T or F?
TRUE
________ is the value of a firm’s ownership in the event that all assets are sold for their exact accounting value and the proceeds remaining after paying all liabilities (including preferred stock) are divided among common stockholders.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the common stock
B
________ is the actual amount each common stockholder would expect to receive if a firm’s assets are sold for their market value, creditors and preferred stockholders are repaid, and any remaining money is divided among the common stockholders.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the dividends
A
________ is a guide to a firm’s value if it is assumed that investors value the earnings of a given firm in the same way they do the average firm in the industry.
A) Liquidation value
B) Book value
C) The P/E multiple
D) The present value of the dividends
C
Which of the following valuation methods tends to value stocks more highly than the others in the list because it considers expected earnings?
A) liquidation value
B) book value
C) P/E multiple
D) present value of the interest
C
The use of the ________ is especially helpful in valuing firms that are not publicly traded.
A) liquidation value
B) book value
C) P/E multiple
D) present value of the dividends
C
Any action taken by a financial manager that increases risk will also increase the required return.
T or F?
TRUE
An action on the part of a firm that increases the level of expected cash flows without a corresponding increase in risk should reduce share value; an action that reduces the level of expected cash flows without a corresponding decline in risk should increase share value.
T or F?
FALSE
An action on the part of a firm that increases the level of expected cash flows without a corresponding increase in risk should increase share value; an action that reduces the level of expected cash flows without a corresponding decline in risk should decrease share value.
Assuming that economic conditions remain stable, any management action that would cause current and prospective stockholders to raise their dividend expectations should decrease a firm’s value.
T or F?
FALSE
The required return can be affected by changes in the risk free rate, even if the risk premium remains constant.
T or F?
TRUE
If the risk-free rate decreases due to a shift in government policy, the required return goes up.
T or F?
FALSE
