Finance Chapter 9 – Flashcards
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Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT
answer
If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's
Statement a is true, because if the required return for Stock A is higher than that of Stock B, and if the dividend yield for Stock A is lower than Stock B's, the growth rate for Stock A must be higher to offset this.
question
Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
X
Y
Price
$30
$30
Expected growth (constant)
6%
4%
Required return
12%
10%
answer
One year from now, Stock X's price is expected to be higher than Stock Y's price
The correct answer is statement c. Both prices are currently the same, but X's price should grow at 6% vs. 4% for Y, so X's price should be higher a year from now.
question
Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
A
B
Beta
1.10
0.90
Constant growth rate
answer
Stock A must have a higher dividend yield than Stock B.
Statement b is true, because Stock A has a higher required return but the stocks have the same growth rate, so Stock A must have the higher dividend yield. Here are some calculations to demonstrate the point.
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The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities.
answer
t
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The corporate valuation model can be used only when a company doesn't pay dividends.
answer
f
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Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the firm's total corporate value.
answer
t
question
From an investor's perspective, a firm's preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer's standpoint, these risk relationships are reversed: bonds are the most risky for the firm, preferred is next, and common is least risky.
answer
t
