Multiple choice questions on return on dividends, bond valuation and WACC.
1. An issue of preferred stock is paying an annual dividend of $5. The growth rate for the firm's common stock is 14%. What is the preferred stock price if the required rate of return is 11%?
a. $45.45
b. $41.67
c. $35.71
d. none of the above
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Preferred Dividend
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$5
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Required Rate of Return on Preferred Stock
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11%
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Price of Preferred Stock
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$45.45
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2. Valuation of financial assets requires knowledge of
a. future cash flows.
b. appropriate discount rate.
c. past asset performance.
d. a and b
3. The weighted average cost of capital is used as a discount rate because
a. it is an indication of how much the firm is earning overall.
b. as long as the cost of capital is earned, the common stock value of the firm will be maintained.
c. it is comparable to the prevailing market interest rates.
d. returns below the cost of capital will cover all fixed costs associated with capital and provide an excess return to stockholders.
4. If a firm's bonds are currently yielding 8% in the marketplace, why would the firm's cost of debt be lower?
a. Interest rates have changed.
b. Additional debt can be issued more cheaply than the original debt.
c. There should be no difference; cost of debt is the same as the bond's market yield.
d. Interest is tax-deductible.
5. Although debt financing is usually the cheapest component of capital, it cannot be used to excess because
a. interest rates may change.
b. the firm's stock price will increase and raise the cost of equity financing.
c. the financial risk of the firm may increase and thus drive up the cost of all sources of financing.
d. underwriting costs may change.
6. Prices of existing bonds move _________ as market interest rates move _________.
a. down, down
b. up, up
c. up, down
d. Bond prices don't move as market interest rates move.
7. Which of the following best represents the hierarchy of creditor and stockholder claims?
a. Common stock, senior secured debt, subordinated debentures
b. Senior debentures, subordinated debentures, junior secured debt
c. Senior secured debt, subordinated debentures, common stock
d. Preferred stock, secured debt, debentures.
8. If a preferred stock is of the cumulative type
a. dividends must be paid on an equal basis with common so long earnings permit.
b. dividends cannot be passed if they are earned.
c. the cumulative voting rule applies in the exercise of the voting privilege.
d. unpaid dividends of one period must be carried forward and paid in subsequent periods before anything can be paid to common stockholders.
9. Kuhns Corp. has 200,000 shares of preferred stock outstanding that is cumulative. The dividend is $6.50 per share and has not been paid for 3 years. If Kuhns earned $3 million this year, what could be the maximum payment to the preferred stockholders on a per share basis?
a. $19.50 per share
b. $15.00 per share
c. $13.00 per share
d. $6.50 per share
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Number of shares of Preferred Stock
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200000
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Dividend per annum
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$6.50
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Preferred Dividend per annum
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$1,300,000
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Earnings
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$3,000,000
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Number of years for which Preferred dividend
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can be paid
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2.31
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Therefore dividends can be paid only for 2 years.
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Dividend per share that can be paid
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$13.00
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