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AHIP Business Finance Exam 2 Notes (Chapter 7) Questions and Correct Answers
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AHIP Business Finance Exam 2 Notes (Chapter7) Questions and Correct Answers
The cash flows from owning a share of stock come in the form of...
✓ ~~~ future dividends.
As the owner of shares of common stock in a corporation, you have various rights,
including:
✓ ~~~ the right to vote to elect corporate directors.
Voting in corporate elections can be either:
✓ ~~~ 1. Cumulative
2. Straight
Most voting is done by...
✓ ~~~ proxy.
Proxy battles...
✓ ~~~ break out when competing sides try to gain enough votes to have their
candidates for the board elected.
Someone seeks after a bunch of investors' proxy votes so they can take control of
the project
,In addition to common stock, some corporations have issued...
✓ ~~~ preferred stock.
Preferred stockholders must...
✓ ~~~ be paid first, before common stockholders can receive anything.
Preferred stock has a...
✓ ~~~ fixed dividend.
The two biggest stock markets in the United States
✓ ~~~ NYSE
NASDAQ
Why does the value of a share of stock depend on dividends?
✓ ~~~ The value of any investment depends on its cash flows; i.e., what investors will
actually receive. The
cash flows from a share of stock are the dividends.
A substantial percentage of the companies listed on the NYSE and the NASDAQ
don't pay dividends, but investors are nonetheless willing to buy shares in them. How
is this possible given your answer to the previous question?
✓ ~~~ Investors believe the company will eventually start paying dividends (or be sold
to another company).
, Referring to the previous questions, under what circumstances might a company
choose not to pay dividends?
✓ ~~~ In general, companies that need the cash will often forgo dividends since
dividends are a cash expense. Young, growing companies with profitable investment
opportunities are one example; another example is a company in financial distress.
This question is examined in depth in a later chapter.
Under what two assumptions can we use the dividend growth model presented in the
chapter to determine the value of a share of stock? Comment on the reasonableness
of these assumptions.
✓ ~~~ The general method for valuing a share of stock is to find the present value of
all expected future dividends. The dividend growth model presented in the text is
only valid (i) if dividends are expected to occur forever; that is, the stock provides
dividends in perpetuity, and (ii) if a constant growth rate of dividends occurs forever.
A violation of the first assumption might be a company that is expected to cease
operations and dissolve itself some finite number of years from now. The stock of
such a company would be valued by the methods of this chapter by applying the
general method of valuation. A violation of the second assumption might be a start-
up firm that isn't currently paying any dividends, but is expected to eventually start
making dividend payments some number of years from now. This stock would also
be valued by the general dividend valuation method of this chapter.
Suppose a company has a preferred stock issue and a common stock issue. Both
have just paid a $2 dividend. Which do you think will have a higher price, a share of
the preferred or a share of the common?
✓ ~~~ The common stock probably has a higher price because the dividend can grow,
whereas it is fixed on the preferred. However, the preferred is less risky because of
the dividend and liquidation preference, so it is possible the preferred could be worth
more, depending on the circumstances.
Based on the dividend growth model, what are the two components of the total
return on a share of stock? Which do you think is typically larger?
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