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Unformatted text preview: Answers to End-of-Chapter Questions Q5-1. How is preferred stock different from common stock? A5-1. Common stock usually grants the investor to vote on important corporate decisions. Preferred stock does not. Preferred shareholders have a higher priority claim than common shareholders do because common shareholders cannot receive dividends unless all dividends owed to preferred stockholders have been paid. Both common and preferred stock have a lower priority claim than debt, however. Finally, preferred dividends are usually set at a fixed percentage of par value, while common dividends vary with the profitability of the company. Q5-3. Describe the role of the underwriting syndicate in a firm-commitment offering. A5-3. In a firm-commitment offering, the investment bank agrees to buy the securities from the issuing firm and resell them to investors. Because the investment bank takes possession of the securities, they bear some risk that the value of the securities can change. The underwriting syndicate shares responsibility for selling the issue. In general the syndicate tries to oversubscribe the issue. This should mean that the issue is easier to sell and that the risk to the investment banker of holding a security that is dropping in value is low. Q5-7. The value of common stocks cannot be tied to the present value of future dividends because most firms don’t pay dividends. Comment on the validity, or lack thereof, of this statement. A5-7. It is true that most stocks don’t pay dividends, and forecasting when those stocks will begin pay- ing dividends is very difficult, so in that sense the statement has some validity. However, the value of a stock depends not just on dividends, but on other forms of cash distributions such as share purchases and cash takeover payments. Regardless of what form a stock distributes its cash, investors must have some expectation that at some point the stock will distribute cash to in- vestors; otherwise the stock would have no value. Q5-10. The book value of a firm’s common equity is usually lower than the market value of the common stock. Why? Can you describe a situation in which the liquidation value of a firm’s equity might exceed its market value?...
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- Spring '08