Common Stock

Question 1

Describe the limited liability of common stock.

Answer 1

Common shareholders’ liability is limited to their investment in a corporation.

Question 2

How is the theoretical value determined for a share of Common Stock (CSV) that is to be held for multiple periods?

Answer 2

CSV = Dividend in 1st year/(Investors’ Required Rate of Return - Dividend Growth Rate)
Note: Dividends are assumed to grow at a constant rate indefinitely.

Question 3

Identify the advantages of using common stock for long-term financing.

Answer 3

1. No legally required periodic payments (i.e., dividends)
2. No maturity date
3. No security required

Question 4

Identify the disadvantages of using common stock for long-term financing.

Answer 4

1. Higher cost of capital than other sources
2. Dividends paid are not tax deductible
3. Additional shares issued dilute ownership and earnings per share

Question 5

Describe the preemptive right of common stock.

Answer 5

The right of first refusal to acquire a proportionate share of any new common stock issued by a corporation.