Deck 17: Payout Policy

Question 1

Anyone who purchases the stock on or after the ________ date will not receive the dividend.

A)declaration
B)ex-dividend
C)record
D)distribution

Answer 1

ex-dividend

Question 2

A firm may announce its intention to buy its own shares in the open market like any other investor, also known as a(n)

A)open market repurchase.
B)off-market buyback.
C)selective buyback.
D)scale-back.

Answer 2

open market repurchase.

Question 3

Dividend payments that are the result of liquidation of assets are known as ________ and are taxed as capital gains.

A)private earnings
B)alternate payments
C)return of capital
D)rolling dividends

Answer 3

return of capital

Question 4

A one-time payment to shareholders that is much larger than a regular dividend is often referred to as a 'special dividend'.

Question 5

When a firm purchases shares directly from a major shareholder it is also known as a(n)

A)open market repurchase.
B)off-market buyback.
C)selective buyback.
D)scale-back.

Question 6

The date four business days prior to the date on which all shareholders of record receive a payment is called the ________ date.

A)declaration
B)record
C)ex-dividend
D)distribution

Question 7

Which of the following cash flow statements is FALSE?

A)From an accounting perspective, dividends generally reduce the firm's current (or accumulated)retained earnings.
B)Occasionally, a firm may pay a one-time, special dividend that is usually much larger than a regular dividend.
C)Most companies that pay dividends pay them semi-annually.
D)The way a firm chooses between paying dividends and retaining earnings is referred to as its 'payout policy'.

Question 8

When a firm offers to buy its shares at a pre-specified price during a short time period, it is also known as a(n)

A)open market repurchase.
B)off-market buyback.
C)selective buyback.
D)scale-back.

Question 9

The 'record date' is the date on which the board of directors of a company authorises the dividend.

Question 10

The 'distribution date' is the date on which a firm pays out dividends.

Question 11

A(n)________ is the most common way that firms repurchase shares.

A)open market repurchase
B)Dutch auction
C)selective buyback
D)off-market buyback

Question 12

The 'ex-dividend date' is three business days before the company's 'record date'.

Question 13

Another to method to repurchase shares is the ________, in which the firm lists different prices at which it is prepared to buy shares, and shareholders in turn indicate how many shares they are willing to sell at each price.

A)open market repurchase
B)selective buyback
C)equal access buyback
D)Dutch auction

Question 14

When a firm reduces the number of shares to be acquired under a buyback because there are more shares tendered than were sought to be repurchased, it is known as a(n)

A)open market repurchase.
B)off-market buyback.
C)selective buyback.
D)scale-back.

Question 15

The firm mails dividend cheques to the registered shareholders on the

A)ex-dividend date.
B)distribution date.
C)declaration date.
D)record date.

Question 16

A firm's payout policy outlines how that firm chooses between alternate uses of free cash flows.

Question 17

The firm will pay the dividend to all shareholders of record on a specific date, set by the board, called the ________ date.

A)declaration
B)record
C)ex-dividend
D)distribution

Question 18

An alternate way to pay investors is when the firm uses cash to buy its own shares, also known as

A)initial public offering.
B)share repurchases.
C)dividend investment.
D)retained earnings.

Question 19

Danroy Inc has announced a $5 dividend. If Danroy's last price while trading cum-dividend is $65, what should its first ex-dividend price be (assuming perfect capital markets)?

A)$75
B)$60
C)$65
D)$70

Question 20

A firm can repurchase shares through a(n)________ in which it offers to buy shares at a pre-specified price during a short time period-generally within 20 days.

A)equal access buyback
B)Dutch auction
C)open market repurchase
D)selective buyback

Question 21

The share price falls when a dividend is paid because the reduction in cash decreases the

A)equity of the firm.
B)current account of the firm.
C)market value of assets.
D)liabilities of the firm.

Question 22

A firm has $400 million of assets that includes $50 million of cash and 10 million shares outstanding. The firm uses $40 million of its cash to pay dividends. If an investor has 1 000 shares, how many shares must she sell to create a homemade dividend of $4 900?

A)35 shares
B)30 shares
C)25 shares
D)40 shares

Question 23

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that Vezuvo uses the entire $75 million in excess cash to pay a special dividend. The amount of the special dividend is closest to:

A)$6.00.
B)$7.00.
C)$7.50.
D)$6.50.

Question 24

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that Vezuvo uses the entire $75 million in excess cash to pay a special dividend. Vezuvo's ex-dividend price is closest to:

A)$75.00.
B)$40.00.
C)$45.00.
D)$50.00.

Question 25

The Modigliani-Miller dividend irrelevance proposition states that in perfect capital markets, holding ________ policy fixed, the firm's choice of dividend policy is irrelevant and does not affect the initial share price.

A)equity issuance
B)interest rate
C)debt
D)investment

Question 26

With perfect capital markets, an open market repurchase increases the share price as the number of outstanding shares is decreased.

Question 27

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Vezuvo's enterprise value is closest to:

A)$500 million.
B)$450 million.
C)$400 million.
D)$600 million.

Question 28

Suppose a firm does not pay a dividend but repurchases shares using $20 million of cash. The market value of the firm decreases by

A)-$20 million.
B)0.
C)$20 million.
D)cannot say for sure

Question 29

In a perfect capital market, when a dividend is paid, the share price drops by the amount of the dividend when the stock begins to trade ex-dividend.

Question 30

When a firm repurchases shares the supply of shares is ________ but at the same time the firm's assets ________.

A)reduced, decline
B)increased, increase
C)increased, decline
D)reduced, increase

Question 31

A firm has $300 million of assets that includes $50 million of cash and 10 million shares outstanding. The firm uses $30 million of its cash to pay dividends. If an investor has 1 000 shares, how many shares must he sell to create a homemade dividend of $3 900?

A)40.2 shares
B)33.3 shares
C)50.5 shares
D)60.3 shares

Question 32

A firm has $300 million of assets that includes $50 million of cash and 10 million shares outstanding. If the firm uses $30 million of its cash to repurchase shares, what is the new price per share?

A)$25
B)$32
C)$27
D)$30

Question 33

Which of the following statements is FALSE?

A)In perfect capital markets, holding fixed the investment policy of a firm, the firm's choice of dividend policy is irrelevant and does not affect the initial share price.
B)In perfect capital markets, investors are indifferent between the firm distributing funds via dividends or share repurchases. By reinvesting dividends or selling shares, they can replicate either payout method on their own.
C)In perfect capital markets, an open market share repurchase has no effect on the share price, and the share price is the same as the ex-dividend price if a dividend were paid instead.
D)In a perfect capital market, when a dividend is paid, the share price drops by the amount of the dividend when the share begins to trade ex-dividend.

Question 34

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that Vezuvo uses the entire $75 million in excess cash to pay a special dividend. The amount of the regular annual dividends in the future is closest to:

A)$5.00.
B)$9.00.
C)$6.00.
D)$7.50.

Question 35

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that Vezuvo uses the entire $75 million in excess cash to pay a special dividend. Vezuvo's cum-dividend price is closest to:

A)$55.00.
B)$57.50.
C)$40.00.
D)$47.50.

Question 36

'Homemade dividend' refers to the process by which an investor

A)can take on more debt.
B)reinvests dividend payments.
C)can sell shares to create a dividend policy to suit his preferences.
D)chooses between equity and debt.

Question 37

A firm has $400 million of assets that includes $50 million of cash and 10 million shares outstanding. If the firm uses $40 million of its cash to repurchase shares, what is the new price per share?

A)$42
B)$44
C)$38
D)$40

Question 38

A firm has $200 million of assets that includes $50 million of cash and 8 million shares outstanding. If the firm uses $20 million of its cash to repurchase shares, what is the new price per share?

A)$32
B)$27
C)$30
D)$25

Question 39

A firm has assets of $250 million, of which $25 million is cash. It has debt of $100 million. If the firm were to repurchase $10 million of its stock, what would its new debt-to-equity ratio be?

A)80%
B)20%
C)28.6%
D)71.4%

Question 40

A firm has $500 million of assets that includes $50 million of cash and 10 million shares outstanding. The firm uses $50 million of its cash to pay dividends. If an investor has 1 000 shares, how many shares must he sell to create a homemade dividend of $6 575?

A)30 shares
B)25 shares
C)35 shares
D)40 shares

Question 41

Australian firms often repurchase shares at a price that is ________ the market price of the shares at the time the buyback is announced.

A)proportionate to
B)lower than
C)greater than
D)equal to

Question 42

If dividends are taxed at a higher personal tax rate than capital gains, shareholders will generally prefer share repurchases to dividends.

Question 43

The system under which Australian companies pass on to their shareholders credit for corporate income taxes paid is called a

A)double tax system.
B)classical tax system.
C)dividend imputation system.
D)franking credit.

Question 44

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that Vezuvo uses the entire $75 million to repurchase shares. The number of shares that Vezuvo will have outstanding following the repurchase is closest to:

A)8.7 million.
B)9.0 million.
C)8.8 million.
D)9.2 million.

Question 45

What are the characteristics of special dividend?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Question 46

'Dividend imputation' allows the tax paid by the company issuing the dividends to offset personal taxes payable on the dividends.

Question 47

The optimal dividend policy when dividend tax rates exceed capital gains tax rates is to pay dividends only.

Question 48

What are the ways in which a firm can pay out its free cash flow?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Question 49

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
A firm has $75 million of assets that includes $12 million of cash and 25 million shares outstanding. If the firm uses $12 million of cash to repurchase shares, what is the new price per share?

A)$1
B)$2
C)$3
D)$4

Question 50

What is the effect on the share price when a firm repurchases its shares?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Question 51

What choices does a firm have in using its free cash flow?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Question 52

What are the different ways a firm can repurchase shares?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Question 53

Share repurchases have a tax advantage over dividends because

A)dividend payments are tax deductible.
B)the discount method may apply to tax only half of any capital gain made by long-term investors.
C)repurchases are associated with increased customer loyalty.
D)share repurchases increase the value of debt.

Question 54

What are the ways in which a firm can retain its free cash flow?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Question 55

What is the bird-in-the-hand fallacy in dividend theory under perfect capital markets?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Question 56

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that Vezuvo uses the entire $75 million to repurchase shares. The amount of the regular annual dividends in the future is closest to:

A)$5.75.
B)$5.00.
C)$9.00.
D)$7.50.

Question 57

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that you own 2 500 shares of Vezuvo stock and that Vezuvo uses the entire $75 million to repurchase shares. Suppose you are unhappy with Vezuvo's decision and would prefer that Vezuvo used the excess cash to pay a special dividend. The number of shares that you would have to sell in order to receive the same amount of cash as if Vezuvo paid the special dividend is closest to:

A)425.
B)310.
C)250.
D)325.

Question 58

Which of the following is NOT a method for a firm to payout excess cash to its shareholders?

A)pay a dividend with the excess cash
B)repurchase shares
C)issue new shares and pay a high dividend
D)issue new shares

Question 59

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that Vezuvo uses the entire $75 million to repurchase shares. The number of shares that Vezuvo will repurchase is closest to:

A)1.2 million.
B)1.9 million.
C)1.3 million.
D)1.1 million.

Question 60

Use the information for the question(s)below.
Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
Assume that you own 2 500 shares of Vezuvo stock and that Vezuvo uses the entire $75 million to pay a special dividend. Suppose you are unhappy with Vezuvo's decision and would prefer that Vezuvo used the excess cash to repurchase shares. The number of shares that you would have to buy in order to undo the special cash dividend that Vezuvo paid is closest to:

A)375.
B)425.
C)250.
D)275.

Question 61

In perfect capital markets, buying and selling securities is a zero-NPV transaction, so retaining cash versus paying it out does not affect firm value.

Question 62

When a firm has excessive cash, managers may make use of the funds in an inefficient manner. This is also referred to as the ________ cost of retaining cash.

A)interest
B)fixed
C)special
D)agency

Question 63

Palomino Enterprises has $100 000 in cash. They wish to invest the money in Treasury bonds at 6% and use the returns to pay dividends to shareholders after a year. Alternately, they can pay a dividend and allow shareholders to make the investment. In perfect capital markets, which option will shareholders prefer?

A)immediate cash dividend
B)prefer half from each source
C)dividend after one year
D)indifferent between options

Question 64

Palomino Enterprises has $200 000 in cash. They wish to invest the money in Treasury bonds at 5% and use the returns to pay dividends to shareholders after a year. Alternately, they can pay a dividend and allow shareholders to make the investment. In perfect capital markets, which option will shareholders prefer?

A)prefer half from each source
B)immediate cash dividend
C)indifferent between options
D)dividend after one year

Question 65

Firms may retain large amounts of cash to cover future potential needs that allows a firm to avoid

A)clientele effects.
B)transaction costs and financial distress costs.
C)tax payments.
D)None of the above.

Question 66

Webster Holding Ltd is a company which owns a number of fashion brands. If Webster Holding makes a taxable profit of $1 000 000 in the 2016 financial year and chooses to pay 100% of its profit after tax as a dividend, how much tax is paid by shareholders, assuming their marginal tax rate is 45%? Assume the company tax rate is 30%.

A)$15 000
B)$450 000
C)$150 000
D)$300 000

Question 67

If an investor sells a share for more than they purchased the share for, the investor is subject to

A)capital gains tax.
B)income tax.
C)indexation tax.
D)franking tax.

Question 68

Prada has 10 million shares outstanding, generates free cash flows of $60 million each year and has a cost of capital of 10%. It also has $40 million of cash on hand. Prada wants to decide whether to repurchase shares or invest the cash in a project that generates free cash flows of $2 million each year. Should Prada invest or repurchase the shares?

A)repurchase
B)indifferent between options
C)invest
D)cannot say for sure

Question 69

The system of taxation of corporate profits in the United States is called a

A)double tax system.
B)classical tax system.
C)dividend imputation system.
D)franking credit system.

Question 70

Webster Holding Ltd is a company which owns a number of fashion brands. If Webster Holding makes a taxable profit of $1 000 000 in the 2016 financial year and the company tax rate is 30%, what is the maximum franking credit that can attach to a dividend paid from that profit?

A)$700 000
B)$1 000 000
C)$300 000
D)$0

Question 71

Palomino Enterprises has generated profits of $100 000 before tax. They wish to invest the money in Treasury bonds at 6% and use the returns to pay dividends to shareholders after a year. Alternately, they can pay a dividend and allow shareholders to make the investment. If corporate tax rates are 30%, which option will shareholders prefer? Assume a dividend imputation system applies.

A)indifferent between options
B)immediate cash dividend
C)dividend after one year
D)cannot determine

Question 72

Webster Holding Ltd is a company which owns a number of fashion brands. If Webster Holding makes a taxable profit of $1 000 000 in the 2016 financial year and chooses to pay 100% of its profit after tax as a dividend, how much is included in the shareholders' taxable income? Assume the company tax rate is 30%.

A)$300 000
B)$700 000
C)$1 000 000
D)$0

Question 73

Palomino Enterprises has generated profits of $300 000 before tax. They wish to invest the money in Treasury bonds at 8% and use the returns to pay dividends to shareholders after a year. Alternately, they can pay a dividend and allow shareholders to make the investment. If corporate tax rates are 30%, which option would be preferred by shareholders paying a marginal tax rate of 45%?

A)Immediate cash dividend
B)Dividend after one year
C)Indifferent between options
D)Cannot determine

Question 74

When a firm pays out a dividend, the share price ________, and when it conducts a share repurchase at the market price, the share price ________.

A)is unchanged, decreases
B)decreases, is unchanged
C)decreases, decreases
D)increases, increases

Question 75

According to the ________ theory of payout policy, managers pay out cash only when pressured to do so by investors.

A)price pressure
B)supply
C)agency
D)managerial entrenchment

Question 76

Use the information for the question(s)below.
Luther Industries has $5 million in excess cash and one million shares outstanding. Luther is considering investing the cash in one-year Treasury bonds that are currently paying 5% interest and then using the cash to pay a dividend next year. Alternatively, Luther can pay the cash out as a dividend immediately and the shareholders can invest in the Treasury bonds themselves. Assume that capital markets are perfect.
If Luther invests the excess cash in Treasury bonds, then the dividend per share next year will be closest to:

A)$4.75.
B)$5.25.
C)$5.00.
D)$1.05.

Question 77

The notional amount attaching to a dividend that can be used to offset personal taxes payable on the dividend is called a

A)classical tax amount.
B)dividend imputation amount.
C)double tax credit.
D)franking credit.

Question 78

Prada has 10 million shares outstanding, generates free cash flows of $50 million each year and has a cost of capital of 10%. It also has $50 million of cash on hand. Prada wants to decide whether to repurchase shares or invest the cash in a project that generates free cash flows of $5 million each year. Should Prada invest or repurchase the shares?

A)invest
B)repurchase
C)indifferent between options
D)cannot say for sure

Question 79

Prada has nine million shares outstanding, generates free cash flows of $40 million each year and has a cost of capital of 10%. It also has $30 million of cash on hand. Prada wants to decide whether to repurchase shares or invest the cash in a project that generates free cash flow of $5 million each year. Should Prada invest or repurchase the shares?

A)repurchase
B)indifferent between options
C)invest
D)cannot say for sure

Question 80

Palomino Enterprises has $300 000 in cash. They wish to invest the money in Treasury bonds at 8% and use the returns to pay dividends to shareholders after a year. Alternately, they can pay a dividend and allow shareholders to make the investment. In perfect capital markets, which option will shareholders prefer?

A)prefer half from each source
B)immediate cash dividend
C)dividend after one year
D)indifferent between options