Deck 17: Payout Policy

Question 1

A one-time payment to shareholders that is much larger than a regular dividend is often referred to as a(n) ________ dividend.

A) taxable
B) divesting
C) special
D) ex-day

Answer 1

special

Question 2

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

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

Answer 2

return of capital

Question 3

The date two 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

Answer 3

ex-dividend

Question 4

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 5

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

A) tender offer
B) open market share repurchase
C) targeted repurchase
D) Dutch auction share repurchase

Question 6

The firm mails dividend checks to the registered shareholders on the ________.

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

Question 7

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

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

Question 8

Which of the following statements is FALSE?

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

Question 9

The date on which a firm pays out dividends is called the ________ date.

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

Question 10

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) tender offer
C) targeted repurchase
D) greenmail

Question 11

The date on which the board of directors of a company authorizes the dividend is called the ________ date.

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

Question 12

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

A) open market purchase
B) tender offer
C) targeted repurchase
D) greenmail

Question 13

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

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

Question 14

Another 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) tender offer
B) Dutch auction share repurchase
C) targeted repurchase
D) open market share repurchase

Question 15

The date on which the board authorizes the dividend is the ________.

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

Question 16

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) tender offer
C) targeted repurchase
D) greenmail

Question 17

The way a firm chooses between alternate uses of free cash flow is referred to as ________.

A) retention ratio
B) payout policy
C) call policy
D) debt policy

Question 18

The firm will pay the dividend to all shareholders who are registered owners on a specific date, set by the board, called the ________.

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

Question 19

A firm may decide to eliminate the threat of a takeover by a major shareholder by purchasing shares from him at a premium also known as a(n) ________.

A) open market purchase
B) tender offer
C) targeted repurchase
D) greenmail

Question 20

The Record Date falls before the Ex-Dividend Date.

Question 21

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

A) targeted repurchase
B) Dutch auction share repurchase
C) tender offer
D) open market share repurchase

Question 22

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

Question 23

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

Question 24

A firm has $400 million of assets that includes $40 million of cash and 12 million shares outstanding. The firm uses $40 million of its cash to pay dividends. If an investor has 1000 shares, how many shares must she sell to create a homemade dividend of $4,900?

A) 52.22 shares
B) 41.78 shares
C) 62.67 shares
D) 73.11shares

Question 25

A firm has a total market value of assets of $240 million, of which $24 million is cash. It has debt of $96 million. If the firm were to repurchase $9.6 million of its stock, what would its new debt-to-equity ratio be?

A) 142.86%
B) 71.43%
C) 35.71%
D) 85.71%

Question 26

What are the different ways a firm can repurchase shares?

Question 27

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

Question 28

A firm has a total market value of assets of $300 that includes $40 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) $24.00
B) $36.00
C) $30.00
D) $42.00

Question 29

A firm has a total market value of assets of $300 million that includes $40 million of cash and 8 million shares outstanding. If the firm uses $30 million of its cash to repurchase shares, what is the new price per share?

A) $30.00
B) $37.50
C) $45.00
D) $52.50

Question 30

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

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

Question 31

Homemade dividend refers to the process by which an investor ________.

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

Question 32

What are the characteristics of special dividend?

Question 33

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

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

Question 34

A firm has a total market value of assets of $300 million that includes $60 million of cash and 8 million shares outstanding. If the firm uses $30 million of its cash to repurchase shares, what is the new price per share?

A) $37.50
B) $30.00
C) $45.00
D) $52.50

Question 35

A(n) ________ may occur if a major shareholder desires to sell a large number of shares but the market for the shares is not sufficiently liquid to sustain such a large sale without severely affecting the price.

A) open market share repurchase
B) Dutch auction share repurchase
C) tender offer
D) targeted repurchase

Question 36

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

Question 37

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 38

Suppose a firm does not pay a dividend but repurchases stock using $28 million of cash, the market value of the firm decreases by ________.

A) $28 million
B) -$28 million
C) 0
D) cannot say for sure

Question 39

A firm has $300 million of assets that includes $40 million of cash and 8 million shares outstanding. The firm uses $30 million of its cash to pay dividends. If an investor has 1000 shares, how many shares must he sell to create a homemade dividend of $6,575?

A) 67 shares
B) 100 shares
C) 84 shares
D) 117 shares

Question 40

A firm has a total market value of assets of $300 million that includes $60 million of cash and 10 million shares outstanding. The firm uses $30 million of its cash to pay dividends. If an investor has 1000 shares, how many shares must he sell to create a homemade dividend of $3,900?

A) 33.33 shares
B) 26.67 shares
C) 40.00 shares
D) 46.67 shares

Question 41

Omicron Technologies has $60 million in excess cash and no debt. The firm expects to generate additional free cash flows of $48 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 9% and there are 12 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $60 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that Omicron uses the entire $60 million to repurchase shares. The amount of the regular yearly dividends in the future is closest to ________.

A) $3.56
B) $5.34
C) $4.45
D) $8.90

Question 42

Omicron Technologies has $40 million in excess cash and no debt. The firm expects to generate additional free cash flows of $32 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 9% and there are 8 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $40 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that Omicron uses the entire $40 million to repurchase shares. The number of shares that Omicron will have outstanding following the repurchase is closest to ________.

A) 5.8 million
B) 8.6 million
C) 14.4 million
D) 7.2 million

Question 43

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

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

Question 44

Long-term investors can defer capital gains tax until they sell, and therefore, there is a tax advantage for share repurchases over dividends.

Question 45

Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 8% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that Omicron uses the entire $50 million to repurchase shares. The number of shares that Omicron will repurchase is closest to ________.

A) 0.73 million
B) 1.09 million
C) 0.9 million
D) 1.82 million

Question 46

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

Question 47

Omicron Technologies has $60 million in excess cash and no debt. The firm expects to generate additional free cash flows of $48 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 9% and there are 12 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $60 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that Omicron uses the entire $60 million in excess cash to pay a special dividend. Omicron's cum-dividend price is closest to ________.

A) $39.56
B) $59.33
C) $98.89
D) $49.44

Question 48

Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 8% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. Omicron's ex-dividend price is closest to ________.

A) $50.00
B) $40.00
C) $60.00
D) $100.00

Question 49

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 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.
C) In perfect capital markets, an open market share repurchase has no effect on the stock price, and the stock price is the same as the ex-dividend price if a dividend were paid instead.
D) 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.

Question 50

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

Question 51

Omicron Technologies has $60 million in excess cash and no debt. The firm expects to generate additional free cash flows of $48 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 12 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $60 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Including its cash, Omicron's total market value is closest to ________.

A) $432.00 million
B) $648.00 million
C) $1080.00 million
D) $540.00 million

Question 52

Omicron Technologies has $60 million in excess cash and no debt. The firm expects to generate additional free cash flows of $48 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 12 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $60 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Omicron's enterprise value is closest to ________.

A) $384.00 million
B) $576.00 million
C) $960.00 million
D) $480.00 million

Question 53

Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. The amount of the special dividend is closest to ________.

A) $5.00
B) $4.00
C) $6.00
D) $10.00

Question 54

Danroy Inc. has announced a $7 dividend. If Danroy's last price while trading cum-dividend is $66, what should its first ex-dividend price be (assuming perfect capital markets)?

A) $59
B) $66
C) $73
D) $80

Question 55

Omicron Technologies has $40 million in excess cash and no debt. The firm expects to generate additional free cash flows of $32 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 8% and there are 8 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $40 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $40 million to repurchase shares. Suppose you are unhappy with Omicron's decision and would prefer that Omicron 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 Omicron paid the special dividend is closest to ________ shares.

A) 227.27
B) 272.73
C) 454.55
D) 181.82

Question 56

Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 8% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. The amount of the regular yearly dividends in the future is closest to ________.

A) $3.20
B) $4.80
C) $4.00
D) $8.00

Question 57

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

Question 58

Modigliani and Miller Dividend Irrelevance 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) debt
B) investment
C) interest rate
D) equity issuance

Question 59

Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 9% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $50 million to pay a special dividend. Suppose you are unhappy with Omicron's decision and would prefer that Omicron 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 Omicron paid is closest to ________ shares.

A) 225.00
B) 337.50
C) 562.50
D) 281.25

Question 60

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) $2.40
B) $1.50
C) $3.00
D) $6.00

Question 61

The JRN Corporation will pay a constant dividend of $3 per share per year in perpetuity. Assume that all investors pay a 25% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 14%. The price of a share of JRN's stock is closest to ________.

A) $16.07
B) $12.86
C) $19.29
D) $32.14

Question 62

What is the general trend of dividend payments of U.S. corporations over the last few decades?

Question 63

The WTC Corporation will pay a constant dividend of $4.20 per share, per year, in perpetuity. If all investors pay a 20% tax on dividends, there is no capital gains tax, and the cost of capital for investing in WTC stock is 14%, what is the price for a share of WTC stock?

A) $24.00
B) $19.20
C) $28.80
D) $48.00

Question 64

The largest proportion of investors in common stock are ________.

A) mutual funds
B) pension funds
C) corporations
D) individual investors

Question 65

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 66

Tax rates on dividends and capital gains differ across investors for a variety of reasons including ________.

A) income
B) investment horizon
C) tax jurisdiction
D) all of the above

Question 67

Which of the following statements is FALSE?

A) While firms do still pay dividends, substantial evidence shows that many firms have recognized their tax disadvantage.
B) The fact that firms continue to issue dividends despite their tax disadvantage is often referred to as the dividend puzzle.
C) At the end of the 1990s, dividend payments exceeded the value of repurchases for U.S. industrial firms.
D) While evidence is indicative of the growing importance of share repurchases as a part of firms' payout policies, it also shows that dividends remain a key form of payouts to shareholders.

Question 68

Corporations enjoy a tax advantage associated with dividends due to ________.

A) personal tax exemptions
B) the 70% exclusion rule
C) laddered tax rates
D) concave tax structure

Question 69

Share repurchases have a tax advantage over dividends because ________.

A) dividend payments are tax deductible
B) share repurchases increase the value of debt
C) capital gains can be deferred by long-term investors
D) repurchases are associated with increased customer loyalty

Question 70

The fact that firms continue to issue dividends despite their tax disadvantage is often referred to as the ________.

A) issuance puzzle
B) dividend puzzle
C) payback puzzle
D) policy puzzle

Question 71

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

Question 72

Palo Alto Enterprises has $200,000 in cash. They wish to invest the money in Treasury bills at 5% and use the returns to pay dividends to shareholders after a year. Alternatively 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) dividend after one year
C) prefer half from each source
D) indifferent between options

Question 73

Which of the following statements is FALSE?

A) Unlike with capital structure, taxes are not an important market imperfection that influence a firm's decision to pay dividends or repurchase shares.
B) If dividends are taxed at a higher rate than capital gains, which has been true until the most recent change to the tax code, shareholders will prefer share repurchases to dividends.
C) Shareholders typically must pay taxes on the dividends they receive. They must also pay capital gains taxes when they sell their shares.
D) Because long-term investors can defer the capital gains tax until they sell, there is still a tax advantage for share repurchases over dividends.

Question 74

Different investor groups have differing tax preferences that create clientele effects in which dividend policy of a firm is optimized for the tax preferences of its investors.

Question 75

Which of the following statements is FALSE?

A) When a firm pays a dividend, shareholders are taxed according to the dividend tax rate. If the firm repurchases shares instead, and shareholders sell shares to create a homemade dividend, the homemade dividend will be taxed according to the capital gains tax rate.
B) When the tax rate on dividends exceeds the tax rate on capital gains, shareholders will pay lower taxes if a firm uses share repurchases rather than dividends for all payouts.
C) Firms that use dividends will have to pay a lower after-tax return to offer their investors the same pretax return as firms that use share repurchases.
D) The optimal dividend policy when the dividend tax rate exceeds the capital gain tax rate is to pay no dividends at all.

Question 76

Historical evidence shows that over the last few decades a larger proportion of firms have used ________ for payouts.

A) repurchases
B) dividends
C) stock reverse splits
D) stock splits

Question 77

The JRN Corporation will pay a constant dividend of $5 per share per year in perpetuity. Assume that all investors pay a 25% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 10%. Assume that management makes a surprise announcement that JRN will no longer pay dividends but will use the cash to repurchase stock instead. The price of a share of JRN's stock is now closest to ________.

A) $40.00
B) $50.00
C) $60.00
D) $100.00

Question 78

What is the general trend of share repurchase as a percentage of total payout over the last few decades?

Question 79

What is the general trend over the last few decades of total payouts by firms to shareholders be it through share repurchase or dividends?

Question 80

Because the dividend tax will be paid whether the firm pays the cash immediately or retains cash and pays the interest over time, the dividend tax rate does not affect the cost of retaining cash.