Question 1

The dividend irrelevance theory, proposed by Miller and Modigliani, says that provided a firm pays at least some dividends, how much it pays does not affect either its cost of capital or its stock price.

Accepted Answer

The dividend irrelevance theory states that the value of a firm is determined by its earnings power and the risk of its underlying assets, regardless of its dividend policy. However, the theory does not say that the amount of dividend paid has no effect on the stock price or cost of capital, as investors may prefer firms that pay higher dividends or may require a higher rate of return for firms that pay lower dividends.

Question 2

Stock dividends and stock splits should, at least conceptually, have the same effect on shareholders' wealth.

Accepted Answer

Both stock dividends and stock splits increase the number of shares owned by shareholders while decreasing the stock price per share proportionally. This means that the total value of the shareholders' investment remains the same. Therefore, both stock dividends and stock splits should have the same effect on shareholders' wealth.

Question 3

One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm's required return constant, other things held constant.

Accepted Answer

According to the bird-in-the-hand theory, investors prefer the certainty of current dividends over the uncertainty of future capital gains or higher dividends. Therefore, if a firm reduces its dividend yield, investors may require a higher rate of return to compensate for the loss of current income. This means that the required return will increase unless there is a more than proportionate increase in growth to offset the reduction in dividend yield.

Question 4

MM's dividend irrelevance theory says that while dividend policy does not affect a firm's value, it can affect the cost of capital.

Accepted Answer

MM's dividend irrelevance theory posits that dividend policy does not affect a firm's value or its cost of capital, assuming perfect capital markets, no taxes, and no transaction costs.

Question 5

Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk.

Accepted Answer

The dividend irrelevance theory proposed by Miller and Modigliani suggests that the value of a firm is determined by its basic earning power and business risk, rather than by its dividend policy. Therefore, the statement is true.

Question 6

Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?

Accepted Answer

If a firm's R&D efforts pay off and it has more high-return investment opportunities, it may choose to reinvest earnings into these opportunities rather than pay out dividends, leading to a decrease in the dividend payout ratio. The other choices do not necessarily lead to a decrease in the dividend payout ratio.

Question 7

Which of the following should NOT influence a firm's dividend policy decision?

Accepted Answer

The fact that much of the firm's equipment has been leased rather than bought and owned should not influence a firm's dividend policy decision as it is not directly related to the company's financial position or obligations. The other options listed have a direct impact on the firm's financial flexibility and obligations, and thus may have an influence on the dividend policy decision.

Question 8

The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price.

Accepted Answer

The optimal distribution policy is determined by finding the right balance between paying out dividends and retaining earnings for reinvestment, in order to maximize the firm's stock price.

Question 9

Trenton Publishing follows a strict residual dividend policy. All else equal, which of the following factors would be most likely to lead to an increase in the firm's dividend per share?

Accepted Answer

Trenton Publishing follows a strict residual dividend policy, which means that the company pays out dividends only after meeting its investment needs for future growth. Therefore, an increase in net income would provide more funds for investment and thereby increase the amount available for dividend payments.

Option B is irrelevant to the company's dividend policy because a change in the capital structure does not directly impact the residual dividend policy.

Option C might lead to an increase in the firm's investments and capital expenditures, which could decrease the amount available for dividends.

Option D is also irrelevant because a change in the tax rate for capital gains is not directly related to the company's dividend policy.

Option E might cause earnings per share to decrease because the number of shares increase, which would result in a lower amount available for dividend payments.

Question 10

Even if a stock split has no information content, and even if the dividend per share adjusted for the split is not increased, there can still be a real benefit (i.e., a higher value for shareholders) from such a split, but any such benefit is probably small.

Accepted Answer

A stock split may make the stock more affordable and accessible to a wider range of investors, potentially increasing demand for the stock and driving up its price. However, any benefit is likely to be small and temporary.

Question 11

If management wants to maximize its stock price, and if it believes that the dividend irrelevance theory is correct, then it must adhere to the residual distribution policy.

Accepted Answer

The dividend irrelevance theory, proposed by Modigliani and Miller, suggests that a firm's dividend policy has no effect on its stock price or its cost of capital. Therefore, adhering to a residual distribution policy is not a requirement under this theory, as dividend payments are considered irrelevant to the firm's value.

Question 12

If the information content, or signaling, hypothesis is correct, then changes in dividend policy can have an important effect on the firm's value and capital costs.

Accepted Answer

According to the information content or signaling hypothesis, firms use dividend policies as signals to convey information about their future prospects and financial health. Changes in dividend policy, such as increases or decreases in dividend payouts, can affect investors' perceptions of the firm's value and profitability, which in turn can impact the firm's cost of capital. Therefore, the statement is true.

Question 13

You own 100 shares of Troll Brothers' stock, which currently sells for $120 a share. The company is contemplating a 2-for-1 stock split. Which of the following best describes what your position will be after such a split takes place?

Accepted Answer

After a 2-for-1 stock split, you will have twice the number of shares that you originally had, so you'll have 200 shares. The stock price will be halved to approximately $60 a share.

Question 14

If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a low payout ratio.

Accepted Answer

If investors prefer firms that retain most of their earnings, then a low payout ratio will signal to investors that the firm is retaining more earnings for future growth opportunities. This could increase investor confidence and demand for the stock, leading to a higher stock price.

Question 15

If the shape of the curve depicting a firm's WACC versus its debt ratio is more like a sharp "V", as opposed to a shallow "U", it will be easier for the firm to maintain a steady dividend in the face of varying investment opportunities or earnings from year to year.

Accepted Answer

A sharp "V" shape indicates a narrow range of optimal debt levels, which means the firm's WACC will increase significantly if it deviates from this range. This can make it difficult for the firm to maintain a steady dividend in the face of varying investment opportunities or earnings from year to year. A shallow "U" shape indicates a broader range of optimal debt levels, which means the firm's WACC will not be as sensitive to deviations from this range.

Question 16

Which of the following statements about dividend policies is CORRECT?

Accepted Answer

The answer of Which of the following statements about dividend...

Question 17

Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that

Accepted Answer

The answer of Myron Gordon and John Lintner believe that...

Question 18

A reverse split reduces the number of shares outstanding.

Accepted Answer

A reverse split aims to increase the stock price by reducing the number of shares outstanding. It typically involves merging multiple shares into a single share, resulting in a decrease in the total number of outstanding shares.

Question 19

The announcement of an increase in the cash dividend should, according to MM, lead to an increase in the price of the firm's stock.

Accepted Answer

According to Modigliani and Miller's dividend irrelevance theory, the announcement of an increase in the cash dividend should not affect the price of the firm's stock because investors are indifferent to whether they receive dividends or capital gains.

Question 20

If a firm adopts a residual distribution policy, distributions are determined as a residual after funding the capital budget. Therefore, the better the firm's investment opportunities, the lower its payout ratio should be.

Accepted Answer

With a residual distribution policy, funds are first allocated towards the capital budget, and any remaining funds are then distributed to shareholders as dividends or buybacks. If a firm has more attractive investment opportunities, it would prioritize funding those projects over distributing more to shareholders, resulting in a lower payout ratio.

Quiz 14: Distributions to Shareholders: Dividends and Repurchases