Question 1

What is the term of a cash payment to shareholders resulting from transforming a company dividend policy into a different policy by means of investors buying and selling on their own account?

Accepted Answer

A homemade dividend refers to the cash payment to shareholders that results from investors creating their own dividend policy by buying and selling shares, rather than relying on the company's dividend policy.

Question 2

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

The benefit may come from increased liquidity and improved marketability of the shares, which could potentially attract more investors and increase demand for the stock, ultimately leading to a higher value for shareholders. However, this benefit is likely to be minor compared to other factors that affect stock prices.

Question 3

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 4

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

This is the main argument presented in the dividend irrelevance theory proposed by Miller and Modigliani. They argue that dividend policy does not affect the value of the firm because investors can create their own dividend income by selling a portion of their shares, and the value of the firm is determined primarily by its earnings power and risk.

Question 5

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 6

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 that there is a small range of debt ratios that result in a lower WACC. This means that a slight change in the debt ratio could result in a significant increase in the WACC, making it more difficult for the firm to maintain a steady dividend. A shallow "U" shape, on the other hand, indicates a wider range of optimal debt ratios and a smoother transition between them, making it easier for the firm to maintain a steady dividend.

Question 7

Given perfect capital mobility and a global economy, dividend yields in different stock markets are similar throughout the world.

Accepted Answer

Dividend yields can differ between different stock markets due to a variety of factors such as differences in tax laws, regulations, and company policies. Perfect capital mobility and a global economy do not necessarily lead to identical dividend yields in all markets.

Question 8

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

This is because according to the bird-in-the-hand theory, investors prefer to receive dividends now rather than later, so if a firm reduces its dividend yield, investors will likely expect a higher growth rate in order to compensate for the reduced immediate return. Therefore, a more than proportionate increase in growth is needed to keep the firm's required return constant.

Question 9

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

A residual distribution policy dictates that a firm's distribution decisions are made after funding its capital budget. As a result, if a company has better investment opportunities, it should retain more earnings and pay out less dividends, resulting in a lower payout ratio.

Question 10

Share repurchases results in a decrease in EPS.

Accepted Answer

Share repurchases reduce the number of outstanding shares, which typically increases the Earnings Per Share (EPS) as the same amount of earnings is distributed over fewer shares.

Question 11

A company planning to pay a cash dividend in excess of the regular dividend does not want investors to believe that such an extra dividend will be repeated. What will the firm likely call this extra dividend?

Accepted Answer

A special dividend is typically a one-time payment of a larger-than-normal dividend, meant to communicate to investors that it is not part of the company's regular dividend policy and should not be expected to be repeated with any regularity. This is in contrast to a stock dividend (A), which is a distribution of additional shares of stock rather than cash, and a cash-liquidating dividend (B), which is a one-time payment that is meant to liquidate the company's assets and close down operations. A homemade dividend (D) is a strategy in which an investor creates their own income stream by selling a small amount of their portfolio holdings rather than relying solely on dividends from the underlying investments.

Question 12

A reverse split reduces the number of shares outstanding.

Accepted Answer

A reverse split consolidates multiple shares into a single share, thereby reducing the number of shares outstanding.

Question 13

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

Accepted Answer

The information content or signalling hypothesis suggests that changes in dividend policy can signal important information about the firm's future earnings prospects and investment opportunities, which can affect the firm's value and capital costs. Therefore, changes in dividend policy can have an important effect on the firm's overall financial performance.

Question 14

In the real world, which of the following is true regarding dividends?

Accepted Answer

Dividends are usually more stable than earnings because companies tend to smooth dividends over time, maintaining consistent payouts even when earnings fluctuate.

Question 15

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 held by shareholders, while decreasing the value per share proportionally. This should result in the same total value of shares held by the shareholder before and after either event, assuming no other changes such as changes in the stock price.

Question 16

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 17

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

Accepted Answer

The optimal distribution policy aims to maximize the firm's stock price, which is achieved by maintaining a balance between cash dividends and capital gains. This is because investors value both types of returns, and a perfect balance between them can lead to higher overall returns for shareholders.

Question 18

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 proposes that a firm's value is determined by its future earnings prospects and risk, rather than its dividend policy. However, it suggests that a firm's stock price may increase as it increases its dividend payments, indicating that dividend policy may have some effect on stock price.

Question 19

Avoiding dividend cuts and maintaining target D/E ratio are the two underlying objectives in the residual dividend policy.

Accepted Answer

The statement is true. The residual dividend policy aims to distribute the available profits as dividends while ensuring that the company avoids cutting dividends and maintains its target debt-to-equity ratio. Any funds left after meeting these two objectives are reinvested back into the company.

Question 20

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

Accepted Answer

The answer of If investors prefer firms that retain most...

Quiz 13: Distributions to Shareholders: Dividends and Repurchases