Question 1

Taxes play a subtle role in the irrelevance theory because dividends and capital gains are taxed at different rates.

Accepted Answer

The irrelevance theory states that the value of a firm is not affected by its capital structure. However, taxes do play a subtle role in this theory because dividends and capital gains are taxed at different rates. This means that an investor might have a preference for receiving capital gains over dividends, which could affect their investment decisions and the value of the firm.

Question 2

The dividend decision is whether to pay cash dividends or retain earnings for growth, both of which benefit shareholders.

Accepted Answer

The dividend decision involves choosing between paying cash dividends to shareholders or retaining earnings for future growth. Both options can benefit shareholders in different ways.

Question 3

Companies generally don't have to pay dividends, but if they have always done so in the past and stockholders invested because of that history, a legal case can be made to force payment even if earnings are depressed.

Accepted Answer

Dividends are typically at the discretion of a company's board of directors and there is no legal obligation to pay them, even if the company has a history of doing so. Shareholders cannot legally force a company to pay dividends.

Question 4

Transaction costs tend to make tailoring an income stream impractical.

Accepted Answer

Transaction costs, such as fees and commissions, can significantly eat into the potential income stream from tailoring investments, making it less practical and less profitable.

Question 5

For the most part, the dividend preference theory opposes the viewpoint that "a bird in hand is worth two in the bush".

Accepted Answer

The dividend preference theory supports the viewpoint that "a bird in hand is worth two in the bush". This means that investors prefer to receive dividends now rather than waiting for potential future capital gains or dividends.

Question 6

Considering that a firm has a PE ratio of 71.4 and an EPS of 0.1, what is the price of a stock that pays an annual dividend of $1.00?

Accepted Answer

The price of the stock is calculated by multiplying the PE ratio by the EPS: 71.4 * 0.1 = 7.14.

Question 7

Dividends can't be paid by a(n)_____firm and must come from current or prior earnings.

Accepted Answer

Dividends are distributions of a company's earnings to its shareholders and can only be paid out of current or prior earnings. An insolvent firm, which is unable to pay its debts as they come due, cannot afford to pay dividends because it does not have sufficient funds or profits.

Question 8

The dividend irrelevance theory implies that the firm should follow a residual dividend policy.

Accepted Answer

The dividend irrelevance theory, proposed by Modigliani and Miller, suggests that a firm's dividend policy is irrelevant to its market value and that dividends do not affect the wealth of shareholders. It does not specifically advocate for a residual dividend policy, which is a strategy where dividends are based on the earnings left over after all project capital needs are met.

Question 9

Loan indentures and _____may limit dividend payments to protect creditors' interest.

Accepted Answer

Loan indentures often contain covenants that restrict certain actions by the borrower to protect the lender's interest. Such covenants may include limits on dividend payments to ensure that the borrower does not distribute funds that should be used to repay the loan or service other debt. The other choices, preferred stock, common stock restrictions, and equity interests, are not directly related to limiting dividend payments in loan agreements.

Question 10

A firm has 4 million common shares outstanding and expects earnings of $20 million next year. If it has a dividend payout ratio of 40%, what will be the yearly dividend per share for next year?

Accepted Answer

Dividend payout ratio = dividends/earnings
40% = dividends/20 million
Dividends = 8 million
Dividend per share = dividends/common shares outstanding
= 8 million/4 million
= $2 per share

Question 11

Tom Parsley has 15,000 shares of Alistair Inc. stock that sells for $12 a share and pays an annual dividend of $0.75 per share. The corporation plans to discontinue its cash dividend and begin reinvesting the money in a new idea that is expected to bring about growth of 7% a year. Assuming no costs are involved in selling securities, how many shares must Tom sell next year to maintain his income and his position in the firm?

Accepted Answer

Tom needs to sell enough shares to replace the lost dividend income. The dividend income is 15,000 shares * $0.75 = $11,250. With a 7% growth, the stock price is expected to be $12 * 1.07 = $12.84. To maintain his income, Tom needs to sell $11,250 / $12.84 ≈ 876 shares.

Question 12

Under dividend preference investors prefer immediate cash to uncertain future benefits.

Accepted Answer

Dividend preference means investors prefer to receive immediate cash payments in the form of dividends rather than waiting for uncertain future benefits such as potential capital gains.

Question 13

Dividends are the basis of value for stocks even though many stocks that don't pay dividends have substantial value.

Accepted Answer

Stocks are valued based on the present value of their future cash flows, which includes dividends. However, stocks can also be valued on their potential for future growth, which can give substantial value to stocks that do not currently pay dividends.

Question 14

The dividend controversy is whether paying or not paying dividends affects stock price.

Accepted Answer

The dividend controversy is a long-standing debate among investors and financial experts on whether paying or not paying dividends affects the stock price. Some argue that paying dividends can attract income-seeking investors and boost the stock price, while others believe that reinvesting profits into the company can lead to better long-term growth and ultimately result in a higher stock price.

Question 15

Investors in growth oriented firms accept the nonpayment of dividends in order to retain earnings partially because they realize that issuing new equity would involve flotation costs that would ultimately lower earnings.

Accepted Answer

Investors understand that issuing new equity would involve costs such as underwriting fees and other expenses, which would ultimately lower earnings. Therefore, they accept the nonpayment of dividends and allow the firm to retain earnings.

Question 16

Scholars and financial professionals have concluded that dividends have a positive effect on stock prices.

Accepted Answer

The answer of Scholars and financial professionals have concluded that...

Question 17

Firms prefer not paying dividends if it avoids selling new stock, because retained earnings cost less than new equity.

Accepted Answer

Retained earnings do not require the issuance of new stock, which can be costly in terms of underwriting and administrative fees, and can also dilute existing shareholders' ownership percentage. Therefore, firms may prefer to retain earnings and not pay dividends, as it is a cheaper source of funding compared to issuing new equity.

Question 18

The price of a stock is $10.00. It is expected to pay an annual dividend of $0.40 next year. If investors require a return of 15% on similar stocks, what is the firm's growth rate?

Accepted Answer

The answer of The price of a stock is $10.00....

Question 19

The dividend irrelevance hypothesis argues that the negative impact on P₀ of reducing or eliminating early dividends is offset by the positive effect of larger dividends later on and an increased selling price.

Accepted Answer

The dividend irrelevance hypothesis states that the value of a firm is not affected by its dividend policy. Therefore, reducing or eliminating early dividends should not have a negative impact on P₀, as it would be offset by other factors such as higher future dividends and an increased selling price.

Question 20

The dividend decision also represents a decision concerning internal vs. external equity financing.

Accepted Answer

The decision to pay dividends can affect both the internal equity (by reducing retained earnings) and external equity (by enhancing the perception of the company's financial strength and attractiveness to potential investors). Therefore, the dividend decision involves a choice between internal and external equity financing.

Quiz 15: Dividends and Repurchases

Taxes play a subtle role in the irrelevance theory because dividends and capital gains are taxed at different rates.

The dividend decision is whether to pay cash dividends or retain earnings for growth, both of which benefit shareholders.

Companies generally don't have to pay dividends, but if they have always done so in the past and stockholders invested because of that history, a legal case can be made to force payment even if earnings are depressed.

Transaction costs tend to make tailoring an income stream impractical.

For the most part, the dividend preference theory opposes the viewpoint that "a bird in hand is worth two in the bush".

Considering that a firm has a PE ratio of 71.4 and an EPS of 0.1, what is the price of a stock that pays an annual dividend of $1.00?

Dividends can't be paid by a(n) _____firm and must come from current or prior earnings.

The dividend irrelevance theory implies that the firm should follow a residual dividend policy.

Loan indentures and _____may limit dividend payments to protect creditors' interest.

A firm has 4 million common shares outstanding and expects earnings of $20 million next year. If it has a dividend payout ratio of 40%, what will be the yearly dividend per share for next year?

Under dividend preference investors prefer immediate cash to uncertain future benefits.

Dividends are the basis of value for stocks even though many stocks that don't pay dividends have substantial value.

The dividend controversy is whether paying or not paying dividends affects stock price.

Investors in growth oriented firms accept the nonpayment of dividends in order to retain earnings partially because they realize that issuing new equity would involve flotation costs that would ultimately lower earnings.

Scholars and financial professionals have concluded that dividends have a positive effect on stock prices.

Firms prefer not paying dividends if it avoids selling new stock, because retained earnings cost less than new equity.

The price of a stock is $10.00. It is expected to pay an annual dividend of $0.40 next year. If investors require a return of 15% on similar stocks, what is the firm's growth rate?

The dividend irrelevance hypothesis argues that the negative impact on P₀ of reducing or eliminating early dividends is offset by the positive effect of larger dividends later on and an increased selling price.

The dividend decision also represents a decision concerning internal vs. external equity financing.

Quiz 15: Dividends and Repurchases

Taxes play a subtle role in the irrelevance theory because dividends and capital gains are taxed at different rates.

The dividend decision is whether to pay cash dividends or retain earnings for growth, both of which benefit shareholders.

Companies generally don't have to pay dividends, but if they have always done so in the past and stockholders invested because of that history, a legal case can be made to force payment even if earnings are depressed.

Transaction costs tend to make tailoring an income stream impractical.

For the most part, the dividend preference theory opposes the viewpoint that "a bird in hand is worth two in the bush".

Considering that a firm has a PE ratio of 71.4 and an EPS of 0.1, what is the price of a stock that pays an annual dividend of $1.00?

Dividends can't be paid by a(n) _____firm and must come from current or prior earnings.

The dividend irrelevance theory implies that the firm should follow a residual dividend policy.

Loan indentures and _____may limit dividend payments to protect creditors' interest.

A firm has 4 million common shares outstanding and expects earnings of $20 million next year. If it has a dividend payout ratio of 40%, what will be the yearly dividend per share for next year?

Under dividend preference investors prefer immediate cash to uncertain future benefits.

Dividends are the basis of value for stocks even though many stocks that don't pay dividends have substantial value.

The dividend controversy is whether paying or not paying dividends affects stock price.

Investors in growth oriented firms accept the nonpayment of dividends in order to retain earnings partially because they realize that issuing new equity would involve flotation costs that would ultimately lower earnings.

Scholars and financial professionals have concluded that dividends have a positive effect on stock prices.

Firms prefer not paying dividends if it avoids selling new stock, because retained earnings cost less than new equity.

The price of a stock is $10.00. It is expected to pay an annual dividend of $0.40 next year. If investors require a return of 15% on similar stocks, what is the firm's growth rate?

The dividend irrelevance hypothesis argues that the negative impact on P0 of reducing or eliminating early dividends is offset by the positive effect of larger dividends later on and an increased selling price.

The dividend decision also represents a decision concerning internal vs. external equity financing.

The dividend irrelevance hypothesis argues that the negative impact on P₀ of reducing or eliminating early dividends is offset by the positive effect of larger dividends later on and an increased selling price.