Question 1

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

Gordon and Lintner's argument is based on the assumption that investors view dividends as being less risky than potential future capital gains, which is why they believe the required return on equity increases as the dividend payout ratio is decreased.

Question 2

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 would indicate that the firm is retaining most of its earnings and therefore meeting the preference of the investors. This can lead to higher stock prices as investors perceive the firm as being a good investment with potential for growth.

Question 3

In the real world,dividends

Accepted Answer

Dividends are usually more stable than earnings because companies tend to smooth dividends over time to avoid frequent changes, reflecting a stable dividend policy.

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

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

Accepted Answer

The goal of optimal distribution policy is to maximize the firm's stock price, and this is achieved by balancing between the current dividends and capital gains. Therefore, the statement is true.

Question 6

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

According to Miller and Modigliani's dividend irrelevance theory, the value of the firm is determined only by its basic earning power and its business risk, and dividends do not affect the value of the firm.

Question 7

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 means that any distributions (dividends or stock repurchases) are determined after the company has funded its capital budget. This means that if a firm has better investment opportunities, it will allocate more funds to its capital budget and have less left over for distributions, resulting in a lower payout ratio.

Question 8

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 now has more high-return investment opportunities, it may choose to invest more in those opportunities instead of paying dividends, leading to a decrease in the dividend payout ratio. The other options are not directly related to dividend payout ratio.

Question 9

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 outstanding and decrease the price per share, but proportionally increase the total value of shares held by each shareholder. Therefore, they have the same effect on shareholders' wealth.

Question 10

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 in the WACC curve indicates a more sensitive cost of capital to changes in the debt ratio, making financial planning and maintaining steady dividends more challenging, especially under varying investment opportunities or earnings.

Question 11

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 of dividends, investors value current dividends more than potential future capital gains. Therefore, if a firm reduces its dividend yield, investors may require a higher rate of return to compensate for the reduced income. This means that the firm would need to have a higher growth rate to maintain its required return, other things held constant. Thus, a given reduction in dividend yield must be offset by a more than proportionate increase in growth to keep the firm's required return constant.

Question 12

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 13

Which of the following statements about dividend policies is correct?

Accepted Answer

The clientele effect suggests that companies attract a certain base of investors based on their dividend policy. A stable dividend policy can appeal to investors who prefer predictability in their income streams, such as retirees. This is why the statement about the clientele effect suggesting companies should follow a stable dividend policy is correct.

Question 14

A reverse split reduces the number of shares outstanding.

Accepted Answer

A reverse split consolidates multiple shares into a single share, reducing the number of shares outstanding. For example, if a company performs a 1-for-5 reverse split, each shareholder who had 5 shares before the split will now only have 1 share. This results in a reduction in the total number of shares outstanding.

Question 15

Poff Industries' stock currently sells for $120 a share.You own 100 shares of the stock.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

A 2-for-1 stock split means that for every share you own, you will receive an additional share. Therefore, after the split, you will own 200 shares. However, the price per share will decrease by half, so the stock will trade at or near $60 a share.

Question 16

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, proposed by Miller and Modigliani, suggests that in a perfect market without taxes or other frictions, the value of a firm is determined by its earning power and riskiness of its assets, and not by the way it chooses to distribute its earnings. However, this theory assumes that investors are rational and can buy and sell shares without transaction costs, which is not always the case in the real world. Moreover, some investors may value dividends more highly than capital gains, and so the level of dividends can affect the demand for and price of a stock.

Question 17

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. This is because the ownership structure of the equipment has no direct relation to the firm's cash flow and ability to pay dividends.

Question 18

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 can potentially increase demand and liquidity for the stock, making it more attractive to investors. However, the benefit is likely to be small and temporary.

Question 19

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 20

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, changes in dividend policy can signal important information to investors and affect the perceived value of the firm, which can in turn impact the cost of capital. Therefore, Option A is correct.

Quiz 14: Distributions to Shareholders: Dividends and Repurchases