Question 1

Which of the following statements is correct?
A) People behave differently towards a company in financial distress, and this increases insolvency costs.
B) People behave differently towards a company in financial distress, and this reduces insolvency costs
C) People behave differently towards a company in financial distress, and this reduces insolvency costs.
D) People behave similarly towards a company in financial distress, and this increases insolvency costs

Accepted Answer

People behave differently towards a company in financial distress, and this increases insolvency costs.

Question 2

The managers and shareholders of a company also often behave in ways that reduce a company's value when the company becomes financially distressed. The resulting costs are a type of:
A) Agency cost.
B) Shareholder -lender agency costs.
C) Shareholder-manager agency costs.
D) None of the above.

Accepted Answer

The managers and shareholders of a company also often behave in ways that reduce a company's value when the company becomes financially distressed. The resulting costs are a type of agency cost.

Question 3

It is important to note that without financial leverage, there would be no:
A) Underinvestment problems.
B) Asset substitution.
C) Both A and B
D) None of the above.

Accepted Answer

It is important to note that without financial leverage, there would be no asset substitution or underinvestment problems.

Question 4

Which of the following statements is incorrect?
A) The interests of managers are normally similar to those of the shareholders.
B) When a company gets into financial distress, the interests of managers and shareholders begin to differ.
C) When a company gets into financial distress, the actions managers and shareholders take to protect their interests often increase company value.
D) Indirect insolvency costs are costs associated with changes in the behaviour of people who deal with a company when it becomes financially distressed.

Accepted Answer

Indirect insolvency costs are costs associated with changes in the behaviour of people who deal with a company when it becomes financially distressed. The interests of many people who deal with a company are normally similar to those of the shareholders - they all want to maximise the company's value. However, when a company gets into financial distress, the interests of these people begin to differ, and the actions they take to protect their interests often reduce company value.

Question 5

It is important to note that without financial leverage, there would be no:
A) Shareholder -lender agency costs.
B) Shareholder-manager agency costs.
C) Asset substitution or underinvestment problems.
D) All of the above.

Accepted Answer

It is important to note that without financial leverage, there would be no asset substitution or underinvestment problems.

Question 6

Which of the following statements is incorrect?
A) The regulatory requirements of government agencies are greater.
B) The share market tends to react positively to announcements that companies are selling shares.
C) The out-of-pocket costs of selling equity are much higher than the comparable costs for bonds.
D) None of the above.

Accepted Answer

The out-of-pocket costs of selling equity are much higher than the comparable costs for bonds. In addition, the regulatory requirements of government agencies are greater, and the share market tends to react negatively to announcements that companies are selling shares.

Question 7

Which of the following statement is consistent with the trade-off theory?
A) More profitable companies pay more tax, so they should use more debt to take advantage of the interest tax shield.
B) The more profitable a company is, the less debt it tends to have.
C) None of the above.
D) All of the above.

Accepted Answer

Under the trade-off theory, more profitable companies pay more tax, so they should use more debt to take advantage of the interest tax shield.

Question 8

Which one of the following statements is consistent with the pecking order theory?
A) In an average year, public companies actually repurchase more shares than they sell.
B) The more profitable a company is, the less debt it tends to have.
C) All of the above.
D) None of the above.

Accepted Answer

More general evidence also indicates that the more profitable a company is, the less debt it tends to have. Instead, this evidence is consistent with the pecking order theory. Highly profitable companies have plenty of cash on hand that can be used to finance their projects and, over time, using this cash will drive down their debt ratios. The pecking order theory is also supported by the fact that, in an average year, public companies actually repurchase more shares than they sell.

Question 9

The trade-off theory of capital structure says that managers will increase debt to the point at which:
A) the costs of adding another dollar of debt is equal to the benefits.
B) the costs of adding another dollar of debt is smaller than the benefits.
C) the costs of adding another dollar of debt is greater than the benefits.
D) none of the above.

Accepted Answer

The trade-off theory of capital structure says that managers will increase debt to the point at which the costs and benefits of adding another dollar of debt are exactly equal because this is the capital structure that maximises company value.

Question 10

How can dividends be distributed?
A) Discounts on company products.
B) Cash.
C) Assets or more shares.
D) All of the above

Accepted Answer

A dividend can involve the distribution of cash, assets or something else, such as discounts on the company's products that are available only to shareholders.

Question 11

A special dividend is different to a regular cash dividend because:
A) It is paid out of retained cash, not company profits.
B) Special dividend is a terminology used by finance professionals to describe the first time a company issues a dividend.
C) It is only paid to some shareholders, not all shareholders.
D) It is a one-time payment outside of the company's normal dividend schedule.

Accepted Answer

A special dividend is a one -time payment to shareholders

Question 12

What is the name of the tax system that was introduced to avoid double taxation?
A) Imputation tax system.
B) The franking system.
C) The neo-classical tax system.
D) Tax credit system.

Accepted Answer

The introduction of the imputation tax system allowed the double taxation problem to be eliminated.

Question 13

The initial decision of whether or not to pay a dividend comes from:
A) shareholder vote.
B) the Board of Directors' vote.
C) the CEO and the executive management team.
D) is written as part of the company's constitution.

Accepted Answer

The process begins with a vote by a company's board of directors to pay a dividend. As shareholder representatives, the board must approve any distribution of value to shareholders.

Question 14

Changing the amount paid for cash dividends implies which of the following:
A) the value of the company will increase/decrease.
B) the share price of the company will increase/decrease.
C) the company has had a fundamental change in their business.
D) all of the above.

Accepted Answer

It is important to recognise that we cannot interpret these studies as proof that changes in dividend policies cause changes in share prices. Rather, the cash flow identity suggests that management change dividend polices when something fundamental has changed in the business.

Question 15

Why are share buy-backs not subject to tax imputation?
A) It is not a dividend. Share buy-backs can be subject to Capital Gains Tax.
B) Because it is optional whether or not to sell your shares in a share-buy back.
C) Because the money used to purchase shares through share buy-backs are not from company profits.
D) None of the above.

Accepted Answer

Share buy-backs are taxed differently to dividends. As we saw in the discussion earlier, the total value of dividends is effectively taxed at an investors' marginal personal tax rate under the imputation tax system. In contrast, when a shareholder sells shares back to the company, the shareholder may incur capital gains tax.

Question 16

The 10/12 limit means:
A) A minimum of 10 percent of shareholders must accept the share buy-back offer.
B) Companies can offer a minimum of 10 percent and a maximum 12 percent premium for the share buy-back.
C) Only shareholders who have held their shares for a minimum of 10 months can sell up to 12 percent of their shareholding.
D) Companies can only buy back 10 per cent or less of their total shares within a 12-monthperiod. This rule is known as the 10/12 limit.

Accepted Answer

Companies can only buy back 10 per cent or less of their total shares within a 12-month period. This rule is known as the 10/12 limit.

Question 17

What are share buy backs used for?
A) Removing shareholders.
B) Signalling to the market.
C) Improving capital structure.
D) All of the above.

Accepted Answer

In terms of the motivation for share buy-backs, the on-market method was most popular to signal undervaluation. On-market buy-backs were also used for improving capital structure, signalling improving earnings per share and using surplus capital. The selective buy-backs method was most commonly used for improving capital structure and signalling improving earnings per share, as well as a method of removing shareholders. The equal access buy-back method was mainly used as a substitution for paying dividends. This method was also used to signal both undervaluation and improving earnings per share.

Question 18

Which of the following sentences are correct about share splits?
A) A share split is when shareholders are issued with additional shares.
B) A share split is another way to distribute value to shareholders.
C) None of the above.
D) All of the above.

Accepted Answer

Share split is a pro -rata distribution of new shares to existing shareholders that is not associated with any change in the assets held by the company.

Question 19

Bonus share issues and share splits have which of the following effects?
A) Always decreases the trading price of a company's shares.
B) Improves liquidity of the shares.
C) Always increases the trading price of a company's shares.
D) B and C

Accepted Answer

liquidity reasons.

Question 20

How does a bonus share issue differ from a share split?
A) They do not differ; they are both issuing new shares to existing shareholders.
B) Bonus share issues distribute value to existing shareholders; share splits remove value from existing shareholders.
C) Bonus share issues are usually issued as a percentage of existing shares, whereas a share split is usually issued as a multiples of existing shares.
D) None of the above.

Accepted Answer

A share split is quite similar to a bonus share issue, but it involves the distribution of a larger multiple of the outstanding shares. When a company pays a bonus share, it distributes new shares on a pro-rata basis to existing shareholders.

Quiz 8: Capital Structure and Dividend Policy

Which of the following statements is correct?

The managers and shareholders of a company also often behave in ways that reduce a company's value when the company becomes financially distressed. The resulting costs are a type of:

It is important to note that without financial leverage, there would be no:

Which of the following statements is incorrect?

It is important to note that without financial leverage, there would be no:

Which of the following statements is incorrect?

Which of the following statement is consistent with the trade-off theory?

Which one of the following statements is consistent with the pecking order theory?

The trade-off theory of capital structure says that managers will increase debt to the point at which:

How can dividends be distributed?

A special dividend is different to a regular cash dividend because:

What is the name of the tax system that was introduced to avoid double taxation?

The initial decision of whether or not to pay a dividend comes from:

Changing the amount paid for cash dividends implies which of the following:

Why are share buy-backs not subject to tax imputation?

The 10/12 limit means:

What are share buy backs used for?

Which of the following sentences are correct about share splits?

Bonus share issues and share splits have which of the following effects?

How does a bonus share issue differ from a share split?