Question 1

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.What will your position be after such a split takes place?

Accepted Answer

A 2-for-1 stock split means that for every one share you own, you will receive an additional share. So, your 100 shares will become 200 shares. However, the stock price will be adjusted to reflect the split, meaning it will likely trade at or near $60 a share after the split. Therefore, you will have 200 shares of stock, and the stock will trade at or near $60 a share.

Question 2

Which statement regarding dividends is true?

Accepted Answer

Dividends are typically more stable than earnings because companies strive to maintain a consistent dividend payout to signal financial health and stability to investors, even when earnings may fluctuate.

Question 3

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

Accepted Answer

Perfect capital mobility and a global economy would mean that investors have the ability to freely move their capital across borders, leading to a single global market for capital. However, dividend yields are determined by individual companies based on their financial performance and decisions made by their management. Therefore, dividend yields can still vary greatly between different stock markets and companies, even with perfect capital mobility.

Question 4

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 5

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

Accepted Answer

The two underlying objectives in the residual dividend policy are indeed avoiding dividend cuts and maintaining the target debt/equity ratio.

Question 6

Which of the following theories is supported by the argument that shareholders can transform a company dividend policy into a different policy by means of investors buying and selling on their own account?

Accepted Answer

The argument that shareholders can transform a company dividend policy into a different policy by means of investors buying and selling on their own account supports the dividend irrelevance theory. This theory suggests that the company's dividend policy has no effect on its value, because shareholders can achieve their desired cash flows by buying and selling shares on their own. Therefore, any change in the dividend policy will have no impact on the company's overall value.

Question 7

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 prefer receiving dividends now rather than future capital gains, assuming that the dividend payout is certain. Therefore, reducing the dividend yield would reduce the attractiveness of the stock to investors and the required return would increase unless there is a more than proportionate increase in growth to compensate for the loss in dividend yield.

Question 8

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 nor its cost of capital, assuming perfect capital markets, no taxes, and no transaction costs.

Question 9

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 the firm is determined only by its basic earning power and its business risk, and not by its dividend policy.

Question 10

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, actually states that a firm's dividend policy is irrelevant to its value, cost of capital, or stock price, assuming perfect capital markets, no taxes, and no transaction costs. It does not condition this irrelevance on the payment of some dividends; rather, it suggests that whether a firm pays high dividends, low dividends, or no dividends at all does not affect its valuation.

Question 11

Share repurchases result in a decrease in EPS.

Accepted Answer

Share repurchases reduce the number of outstanding shares, which typically results in an increase in Earnings Per Share (EPS) if all other factors remain constant.

Question 12

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

Accepted Answer

Gordon and Lintner's argument is based on the assumption that investors perceive dividends as less risky than future capital gains. This is because dividends provide immediate, tangible returns, whereas capital gains are dependent on future market conditions and thus are considered more uncertain.

Question 13

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 a one-time payment to shareholders that is separate from the regular dividend payout. The company can make it clear that it is a special, or one-time, dividend and not expected to be repeated in the future. This avoids creating an expectation of a higher regular dividend in the future, which could be difficult for the company to sustain. Option A, stock dividends, involve the distribution of additional shares instead of cash and are not relevant in this context. Option B, cash-liquidating dividends, are paid when a company is going out of business or selling off assets, and also do not apply in this scenario. Option D, residual dividends, refer to dividends paid after all required investments have been made, and are also not indicative of a one-time, special dividend.

Question 14

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 higher WACC at low and high debt ratios, meaning that the cost of debt and equity is very high for the firm. This makes it harder 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 lower WACC at moderate levels of debt, making it easier for the firm to maintain a steady dividend.

Question 15

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 signaling hypothesis suggests that changes in dividend policy can signal important information to investors about a firm's prospects and future earnings potential. Thus, changes in dividend policy can affect investor perceptions of the firm's value, which can in turn impact the firm's capital costs. Therefore, this statement is true.

Question 16

What is the chronology of a dividend payment?

Accepted Answer

The chronology of a dividend payment starts with the declaration date where the company announces the dividend amount and the ex-dividend date. The ex-dividend date is the date when the investors can buy or sell the company's shares without affecting their right to receive the dividend. Then the holder-of-record date is when the company determines the eligible shareholders who will receive the dividend. Lastly, the payment date is when the dividend is actually paid to the eligible shareholders. Therefore, the correct chronology of a dividend payment is the declaration date, ex-dividend date, holder-of-record date, and payment date, which is represented by option B.

Question 17

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 18

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

This statement is true as per the residual distribution policy. Under this policy, a firm first funds its capital budget and then determines the amount available for distribution to its shareholders as a residual. Therefore, if a firm has better investment opportunities, it would allocate more funds towards capital budgeting, resulting in a lower payout ratio.

Question 19

Which statement about dividend policies is correct?

Accepted Answer

The clientele effect suggests that companies attract a certain type of investor based on their dividend policy, and thus, it supports the idea that companies should maintain a stable dividend policy to keep their investor base satisfied.

Question 20

Which circumstance 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 is not a relevant factor in determining a firm's dividend policy. The other options are all relevant factors that could impact a firm's dividend decision.

Quiz 13: Distributions to Shareholders: Dividends and Repurchases