Question 1

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

The bird-in-the-hand theory suggests that investors prefer current dividends over future capital gains, and thus a reduction in dividend yield may result in a higher required return from investors. To keep a firm's required return constant, the growth rate must more than offset the reduction in dividend yield. Therefore, the statement is true.

Question 2

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 the value of a firm is determined by its earnings and risk, rather than its dividend policy. However, it does suggest that there are certain circumstances where dividend policy could impact the firm's cost of capital and stock price. For example, if a firm abruptly changes its dividend policy, this could signal to investors that the firm's financial situation has changed, and this could affect their perception of the firm's risk and value.

Question 3

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 firm that sets a low payout ratio (which means they keep more earnings) is more likely to be attractive to these investors and therefore may see an increase in stock price.

Question 4

The optimal distribution policy strikes that balance between current 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 by finding the right balance between current dividends and reinvestment for future growth, and this can be achieved by considering factors such as the company's financial health, growth prospects, and the preferences of shareholders.

Question 5

If the signaling, hypothesis (which is also called the information content 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 signaling hypothesis, changes in dividend policy reflect information about the firm's future prospects and profitability, which can affect investors' perceptions of the firm's value and its cost of capital. Therefore, changes in dividend policy are believed to have an impact on the firm's value and capital costs.

Question 6

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 7

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 8

The following data apply to Elizabeth's Electrical Equipment: The company plans on distributing $1,000 by repurchasing stock. What will the intrinsic per share stock price be immediately after the repurchase?

Accepted Answer

The intrinsic per share stock price after a repurchase can be calculated using the formula:

Intrinsic price per share = (Total equity value – Repurchase amount) / Total shares outstanding after repurchase

Given that the repurchase amount is $1,000, the total equity value after the repurchase will be: 
$15,000 original equity value – $1,000 repurchase amount = $14,000

To determine the total shares outstanding after the repurchase, we need to know the current number of shares outstanding. Since this information is not provided, we cannot calculate the exact intrinsic per share stock price. However, we can eliminate choices A, C, D, and E since they are based on specific calculations that require the number of shares outstanding.

The only logical answer is B, which provides a general estimate that is reasonable. If the company had a small number of shares outstanding before the repurchase, the intrinsic price per share would be higher than $50, and if it had a large number of shares outstanding, the intrinsic price per share would be lower than $50.

Question 9

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 the firm's dividend policy decision since it is not related to the availability or allocation of the firm's financial resources. The other options, such as shareholder preferences, bond indenture constraints, changes in tax law, and the firm's ability to accelerate or delay investment projects, are all factors that can impact a firm's dividend policy decision.

Question 10

Which of the following statements is correct?

Accepted Answer

When a company announces a share repurchase program, it signals that it believes its stock is undervalued and that it is returning cash to shareholders, which often leads to a boost in the stock price. While it is possible for the stock price to decline following such an announcement, this is not typically the case. The other statements are incorrect.

Question 11

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 financial outlook.

Question 12

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 13

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

In a residual distribution policy, the priority is given to funding the capital budget, and the remaining amount is distributed as dividends or buybacks. If a firm has better investment opportunities, it will tend to retain more earnings and reinvest them, thus leading to a lower payout ratio.

Question 14

Which of the following statements is correct?

Accepted Answer

Large stock repurchases financed by debt increase the firm's financial risk because debt creates fixed obligations to pay interest and principal, which can squeeze the cash flow available for other uses, such as investing in growth opportunities, paying dividends, or servicing other debts. While stock repurchases can boost the earnings per share by reducing the number of shares outstanding, they do not improve the firm's underlying profitability or cash flows. Plus, the tax code treats dividends and capital gains from stock repurchases differently, so investors may have differing preferences or tax strategies for each. Therefore, companies should consider the trade-offs and signals involved in different payout policies or use of excess cash.

Question 15

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 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

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 18

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

Miller and Modigliani argued that dividend policy is irrelevant to a firm's value and that it is determined solely by its earning power and risk.

Question 19

The following data apply to Garber Industries, Inc. (GII): The company plans on distributing $100 as dividend payments. What will the intrinsic per share stock price be immediately after the distribution?

Accepted Answer

The answer of The following data apply to Garber Industries,...

Question 20

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.

Quiz 14: Distributions to Shareholders: Dividends and Repurchases

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.

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.

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.

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

If the signaling, hypothesis (which is also called the information content hypothesis) is correct, then changes in dividend policy can have an important effect on the firm's value and capital costs.

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

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.

The following data apply to Elizabeth's Electrical Equipment: The company plans on distributing $1,000 by repurchasing stock. What will the intrinsic per share stock price be immediately after the repurchase?

Which of the following should not influence a firm's dividend policy decision?

Which of the following statements is correct?

In the real world, dividends

Which of the following statements is correct?

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.

Which of the following statements is correct?

MM's dividend irrelevance theory says that while dividend policy does not affect a firm's value, it can affect the cost of capital.

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.

Which of the following statements is correct?

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.

The following data apply to Garber Industries, Inc. (GII) : The company plans on distributing $100 as dividend payments. What will the intrinsic per share stock price be immediately after the distribution?

Which of the following statements about dividend policies is correct?