Question 1

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 typically a one-time payment made by a company in addition to their regular dividend. The company may use the term "special" to indicate that it is not a recurring payment and is not part of their regular dividend policy.

Question 2

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 3

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 owned by the shareholder, but do not change the underlying value of the company. Therefore, the total value of the shareholder's investment remains the same, and their wealth should not be affected.

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

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 the dividend irrelevance theory proposed by Miller and Modigliani, the value of the firm is determined only by its basic earning power and its business risk, hence the statement is true.

Question 6

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 7

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 increase the liquidity and affordability of a stock, making it more attractive to a larger pool of investors. This, in turn, can increase demand for the stock, potentially driving up its price. However, any such benefit is likely to be small and temporary.

Question 8

In the real world, which statement regarding dividends is true?

Accepted Answer

Dividends are usually more stable than earnings because companies tend to smooth dividends over time, maintaining them even when earnings fluctuate, to provide consistent returns to shareholders.

Question 9

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

Accepted Answer

Even with perfect capital mobility, differences in taxation and investor preferences can result in different dividend yields across different stock markets.

Question 10

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

Accepted Answer

The optimal distribution policy aims to achieve the maximum stock price, which requires balancing between cash dividends and capital gains. Companies need to keep a portion of their earnings to reinvest in their business operations to generate future growth and increase their stock prices. However, they also need to provide some returns to their shareholders in the form of dividends to maintain their trust and loyalty. Finding the optimal balance between these two factors is crucial for maximizing the overall value of the company's stock.

Question 11

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 firm first funds its capital budget and then distributes the remaining funds as dividends. Therefore, if the firm has better investment opportunities, it will allocate more funds towards the capital budget, resulting in a lower payout ratio for dividends.

Question 12

A reverse split reduces the number of shares outstanding.

Accepted Answer

In a reverse split, the number of shares outstanding is reduced through a consolidation of existing shares. The reverse split ratio determines how many old shares will be consolidated into one new share, resulting in a reduced number of outstanding shares.

Question 13

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 14

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

Accepted Answer

In residual dividend policy, the two underlying objectives are to avoid dividend cuts and to maintain the target debt-to-equity (D/E) ratio.

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

According to the information content, or signalling, hypothesis, changes in dividend policy can signal information to the market about the firm's financial health and future prospects, which can affect the firm's value and capital costs. Therefore, A is the correct answer.

Question 16

If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its share price should set a low payout ratio.

Accepted Answer

If investors prefer firms that retain earnings, they likely value reinvestment for growth over immediate dividends, suggesting a low payout ratio could maximize share price.

Question 17

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's dividend policy by buying and selling shares on their own account supports the dividend irrelevance theory. According to this theory, the value of a firm is determined by its earnings capacity and the risk of its assets, and not by its dividend policy. Therefore, changes in the company's dividend policy should have no effect on the company's value or share price.

Question 18

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, investors prefer current dividends over potential future capital gains. Therefore, if a firm reduces its dividend yield, it may negatively affect the required return for investors. In order to offset this reduction and keep the required return constant, the firm must increase its growth rate by a more than proportionate amount.

Question 19

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 20

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 the value of a firm is not affected by how much it pays in dividends. However, it does suggest that the cost of capital and stock price are affected by the firm's investment and financing decisions.

Quiz 13: Distributions to Shareholders: Dividends and Repurchases