Deck 15: How Taxes Affect Dividends and Share Repurchases

Question 1

Which of the following is an assumption of the Miller-Modigliani dividend irrelevancy theorem?

A)The expected rate of return of the firm is equal to the dividend growth rate.
B)The firm will make profit every year and consistently pay dividends.
C)The firm is either 100% equity financed or 100% debt financed.
D)The investment,financing and operating policies of the firm are held fixed.

Answer 1

D

Question 2

Managers prefer funding investment first with retained earnings,second,after the supply of retained earnings has been exhausted,with debt,and finally,when it is imprudent for the firm to borrow additional amounts,by issuing outside equity.This is known as the:

A)capital structure substitution theory.
B)pecking order of financing choices.
C)trade-off theory of capital structure.
D)efficient market theory.

Answer 2

B

Question 3

The combination of the corporate tax deductibility of interest payments and the personal taxes on dividends (and share repurchases)implies that:

A)individual investors with sufficiently high personal tax rates prefer financing new investment with debt.
B)taxable shareholders are indifferent to financing new projects with debt and equity.
C)taxable shareholders prefer debt financing over equity financing for funding new projects.
D)debt financing is favour by tax systems over equity financing.

Answer 3

D

Question 4

Dividend yield is the ratio of the:

A)dividend per share to the earnings per share.
B)dividend per share to the price per share.
C)dividend per share to the net income.
D)dividend per share to the book value per share.

Question 5

Investors prefer retained earnings over a cash dividend if expected returns,adjusted for their premiums due to risk,under which of the following conditions?

A)(After personal tax return outside the corporation)> (1 - T_C) $\times$ (Pre-tax return within the corporation)
B)(Pre-tax return within the corporation)> (1 - T_C)² $\times$ (After personal tax return outside the corporation)
C)(Pre-tax return within the corporation)> (1 - T_C) $\times$ (After personal tax return outside the corporation)
D)(1 - T_C) $\times$ (Pre-tax return within the corporation)> (After personal tax return outside the corporation)

Question 6

In the presence of taxes,which of the following types of investors are indifferent between receiving dividends or having the firm repurchase shares when there are no transaction costs?

A)Hedge funds
B)Pension funds
C)An individual investor in the highest tax-bracket
D)A high-net-worth individual

Question 7

Dividend payout ratio is the ratio of the:

A)dividend per share to the earnings per share.
B)dividend per share to the price per share.
C)dividend per share to the net income.
D)dividend per share to the book value per share.

Question 8

Which of the following is true of the classical tax system?

A)It has two tax rates: the personal income tax rate and the capital gains rate.
B)There is a double taxation of corporate profits.
C)Dividends are taxed at the capital gains rate.
D)Profits are taxed at the capital gains rate.

Question 9

Consider the choice between paying out earnings to shareholders versus retaining the earnings for investment.Which of the following assumptions must hold for dividend payout to either increase or decrease firm value,depending on whether there are positive NPV investment opportunities?

A)It assumes that dividend payments are irrelevant under all circumstances.
B)The firm will make profit every year and will pay dividends consistently.
C)There are no tax considerations.
D)Debt holders are indifferent to the choice between paying out earnings to shareholders versus retaining the earnings for investment.

Question 10

Which of the following is an assumption of the Miller-Modigliani dividend irrelevancy theorem?

A)The expected rate of return of the firm is equal to the dividend growth rate.
B)The firm will make profit every year and consistently pay dividends.
C)The firm is either 100% equity financed or 100% debt financed.
D)The investment,financing and operating policies of the firm are held fixed.

Question 11

Under imputation systems:

A)dividends are tax-free and capital gains are taxed
B)capital gains are taxed as ordinary income,and dividends are generally taxed at a lower rate than ordinary income.
C)dividends are taxed as ordinary income,and capital gains are generally taxed at a lower rate than ordinary income.
D)ordinary taxes payable on dividends are partly offset by the tax credit from taxes paid by the corporation.

Question 12

Explain the Miller-Modigliani dividend irrelevancy theorem.

Question 13

The tax preference for debt financing versus internal equity financing:

A)depends on the investing cash flows of the firm.
B)depends on the beta of the new projects.
C)depends on the personal tax rates of shareholders.
D)depends on the corporate tax rates of competing firms.

Question 14

In a classical tax system,_____.

A)dividends are taxed as ordinary income,and capital gains taxed at a lower rate than ordinary income
B)dividends are tax-free and capital gains are taxed
C)investors who receive taxable dividends get a tax credit for part or all of the taxes paid by the corporation
D)the tax credit partly offsets the personal taxes the investors must pay on dividend income

Question 15

Compare the classical and imputation tax systems.

Question 16

Which of the following is true of the impact of tax on dividends?

A)The immediate tax liability is considerably higher with dividend payments than share repurchases.
B)When the dividends are paid,the share prices will drop by the amount of tax on dividend.
C)Double taxation on dividends makes equity a more favourable financing options for firms.
D)Low dividend taxes cause corporations to rely too much on equity rather than debt financing.

Question 17

Which of the following is true of dividend yields?

A)Dividend yields have no influence on the price of the equity.
B)Equities with high dividend yields are fundamentally same as the equities with low dividend yields in terms of their risk profiles.
C)Equities with high dividend yields have higher returns than equities with low dividend yields.
D)An increase in dividends will always increase the equity?s required rate of return.

Question 18

Explain how personal taxes influence investment choices.

Question 19

How does the dividend policy affect expected equity returns?