Question 1

Which of the following statements is most correct?
A) If a firm repurchases its stock in the open market, the shareholders that tender are subject to capital gains taxes.
B) If you own 100 shares in a company's stock, and the company does a 2- for-1 stock split, you will own 200 shares in the company following the split.
C) Some dividend reinvestment plans increase the amount of equity capital available to the firm.
D) All of the statements above are correct.
E) Answers a and b are correct.

Accepted Answer

All the statements are correct: A) Shareholders who tender their shares in a repurchase may face capital gains taxes. B) A 2-for-1 stock split doubles the number of shares owned. C) Dividend reinvestment plans can increase a firm's equity capital.

Question 2

Which of the following statements is most correct?
A) One advantage of stock repurchases is that they are generally taxed more favorably than dividend payments.
B) One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive.
C) Stock repurchases make sense if a company is interested in increasing its equity ratio.
D) Stock repurchases make sense if a company believes that its stock is overvalued and that it has a lot of profitable projects to fund over the next year.
E) One advantage of an open market dividend reinvestment plan is that it increases the number of shares the company has outstanding.

Accepted Answer

Stock repurchases are taxed more favorably than dividend payments because they are considered a capital gain, which has a lower tax rate than ordinary income.

Question 3

Modigliani and Miller (MM) argued that dividend policy is irrelevant. On the other hand, Gordon and Lintner (GL) argued that dividend policy does matter. GL's argument rests on the contention that
A) rs = D1/P0 + g is constant for any dividend policy.
B) Because of perceived differences in risk, investors value a dollar of dividends more highly than a dollar of expected capital gains.
C) Investors, because of tax differentials, value a dollar of expected capital gains more highly than a dollar of dividends.
D) Most investors will reinvest rather than spend dividends, so it would save investors money (taxes) if corporations simply reinvested earnings rather than paid them out as dividends.
E) None of the answers above.

Accepted Answer

Gordon and Lintner argue that investors value a dollar of dividends more highly than a dollar of expected capital gains because of perceived differences in risk. This means that dividend policy does matter, as it can affect how investors value the stock and ultimately impact the stock price.

Question 4

Which of the following statements is most correct?
A) "New-stock" dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don't change the total equity of a firm.
B) Investors receiving stock dividends must pay taxes on the new shares at the time the stock dividends are received.
C) Stockholders pay no income tax on dividends reinvested in a dividend reinvestment plan.
D) Both statements a and b are correct.
E) None of the statements above is correct.

Accepted Answer

Explanation: Statement A is incorrect because while both increase the number of shares, stock dividends do not change total equity, but new-stock DRIPs can increase equity. Statement B is incorrect because stock dividends are generally not taxed until sold. Statement C is incorrect as reinvested dividends are typically taxed as income.

Question 5

Which of the following statements is most correct?
A) One reason that companies tend to avoid stock repurchases is that dividend payments are taxed more favorably than stock repurchases.
B) One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest.
C) If a company announces a 2-for-1 stock split and the overall value of the firm remains unchanged, the company's stock price must have doubled.
D) All of the statements above are correct.
E) None of the statements above is correct.

Accepted Answer

None of the statements are correct. A) is incorrect because stock repurchases are often taxed more favorably than dividends. B) is incorrect because dividends are taxable even if reinvested. C) is incorrect because a 2-for-1 stock split halves the stock price, not doubles it.

Question 6

Which of the following statements is most correct?
A) In general, stock repurchases are taxed the same way as dividends.
B) One nice feature of dividend reinvestment plans is that they enable investors to reduce the taxes paid on their dividends.
C) On average, companies send a negative signal to the marketplace when they announce an increase in their dividend.
D) If a company is interested in issuing new equity capital, a new stock dividend reinvestment plan probably makes more sense than an open market dividend reinvestment plan.
E) Statements b and d are correct.

Accepted Answer

A new stock dividend reinvestment plan allows the company to issue new shares directly to investors, which can be beneficial if the company is looking to raise new equity capital.

Question 7

If a firm adheres strictly to the residual distribution policy with all distributions in the form of dividends), then if its optimal capital budget requires the use of all earnings for that year (along with new debt according to the optimal debt/total assets ratio), the firm should pay
A) No dividends except out of past retained earnings.
B) No dividends to common stockholders.
C) Dividends, in effect, out of a new issue of common stock.
D) Dividends by borrowing the money (debt).
E) Either c or d above could be used.

Accepted Answer

Under the residual distribution policy, dividends are paid only from leftover earnings after all optimal capital budget needs are met. If all earnings are required for the capital budget, no dividends are paid.

Question 8

Which of the following statements is most correct?
A) The tax preference theory states that, all else equal, investors prefer stocks that pay low dividends because retained earnings can lead to capital gains that are taxed preferentially.
B) An increase in the cost of equity capital (rs) when a company announces an increase in its dividend per share would be consistent with the bird-in-the-hand theory.
C) An increase in the stock price when a company decreases its dividend is consistent with the signaling theory.
D) A dividend policy that involves paying a consistent percentage of net income is the best policy if the "clientele effect" is correct.
E) Both statements a and d are correct.

Accepted Answer

The tax preference theory explains that investors prefer stocks that pay low dividends because retained earnings can lead to capital gains that are taxed preferentially. The statement in option A correctly explains this theory, making it the most correct statement among the given options. Option B is incorrect as an increase in dividend per share should decrease the cost of equity capital according to the bird-in-the-hand theory. Option C is also incorrect as an increase in stock price after a dividend decrease is not consistent with the signaling theory. Option D is partially correct as consistent dividend percentage is preferred when the clientele effect is correct, but it is not mentioned whether it is the best policy overall, making option A a better selection. Thus, option A is the most correct statement.

Question 9

A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?
A) Cash.
B) Common stock.
C) Paid-in capital.
D) Retained earnings.
E) None of the above.

Accepted Answer

The answer of A stock split will cause a change...

Question 10

If a firm adheres strictly to the residual distribution policy (with all distributions in the form of dividends), a sale of new common stock by the company would suggest that
A) The dividend payout ratio has remained constant.
B) The dividend payout ratio is increasing.
C) No dividends were paid for the year.
D) The dividend payout ratio is decreasing.
E) The dollar amount of investments has decreased.

Accepted Answer

Under the residual distribution policy, dividends are paid only after all profitable investment opportunities are funded. If the company is selling new stock, it indicates that internal funds were insufficient to cover investments, leaving no residual funds for dividends.

Question 11

Which of the following statements is most correct?
A) An open-market dividend reinvestment plan is likely to be attractive to companies that are looking to issue additional shares of common stock.
B) Stock repurchases have the effect of reducing financial leverage.
C) If a company does a 2-for-1 stock split, its stock price will roughly double.
D) All of the answers above are correct.
E) None of the answers above is correct.

Accepted Answer

An open-market dividend reinvestment plan does not involve issuing new shares, stock repurchases increase financial leverage by reducing equity, and a 2-for-1 stock split halves the stock price, not doubles it.

Question 12

If the MM hypothesis about dividends is correct, and if one found a group of companies that differed only with respect to dividend policy, which of the following statements would be most correct?
A) The residual distribution model should not be used, because it is inconsistent with the MM dividend hypothesis.
B) The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends.
C) If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D1/P0 = a + b(g)) would be equal to +1.0.
D) None of the statements above is true.
E) All of the statements above are true.

Accepted Answer

The MM hypothesis suggests that dividend policy is irrelevant to a firm's value, so none of the statements accurately reflect this theory.

Question 13

Which of the following statements is most correct?
A) The tax preference hypothesis suggests that companies can reduce their costs of capital by increasing their dividend payout ratios.
B) One advantage of the residual distribution policy (with all distributions as dividends) is that it leads to a stable dividend payout, which is desired by investors.
C) Firms with a large number of investment opportunities and a relatively small amount of cash tend to have above average dividend payouts.
D) Answers a and b are correct.
E) None of the answers above is correct.

Accepted Answer

The tax preference hypothesis suggests that investors prefer capital gains over dividends due to tax advantages, not increasing dividend payouts. The residual distribution policy does not necessarily lead to stable dividends, as it depends on investment opportunities. Firms with many investment opportunities and limited cash typically have lower dividend payouts.

Question 14

Which of the following statements is most correct?
A) The bird-in-the-hand theory would predict that companies could decrease their cost of equity financing by raising their dividend payout.
B) The clientele effect can explain why firms often change their dividend policies.
C) One advantage of adopting a residual distribution policy (with all distributions in the form of dividends) is that it makes it easier for corporations to maintain dividend clienteles.
D) Answers a and c are correct.
E) None of the answers above is correct.

Accepted Answer

The answer of Which of the following statements is most...

Question 15

Which of the following statements is most correct?
A) The tax code encourages companies to pay large dividends to their shareholders.
B) If your company has established a clientele of investors who prefer large dividends, the company is unlikely to adopt a residual dividend policy.
C) If a firm follows a residual distribution policy (with all distributions in the form of dividends), holding all else constant, its dividend payout will tend to rise whenever the firm's investment opportunities improve.
D) All of the statements above are correct.
E) Answers b and c are correct.

Accepted Answer

The answer of Which of the following statements is most...

Question 16

You currently own 100 shares of stock in Beverly Brothers Inc. The stock currently trades at $120 a share. The company is contemplating a 2-for-1 stock split. Which of the following best describes your position after the proposed stock split takes place?
A) You will have 200 shares of stock, and the stock will trade at or near $120 a share.
B) You will have 200 shares of stock, and the stock will trade at or near $60 a share.
C) You will have 100 shares of stock, and the stock will trade at or near $60 a share.
D) You will have 50 shares of stock, and the stock will trade at or near $120 a share.
E) You will have 50 shares of stock, and the stock will trade at or near $60 a share.

Accepted Answer

A 2-for-1 stock split means that for every share you own, you will receive an additional share. Therefore, if you currently own 100 shares, after the split you will have 200 shares. However, the stock price will likely decrease proportionally to the split, so the new trading price for each share will be around $60 ($120/2).

Question 17

Which of the following statements is most correct?
A) If a company puts in place a 2-for-1 stock split, its stock price should roughly double.
B) Share repurchases are taxed less favorably than dividends; this explains why companies typically pay dividends and avoid share repurchases.
C) On average, a company's stock price tends to rise when it announces that it is initiating a share repurchase program.
D) Statements a and b are correct.
E) All of the statements above are correct.

Accepted Answer

While statement A may seem logical, a stock split does not in itself change the value of the company or its earnings. The stock price will adjust to reflect the split, but the total value of the investor's holdings will remain the same. Statement B is also incorrect - share repurchases can be more tax-efficient than dividends, as they do not trigger taxes until the investor sells the shares. Statement C is the most correct, as share repurchases can indicate that a company has confidence in its future earnings and may lead to an increase in demand for the stock.

Question 18

Which of the following statements is most correct?
A) Companies can repurchase shares either (1) to change their capital structures or (2) to distribute cash to stockholders without paying cash dividends. In the second situation, tax considerations will probably play a key role in the decision to repurchase stock versus to pay more cash dividends.
B) Stock dividends provide investors with additional shares of stock, not cash, yet many investors must pay cash in the form of taxes on the value of the stock dividends. For this reason, stock dividends are rarely used today.
C) The bird-in-the-hand theory of dividend policy could be rejected immediately if personal income taxes were abolished.
D) If the curve relating the WACC and the debt ratio looks like a sharp 'V', this would make it more feasible for a firm to follow the residual dividend policy than if the curve looks like a shallow bowl (or a shallow 'U').
E) The open market type of dividend reinvestment plan is the best type for firms that need to bring in new equity capital.

Accepted Answer

A is the most correct statement as it accurately describes the reasons for companies to repurchase shares and acknowledges the role of tax considerations in such decisions. Option B is incorrect as stock dividends are still commonly used and the tax implications vary depending on the investor's individual tax situation. Option C is incorrect as the bird-in-the-hand theory is based on the preference of investors for current dividends over potential future capital gains, irrespective of tax considerations. Option D is incorrect as the shape of the WACC-debt ratio curve does not impact the feasibility of the residual dividend policy. Option E is incorrect as the type of dividend reinvestment plan that is best suited for a firm depends on multiple factors, including the firm's specific needs and circumstances.

Question 19

Which of the following statements is most correct?
A) If a company wants to issue new shares of common stock and also wants to implement a dividend reinvestment plan, then it should implement a new-stock dividend reinvestment plan, rather than an open-market purchase plan.
B) If a company undertakes a 3-for-1 stock split, then the number of shares outstanding should fall, and the stock price should rise.
C) If a company wants to reduce its debt ratio, then it should repurchase some of its common stock.
D) Answers a and c are correct.
E) Answers b and c are correct.

Accepted Answer

The answer of Which of the following statements is most...

Question 20

Which of the following statements is most correct?
A) If the dividend irrelevance theory (which is associated with the names Modigliani and Miller) were exactly correct, and if this theory could be tested with "clean" data, then we would find, in a regression of dividend yield and capital gains, a line with a slope of -1.0.
B) The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy.
C) If a company raises its dividend by an unexpectedly large amount, the announcement of this new and higher dividend is generally accompanied by an increase in the stock price. This is consistent with the bird-in-the-hand theory, and Modigliani and Miller used these findings to support their position on dividend theory.
D) If it could be demonstrated that a clientele effect exists, this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs.
E) Each of the statements above is false.

Accepted Answer

According to the dividend irrelevance theory by Modigliani and Miller, dividends do not affect a company's value. If this theory holds, a regression of dividend yield and capital gains would show a slope of -1.0, indicating that any increase in dividends would be offset by a decrease in capital gains, keeping the total return constant.

Quiz 17: Distributions to Shareholders

Which of the following statements is most correct?

Which of the following statements is most correct?

Modigliani and Miller (MM) argued that dividend policy is irrelevant. On the other hand, Gordon and Lintner (GL) argued that dividend policy does matter. GL's argument rests on the contention that

Which of the following statements is most correct?

Which of the following statements is most correct?

Which of the following statements is most correct?

If a firm adheres strictly to the residual distribution policy with all distributions in the form of dividends) , then if its optimal capital budget requires the use of all earnings for that year (along with new debt according to the optimal debt/total assets ratio) , the firm should pay

Which of the following statements is most correct?

A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?

If a firm adheres strictly to the residual distribution policy (with all distributions in the form of dividends) , a sale of new common stock by the company would suggest that

Which of the following statements is most correct?

If the MM hypothesis about dividends is correct, and if one found a group of companies that differed only with respect to dividend policy, which of the following statements would be most correct?

Which of the following statements is most correct?

Which of the following statements is most correct?

Which of the following statements is most correct?

You currently own 100 shares of stock in Beverly Brothers Inc. The stock currently trades at $120 a share. The company is contemplating a 2-for-1 stock split. Which of the following best describes your position after the proposed stock split takes place?

Which of the following statements is most correct?

Which of the following statements is most correct?

Which of the following statements is most correct?

Which of the following statements is most correct?