Question 1

Which of the following should NOT influence a firm's dividend policy decision?
A) A strong preference by most shareholders for current cash income versus capital gains.
B) Constraints imposed by the firm's bond indenture.
C) The fact that much of the firm's equipment has been leased rather than bought and owned.
D) The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains.
E) The firm's ability to accelerate or delay investment projects.

Accepted Answer

The fact that much of the firm's equipment has been leased rather than bought and owned should not influence a firm's dividend policy decision as it is not directly related to the firm's financial health or its ability to pay dividends. The other options listed can have direct or indirect impacts on the firm's financial health, legal constraints, or shareholder preferences, which can influence the firm's dividend policy decision.

Question 2

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, under perfect market conditions, the value of a firm is determined by its earning power and the risk of its underlying assets, and the payment of dividends has no impact on the firm's overall value or cost of capital. However, this theory assumes perfect market conditions, which are not always present in the real world. In addition, some investors may prefer certain dividend policies and may factor them into their investment decisions, which can in turn affect the firm's stock price.

Question 3

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. If a firm has better investment opportunities, it should prioritize funding those opportunities first before distributing any excess funds to shareholders. As a result, the payout ratio (the percentage of earnings paid out as dividends) would be lower in order to retain more funds for investing in growth opportunities.

Question 4

Industries' stock currently sells for $120 a shareYou own 100 shares of the stockThe company is contemplating a 2-for-1 stock split Which of the following best describes what your position will be after such a split takes place?
A) You will have 200 shares of stock, and the stock will trade at or near $60 a share.
B) You will have 100 shares of stock, and the stock will trade at or near $60 a share.
C) You will have 50 shares of stock, and the stock will trade at or near $120 a share.
D) You will have 50 shares of stock, and the stock will trade at or near $60 a share.
E) You will have 200 shares of stock, and the stock will trade at or near $120 a share.

Accepted Answer

A 2-for-1 stock split means that for every one share you currently own, you will receive two shares. Therefore, if you currently own 100 shares, after the split you will have 200 shares (100 x 2). However, the stock price will adjust to reflect the split, so instead of trading at $120 a share, the stock will trade at or near $60 a share ($120/2). Therefore, your position will be 200 shares of stock with a value of approximately $60 per share.

Question 5

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 high sensitivity of WACC to changes in debt ratio, making it harder to maintain steady dividends due to increased financial risk and cost of capital volatility.

Question 6

the information content, or signaling, 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 valuable information to the market and impact the firm's value and capital costs. Therefore, if this hypothesis is correct, changes in dividend policy can have an important effect on the firm.

Question 7

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

While a stock split may not provide new information or an increased dividend per share, it can still make the shares more affordable and accessible to a wider range of investors, potentially increasing demand and raising the stock price. However, any resulting benefit is likely to be relatively small compared to other factors affecting the stock's value.

Question 8

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

Accepted Answer

The dividend irrelevance theory, proposed by Modigliani and Miller, suggests that dividend policy does not affect a firm's value or its cost of capital in a perfect market.

Question 9

Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?
A) Its access to the capital markets increases.
B) Its R&D efforts pay off, and it now has more high-return investment opportunities.
C) Its accounts receivable decrease due to a change in its credit policy.
D) Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.
E) Its earnings become more stable.

Accepted Answer

If a firm's R&D efforts pay off, it will have more high-return investment opportunities, which would likely lead to a decrease in the firm's dividend payout ratio. This is because the firm may prioritize reinvesting its earnings into these opportunities rather than paying out a portion of its earnings as dividends. Options A, C, D, and E do not necessarily have a direct impact on the firm's dividend payout ratio.

Question 10

reverse split reduces the number of shares outstanding.

Accepted Answer

A reverse split involves reducing the number of shares outstanding by combining multiple shares into a single share. Therefore, there are fewer shares but each share has a higher value.

Question 11

Which of the following statements about dividend policies is CORRECT?
A) One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than gains on 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) One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy.
D) The clientele effect suggests that companies should follow a stable dividend policy.
E) Modigliani and Miller argue that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the "bird-in-the hand" effect.

Accepted Answer

The clientele effect suggests that companies should follow a stable dividend policy because different groups of investors, or clienteles, prefer different dividend policies. Companies can attract and retain investors by maintaining a consistent dividend policy that aligns with the preferences of their target clientele.

Question 12

Reynolds Paper Products Corporation follows a strict residual dividend policy All else equal, which of the following factors would be most likely to lead to an increase in the firm's dividend per share?
A) The company increases the percentage of equity in its target capital structure.
B) The number of profitable potential projects increases.
C) Congress lowers the tax rate on capital gains. The remainder of the tax code is not changed.
D) Earnings are unchanged, but the firm issues new shares of common stock.
E) The firm's net income increases.

Accepted Answer

Since Reynolds follows a residual dividend policy, the dividend paid is based on the firm's net income. Therefore, an increase in net income would lead to an increase in the firm's dividend per share.

Question 13

a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio), then the firm should pay
A) no dividends to common stockholders.
B) dividends only out of funds raised by the sale of new common stock.
C) dividends only out of funds raised by borrowing money (i.e., issue debt).
D) dividends only out of funds raised by selling off fixed assets.
E) no dividends except out of past retained earnings.

Accepted Answer

The residual dividend policy dictates that dividends should only be paid after all necessary investments in new projects and debt repayment have been made. If the optimal capital budget requires the use of all earnings and new debt to meet these investment needs, there would be no funds left to pay dividends. Therefore, the best choice is option A, which states that no dividends should be paid to common stockholders.

Question 14

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

Investors may prefer firms that retain earnings for reinvestment in growth opportunities, potentially leading to higher future returns and stock prices.

Question 15

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's dividend irrelevance theory argues that the value of a firm is determined by its earning power and business risk, and not by its dividend policy.

Question 16

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

Accepted Answer

The statement is true. An optimal distribution policy is one that distributes the right amount of dividends and retains the right amount of earnings to maximize the firm's stock price. It seeks to balance the shareholders' desire for current income (dividends) with their desire for future capital gains.

Question 17

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 of dividends suggests that investors value dividends more than potential future capital gains. Therefore, a reduction in dividend yield (i.e. less dividends paid out) must be offset by a more than proportionate increase in growth (i.e. higher potential for future capital gains) in order to maintain a constant required return for investors.

Question 18

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 (MM) dividend irrelevance theory, dividend policy does not affect the value of a firm or its stock price in a perfect market.

Question 19

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 held by shareholders, while decreasing the price per share proportionally. Therefore, the total value of the shares held by the shareholder remains the same, and there is no impact on their wealth.

Question 20

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 answer of management wants to maximize its stock price,...

Quiz 17: Dividends

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