Question 1

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

Accepted Answer

If a firm's research and development efforts pay off and it now has more high-return investment opportunities, it may choose to reinvest earnings into these opportunities rather than paying out dividends. This would lead to a decrease in the dividend payout ratio.

Question 2

Which of the following statements is CORRECT?
A) One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their investment in the company.
B) One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account.
C) Stock repurchases can be used by a firm that wants to increase its debt ratio.
D) Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities.
E) One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 3

Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is lowered. Their argument is based on the assumption that
A) investors are indifferent between dividends and capital gains.
B) investors require that the dividend yield plus the capital gains yield equal a constant.
C) capital gains are taxed at a higher rate than dividends.
D) investors view dividends as being less risky than potential future capital gains.
E) investors prefer a dollar of expected capital gains to a dollar of expected dividends because of the lower tax rate on capital gains.

Accepted Answer

The answer of Myron Gordon and John Lintner believe that...

Question 4

One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest.

Accepted Answer

The answer of One advantage of dividend reinvestment plans is...

Question 5

Your firm uses the residual dividend model to set dividend policy. Market interest rates suddenly rise, and stock prices decline. Your firm's earnings, investment opportunities, and capital structure do not change. If the firm follows the residual dividend model, then its dividend payout ratio would increase.

Accepted Answer

The answer of Your firm uses the residual dividend model...

Question 6

Suppose you plotted a curve which showed a Firm U's WACC on the vertical axis and its debt ratio on the horizontal axis. Then you plotted a similar curve for Firm V. The curve for firm U resembled a shallow "U," while that for Firm V resembled a sharp "V." Both firms have debt ratios that cause their WACCs to be minimized. Other things held constant, it would be easier for Firm V than for Firm U to maintain a steady dividend in the face of varying investment opportunities and earnings from year to year.

Accepted Answer

The sharp "V" curve implies that small changes in the debt ratio can have a large impact on the WACC, indicating a high level of financial risk. This means that it would be more difficult for Firm V to maintain a steady dividend in the face of varying investment opportunities and earnings from year to year, compared to Firm U with its shallow "U" curve and lower financial risk.

Question 7

There are two types of dividend reinvestment plans. Under one type of plan, the firm uses the cash that would have been paid as dividends to buy stock on the open market. Under the other type, the company issues new stock, keeps the cash that would have been paid out, and in effect sells new stock to those investors who choose to reinvest their dividends.

Accepted Answer

The answer of There are two types of dividend reinvestment...

Question 8

If a firm declares a 20:1 stock split, and the pre-split price was $500, then we might expect the post-split price to be
$25. However, it often turns out that the post-split price will be higher than $25. This higher price could be due to signaling effects investors believe that management split the stock because they think the firm is going to do better in the future. The higher price could also be because investors like lower-priced shares.

Accepted Answer

The statement correctly explains that while a 20:1 stock split would theoretically result in a post-split price of $25, other factors such as signaling effects and investor preferences may cause the actual post-split price to be higher.

Question 9

Your firm adheres strictly to the residual dividend model. 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 firm's net income increases.
B) The company increases the percentage of equity in its target capital structure.
C) The number of profitable potential projects increases.
D) Congress lowers the tax rate on capital gains, leaving the rest of the tax code unchanged.
E) Earnings are unchanged, but the firm issues new shares of common stock.

Accepted Answer

According to the residual dividend model, dividends are paid out of residual earnings, which are the earnings that remain after all necessary investments in the business have been made. Therefore, an increase in net income would lead to an increase in residual earnings and thus an increase in the firm's dividend per share. The other choices are unlikely to directly lead to an increase in the firm's dividend per share under the residual dividend model.

Question 10

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

Accepted Answer

The residual dividend policy states that a firm will first invest in all positive NPV projects, and then distribute the remaining earnings to shareholders as dividends. If the optimal capital budget requires the use of all earnings, there will be no funds left to distribute as dividends. Therefore, the firm should not pay any dividends to common stockholders, as indicated by choice B.

Question 11

You own 100 shares of Troll Brothers' stock, which currently sells for $120 a share. The company is about to declare a 2-for-1 stock split. Which of the following best describes your likely position after the split?
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 $600 a share.

Accepted Answer

The answer of You own 100 shares of Troll Brothers'...

Question 12

Which of the following statements is CORRECT?
A) Historically, the tax code has encouraged companies to pay dividends rather than retain earnings.
B) If a company uses the residual dividend model to determine its dividend payments, dividend payout will tend to increase whenever its profitable investment opportunities increase relatively rapidly.
C) The more a firm's management believes in the clientele effect, the more likely the firm is to adhere strictly to the residual dividend model.
D) Large stock repurchases financed by debt tend to increase expected earnings per share, but they also tend to increase the firm's financial risk.
E) A dollar paid out to repurchase stock has the same tax benefit as a dollar paid out in dividends. Thus, both companies and investors should be indifferent between distributing cash through dividends and stock repurchase programs.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 13

If on January 3, 2014, a company declares a dividend of $1.50 per share, payable on January 31, 2014, then the price of the stock should drop by approximately $1.50 on January 31.

Accepted Answer

The stock price typically drops by the dividend amount on the ex-dividend date, not the payment date. The ex-dividend date is usually set a few days before the record date, which is before the payment date.

Question 14

Which of the following does NOT normally influence a firm's dividend policy decision?
A) The firm's ability to accelerate or delay investment projects without adverse consequences.
B) A strong preference by most of its shareholders for current cash income versus potential future capital gains.
C) Constraints imposed by the firm's bond indenture.
D) The fact that much of the firm's equipment is leased rather than bought and owned.
E) The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains.

Accepted Answer

The fact that much of the firm's equipment is leased rather than bought and owned is unlikely to affect the firm's dividend policy decision. The other factors listed, such as the firm's ability to invest in projects, shareholder preferences for income, bond indenture constraints, and potential tax law changes, could all influence the firm's dividend policy decision.

Question 15

If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of their dividends reinvested, the company should reconsider its dividend policy and possibly move to a lower dividend payout ratio.

Accepted Answer

If the stockholders are reinvesting all of their dividends, it may indicate that they are seeking long-term growth rather than immediate income. In this case, a lower dividend payout ratio may be more appropriate to allow the company to retain earnings and invest in future growth opportunities.

Question 16

Which of the following statements about dividend policies is CORRECT?
A) Miller and Modigliani argued that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the "bird-in-the-hand" effect.
B) One reason that companies tend to favor distributing excess cash as dividends rather than by repurchasing stock is that dividends are normally taxed at a lower rate than gains on repurchased stock.
C) One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest.
D) One key advantage of the residual dividend model is that it enables a company to follow a stable dividend policy.
E) The clientele effect suggests that companies should follow a stable dividend policy.

Accepted Answer

The answer of Which of the following statements about dividend...

Question 17

If a firm adheres strictly to the residual dividend model, the issuance of new common stock would suggest that
A) the dividend payout ratio has remained constant.
B) the dividend payout ratio is increasing.
C) no dividends will be paid during the year.
D) the dividend payout ratio is decreasing.
E) the dollar amount of capital investments had decreased.

Accepted Answer

The answer of If a firm adheres strictly to the...

Question 18

Which of the following statements is CORRECT?
A) When firms are deciding on the size of stock splits--say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used.
B) Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and reverse splits are illegal today.
C) Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits.
D) When a company declares a stock split, the price of the stock typically declines--for example, by about 50% after a 2-for-1 split--and this necessarily reduces the total market value of the firm's equity.
E) If a firm's stock price is quite high relative to most stocks-- say $500 per share--then it can declare a stock split of say 20-for-1 so as to bring the price down to something close to $25. Moreover, if the price is relatively low--say $2 per share--then it can declare a "reverse split" of say 1-for-10 so as to bring the price up to somewhere around $20 per share.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 19

Which of the following statements is CORRECT?
A) Under the tax laws as they existed in 2011, a dollar received by an individual taxpayer as interest income is taxed at the same rate as a dollar received as dividends.
B) One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends.
C) Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend. As a result, share prices fall when dividend increases are announced because investors interpret the increase as a signal that the firm expects fewer good investment opportunities in the future.
D) If a company needs to raise new equity capital, a new-stock dividend reinvestment plan would make sense. However, if the firm does not need new equity, then an open market purchase dividend reinvestment plan would probably make more sense.
E) Dividend reinvestment plans have not caught on in most industries, and today over 99% of all DRIPs are offered by utilities.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 20

If on January 3, 2014, a company declares a dividend of $1.50 per share, payable on January 31, 2014, to holders of record on January 17, then the price of the stock should drop by approximately $1.50 on January 15, which is the ex- dividend date.

Accepted Answer

The ex-dividend date is typically set one business day before the record date, so the stock price usually drops by the dividend amount on the ex-dividend date, which would be January 15 in this case.

Quiz 14: Distributions to Shareholders: Dividends and Share Repurchases

Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?

Which of the following statements is CORRECT?

Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is lowered. Their argument is based on the assumption that

One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest.

Your firm adheres strictly to the residual dividend model. All else equal, which of the following factors would be most likely to lead to an increase in the firm's dividend per share?

If a firm adheres strictly to the residual dividend policy, and if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/assets ratio) , then the firm should pay

You own 100 shares of Troll Brothers' stock, which currently sells for $120 a share. The company is about to declare a 2-for-1 stock split. Which of the following best describes your likely position after the split?

Which of the following statements is CORRECT?

If on January 3, 2014, a company declares a dividend of $1.50 per share, payable on January 31, 2014, then the price of the stock should drop by approximately $1.50 on January 31.

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

If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of their dividends reinvested, the company should reconsider its dividend policy and possibly move to a lower dividend payout ratio.

Which of the following statements about dividend policies is CORRECT?

If a firm adheres strictly to the residual dividend model, the issuance of new common stock would suggest that

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

If on January 3, 2014, a company declares a dividend of $1.50 per share, payable on January 31, 2014, to holders of record on January 17, then the price of the stock should drop by approximately $1.50 on January 15, which is the ex- dividend date.