Question 1

Company X has 100 shares outstanding.It earns $1,000 per year and announces that it will use all $1,000 to repurchase its shares in the open market instead of paying dividends.Calculate the number of shares outstanding at the end of year 1, after the first share repurchase, if the required rate of return is 10 percent.
A)110
B)100
C)90.91
D)89

Accepted Answer

The cost of the repurchase is $1,000, and at a required rate of return of 10%, the price per share is  $10 ($1000/100 shares). Therefore, 100/($10) = 10 shares will be repurchased. As a result, the number of shares outstanding will be reduced to 100 - 10 = 90.91 shares, which is answer choice C.

Question 2

One possible reason that shareholders often insist on higher dividends is
A)they agree with Miller and Modigliani.
B)the capital gains tax disadvantage.
C)the stock market is efficient.
D)they do not trust managers to spend retained earnings wisely.

Accepted Answer

Shareholders may insist on higher dividends because they do not trust managers to spend retained earnings wisely. They may prefer receiving cash dividends instead of allowing the company to retain earnings and possibly invest in projects that may not provide a high enough return on investment.

Question 3

A firm in Australia earns a pretax profit of $A10 per share.Suppose that it pays a corporate tax of $3 per share (30 percent tax rate) in taxes.The firm pays the remaining $A7 in dividends to a shareholder in the 30 percent marginal tax bracket.What is the amount of additional tax paid by the shareholder under an imputation tax system?
A)$A2.10
B)$A0
C)$A3
D)$A5.10

Accepted Answer

Under an imputation tax system, the shareholder receives a tax credit for the corporate tax already paid, so no additional tax is paid by the shareholder.

Question 4

If dividends are taxed more heavily than capital gains, then investors
A)should be willing to pay more for stocks with low dividend yields.
B)should be willing to pay more for stocks with high dividend yields.
C)should be willing to pay the same for stocks regardless of their dividend yields.
D)should be willing to pay more for stocks having infrequent share repurchases.

Accepted Answer

Investors would prefer stocks with low dividend yields because the lower dividends mean they would incur less tax liability compared to stocks with high dividend yields, assuming capital gains are taxed at a lower rate.

Question 5

Even if both dividends and capital gains are taxed at the same ordinary income tax rate, the effect of each type of tax is different because
A)capital gains are actually taxed, while dividends are taxed on paper only.
B)dividends are taxed when distributed, while capital gains are deferred until the stock is sold.
C)both dividends and capital gains are taxed every year.
D)capital gains are actually taxed, while dividends are taxed on paper; and both dividends and capital gains are taxed every year.

Accepted Answer

Dividends are taxed when they are distributed to shareholders, while capital gains are only taxed when an asset is sold. This means that capital gains can be deferred until a more advantageous tax year, while dividends cannot be deferred. Therefore, the effect of each type of tax is different.

Question 6

The following are indicators that the firm has a cash surplus:.
A)Competitors' stock prices are dropping.
B)The firm has a low debt ratio compared to similar firms.
C)The firm has sufficient debt capacity to cover unexpected opportunities or setbacks.
D)Competitors' stock prices are dropping, the firm has a low debt ratio compared to similar firms, and the firm has sufficient debt capacity to cover unexpected opportunities or setbacks.

Accepted Answer

A cash surplus can be indicated by a combination of factors, including competitors' stock prices dropping (indicating the firm is performing better than its competitors), having a low debt ratio compared to similar firms (indicating the firm has less debt to service and more cash on hand), and having sufficient debt capacity to cover unexpected opportunities or setbacks (indicating the firm has access to additional funds if needed). Therefore, the best choice is D.

Question 7

Company X has 100 shares outstanding.It earns $1,000 per year and expects to pay all of it as dividends.If the firm expects to maintain this dividend forever, calculate the stock price today.(The required rate of return is 10 percent.)
A)$110
B)$100
C)$90
D)$10

Accepted Answer

The price of the stock can be calculated using the perpetual dividend formula: Stock Price = Dividend / Required Rate of Return.
Stock Price = $1,000 / 0.10 = $10, therefore the correct answer is B.

Question 8

Company X has 100 shares outstanding.It earns $1,000 per year and expects to pay all of it as dividends.If the firm expects to maintain this dividend forever, calculate the stock price after the dividend payment.(The required rate of return is 10 percent.)
A)$110
B)$100
C)$90
D)$10

Accepted Answer

We can use the Gordon growth model to solve for the stock price: 
P = D / (r - g)
where P is the stock price, D is the dividend, r is the required rate of return, and g is the expected growth rate of dividends. In this case, there is no expected growth rate of dividends, so g = 0.

Plugging in the numbers: 
P = 1,000 / (0.10 - 0) 
P = 10,000 / 1 
P = 10,000

However, we need to adjust for the fact that the dividend has already been paid out. The total amount paid out in dividends is 100 shares * $1,000 = $100,000. So each share received $1,000 / 100 = $10 in dividends.

Thus, the stock price after the dividend payment will be: 
P' = P - $10 
P' = $10,000 - $10 
P' = $9,990

Therefore, the correct answer is B, $100.

Question 9

If the corporate tax rate is 35 percent, what is the maximum effective tax rate on dividends received by another corporation?
A)35 percent
B)30 percent
C)10.5 percent
D)65 percent

Accepted Answer

The maximum effective tax rate on dividends received by another corporation would be 35% - (35% x 0.7) = 10.5%. This is because the dividends received would have already been taxed at the corporate level at 35%, but the receiving corporation is only taxed on 65% of the dividend amount (35% is excluded as it is already taxed at the corporate level).

Question 10

Miller and Modigliani's indifference proposition regarding dividend policy
A)assumes that tax rates increase at the same rate as inflation.
B)assumes that investors can sell their stock at a fair price.
C)states that investors are indifferent between stock dividends and cash dividends.
D)states that investors are indifferent between stock repurchases and cash dividends.

Accepted Answer

Miller and Modigliani's indifference proposition assumes investors can sell their stock at a fair price, meaning there are no transaction costs or informational asymmetries that would prevent an investor from realizing the full value of their investment. The proposition states that investors are indifferent between stock dividends and cash dividends if they can sell their stock at a fair price, but it does not address tax rates or stock repurchases.

Question 11

According to behavioral finance, investors prefer dividends because
A)investors prefer the discipline that comes from spending only the dividends.
B)dividends generate lower taxes.
C)the stock market is efficient.
D)dividends provide a tax deduction.

Accepted Answer

According to behavioral finance, investors prefer dividends because they prefer the discipline that comes from spending only the dividends. This is known as the "mental accounting" theory, where investors like to categorize their income into specific buckets, such as dividends for spending and capital gains for reinvestment. This provides a sense of control and helps them stick to their financial goals. Dividends do not necessarily generate lower taxes or provide a tax deduction, and the efficiency of the stock market is still debated in the field of finance.

Question 12

Two corporations A and B have exactly the same risk, and both have a current stock price of $100.Corporation A pays no dividend and will have a price of $120 one year from now.Corporation B pays dividends and will have a price of $113 one year from now after paying the dividend.The corporations pay no taxes and investors pay no taxes on capital gains, but pay a 30 percent income tax on dividends.What is the value of the dividend that investors expect corporation B to pay one year from today?
A)$7
B)$13
C)$10
D)$20

Accepted Answer

Since both corporations have exactly the same risk, the investors would expect the same rate of return from both corporations. Let's assume that the rate of return is r. 
For Corporation A: 
Current Stock Price = $100 
Future Stock Price = $120 
Rate of return (r) = (120-100)/100 = 0.2 or 20%

For Corporation B: 
Current Stock Price = $100 
Future Stock Price after paying dividend = $113 
Let the dividend per share be x 
After paying the dividend, the price of the stock would be: 
(100-x) + (x*(1-0.3)) = 113 
Solving for x, we get x = $10 
So investors expect Corporation B to pay a dividend of $10 per share one year from today.

Question 13

If investors do not like dividends because of the additional taxes that they have to pay, how would you expect stock prices to behave on the ex-dividend date?
A)Fall by more than the amount of the dividend
B)Fall exactly by the amount of the dividend
C)Fall by less than the amount of the dividend
D)The result cannot be predicted.

Accepted Answer

If investors dislike dividends due to tax implications, they may value the dividend less, leading to a smaller drop in stock price on the ex-dividend date compared to the dividend amount.

Question 14

The rightist position is that the market will reward firms for having
A)a high dividend yield.
B)a low dividend yield
C)good management, regardless of dividend yield.
D)a zero payout policy.

Accepted Answer

The answer of The rightist position is that the market...

Question 15

Which of the following investors has the strongest tax reason to prefer dividends over capital gains?
A)Pension funds
B)Financial institutions
C)Individuals
D)Corporations

Accepted Answer

The answer of Which of the following investors has the...

Question 16

The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy:
A)Changes in investment policy will alter dividend policy.
B)Changes in dividend policy will alter investment policy.
C)Investment policy is independent of dividend policy.
D)Dividends are tax-deductible and investments are depreciable.

Accepted Answer

The dividend-irrelevance proposition of Miller and Modigliani states that the value of the firm is determined by its investment policy and not by its dividend policy. In other words, dividend policy is irrelevant in determining the value of the firm. Therefore, investment policy is independent of dividend policy.

Question 17

Consider the payout policies of U.S.firms from 2003-2013.Which category had the highest percentage of firms?
A)Firms that paid dividends and repurchased shares
B)Firms that paid dividends but did not repurchase shares
C)Firms that paid no dividends but did repurchase shares
D)Firms that paid no dividends and did not repurchase shares

Accepted Answer

During the period from 2003-2013, the majority of U.S. firms did not pay dividends or repurchase shares, making this category the largest in terms of the percentage of firms.

Question 18

A key assumption of the Miller and Modigliani (MM) dividend irrelevance argument is that
A)future stock prices are certain.
B)firms have an adequate supply of Treasury shares.
C)there exists a risk-free asset.
D)new shares are sold at a fair price.

Accepted Answer

The Miller and Modigliani dividend irrelevance theory assumes that new shares are sold at a fair price, among other assumptions, implying that the financing decisions (like dividend payments) do not affect the firm's value in a perfect market.

Question 19

A firm in Australia earns a pretax profit of $A10 per share.Suppose that it pays a corporate tax of $3 per share (30 percent tax rate) in taxes.The firm pays the remaining $A7 in dividends to a shareholder in the 40 percent marginal tax bracket.What is the amount of additional tax paid by the shareholder under an imputation tax system?
A)$A1
B)$0
C)$A4
D)$A5.80

Accepted Answer

The answer of A firm in Australia earns a pretax...

Question 20

Dividend policy may affect firm value because
A)there is an unsatisfied clientele that prefers dividends to capital gains.
B)there is an unsatisfied clientele that prefers dividends to capital gains, and there are sufficient loopholes in the tax system that wealthy shareholders can avoid taxes on dividends.
C)there is an unsatisfied clientele that prefers dividends to capital gains, and well-managed companies prefer to signal their worth by paying high dividends.
D)there are sufficient loopholes in the tax system that wealthy shareholders can avoid taxes on dividends, and well-managed companies prefer to signal their worth by paying high dividends.

Accepted Answer

The unsatisfied clientele theory suggests that firms should match their dividend policy with the preferences of their investors to maximize the firm's value. Well-managed companies may prefer to signal their worth by paying high dividends, which may attract investors who prefer income over capital gains. Loopholes in the tax system may provide an additional incentive for investors to prefer dividends over capital gains, but this is not the only reason for the impact of dividend policy on firm value.

Quiz 16: Payout Policy

One possible reason that shareholders often insist on higher dividends is

If dividends are taxed more heavily than capital gains, then investors

Even if both dividends and capital gains are taxed at the same ordinary income tax rate, the effect of each type of tax is different because

The following are indicators that the firm has a cash surplus:.

Company X has 100 shares outstanding.It earns $1,000 per year and expects to pay all of it as dividends.If the firm expects to maintain this dividend forever, calculate the stock price today.(The required rate of return is 10 percent.)

Company X has 100 shares outstanding.It earns $1,000 per year and expects to pay all of it as dividends.If the firm expects to maintain this dividend forever, calculate the stock price after the dividend payment.(The required rate of return is 10 percent.)

If the corporate tax rate is 35 percent, what is the maximum effective tax rate on dividends received by another corporation?

Miller and Modigliani's indifference proposition regarding dividend policy

According to behavioral finance, investors prefer dividends because

If investors do not like dividends because of the additional taxes that they have to pay, how would you expect stock prices to behave on the ex-dividend date?

The rightist position is that the market will reward firms for having

Which of the following investors has the strongest tax reason to prefer dividends over capital gains?

The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy:

Consider the payout policies of U.S.firms from 2003-2013.Which category had the highest percentage of firms?

A key assumption of the Miller and Modigliani (MM) dividend irrelevance argument is that

Dividend policy may affect firm value because