Question 1

The federal government sometimes taxes dividends and capital gains at different rates.Other things held constant,if the tax rate on dividends is high relative to that on capital gains,then individuals with low taxable incomes should favor stocks with low payouts and high-income individuals should favor high-payout companies.

Accepted Answer

False

Question 2

Other things held constant,the higher a firm's target payout ratio,the higher its expected growth rate should be.

Accepted Answer

The higher a firm's payout ratio, the lower the funds it retains for reinvestment in growth opportunities. Therefore, a higher payout ratio would generally lead to a lower expected growth rate, not a higher one.

Question 3

If a retired individual lives on his or her investment income,then it would make sense for this person to prefer stocks with high payouts so he or she could receive cash without going to the trouble and expense of selling stocks.On the other hand,it would make sense for an individual who would just reinvest any dividends received to prefer a low-payout company because that would save him or her taxes and brokerage costs.

Accepted Answer

The statement accurately describes the preferences of retired individuals and those who reinvest dividends.

Question 4

Suppose a firm that has been earning $2 and paying a dividend of $1.00,or a 50% dividend payout,announces that it is increasing the dividend to $1.50.The stock price then jumps from $20 to $30.Some people would argue that this is proof that investors prefer dividends to retained earnings.Miller and Modigliani would agree with this argument.

Accepted Answer

Miller and Modigliani's dividend irrelevance theory suggests that the stock price is determined by the firm's earnings and not by its dividend policy. Therefore, the increase in dividend payout should not affect the stock price. The jump in stock price could be attributed to other factors, such as an increase in earnings or changes in market conditions.

Question 5

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

Accepted Answer

The optimal distribution policy aims to balance current dividends and reinvesting earnings for future growth in a way that maximizes the long-term value of the company and hence its stock price.

Question 6

If a firm uses the residual dividend model to set dividend policy,then dividends are determined as a residual after providing for the equity required to fund the capital budget.Under this model,the higher the firm's debt ratio,the lower its payout ratio will be,other things held constant.

Accepted Answer

The answer of If a firm uses the residual dividend...

Question 7

If the information content,or signaling,hypothesis is correct,then a change in a firm's dividend policy can have an important effect on its stock price and cost of equity.

Accepted Answer

According to the information content or signaling hypothesis, a change in a firm's dividend policy can signal important information to investors and affect their perceptions of the firm's future prospects, leading to changes in the stock price and cost of equity. Hence, the statement is true.

Question 8

The announcement of an increase in the cash dividend should,according to MM,lead to an increase in the price of the firm's stock,other things held constant.

Accepted Answer

The answer of The announcement of an increase in the...

Question 9

A 100% stock dividend and a 2:
1 stock split should,at least conceptually,have the same effect on the firm's stock price.

Accepted Answer

Both a 100% stock dividend and a 2:1 stock split increase the number of shares outstanding while maintaining the overall value of the company. Therefore, they should have the same effect on the stock price.

Question 10

Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on either its cost of capital or its stock price.

Accepted Answer

According to Miller and Modigliani's dividend irrelevance theory, the percentage of earnings a firm pays out in dividends does not affect its cost of capital or stock price. This is because investors can create their own desired payout by selling shares if the firm retains earnings, or buying more shares if the firm pays out dividends. Therefore, the firm's payout policy does not affect the overall value of the firm.

Question 11

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 theory states that the value of a firm is not affected by its dividend policy, but rather by its earning power and business risk.

Question 12

If a firm uses the residual dividend model to set dividend policy,then dividends are determined as a residual after providing for the equity required to fund the capital budget.Under this model,the better the firm's investment opportunities,the lower its payout ratio will be,other things held constant.

Accepted Answer

In the residual dividend model, dividends are determined as a residual after providing for the equity required for capital expenditures. Therefore, if a firm has more investment opportunities, it will require more equity to finance those opportunities and will have less left over for dividends, resulting in a lower payout ratio.

Question 13

If 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 dividend policy.

Accepted Answer

The answer of If management wants to maximize its stock...

Question 14

Some investors prefer dividends to retained earnings (and the capital gains retained earnings bring),while others prefer retained earnings to dividends.Other things held constant,it makes sense for a company to establish its dividend policy and stick to it,and then it will attract a clientele of investors who like that policy.

Accepted Answer

It is true that establishing a consistent dividend policy can attract a certain type of investor who prefers regular dividend payments. This can create a loyal shareholder base and help to stabilize the company's stock price. However, there are also reasons why some investors may prefer retained earnings and capital gains rather than dividends, such as the potential for higher growth and future returns. Ultimately, the decision on whether to pay dividends or retain earnings should depend on the company's financial situation and goals.

Question 15

The federal government sometimes taxes dividends and capital gains at different rates.Other things held constant,an increase in the tax rate on dividends relative to that on capital gains would logically lead to an increase in dividend payout ratios.

Accepted Answer

An increase in the tax rate on dividends relative to that on capital gains would reduce the after-tax return on dividends compared to capital gains, which would make companies less likely to pay dividends and more likely to retain earnings for investment. Therefore, it would lead to a decrease in dividend payout ratios, not an increase.

Question 16

A "reverse split" reduces the number of shares outstanding.

Accepted Answer

In a reverse split, the number of shares outstanding is reduced by combining multiple shares into one. This means that the total number of outstanding shares decreases, while the value of each individual share increases proportionally.

Question 17

Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on its cost of capital,but it does affect its stock price.

Accepted Answer

The answer of Miller and Modigliani's dividend irrelevance theory says...

Question 18

If 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

If investors prefer firms that retain most of their earnings, a low payout ratio will indicate to investors that the firm is retaining more earnings and may lead to an increase in the firm's stock price. Therefore, a firm that wants to maximize its stock price should set a low payout ratio.

Question 19

It has been argued that investors prefer high-payout companies because dividends are more certain (less risky)than the capital gains that are supposed to come from retained earnings.However,Miller and Modigliani say that this argument is incorrect,and they call it the "bird-in-the-hand fallacy." MM base their argument on the belief that most dividends are reinvested in stocks,hence are exposed to the same risks as reinvested earnings.

Accepted Answer

Miller and Modigliani argue that most dividends are reinvested in stocks and are therefore exposed to the same risks as reinvested earnings. Therefore, the argument that investors prefer high-payout companies because dividends are less risky than capital gains is incorrect.

Question 20

One 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

According to the bird-in-the-hand theory of dividends, investors prefer current dividends over future capital gains because of the inherent uncertainty about the future. Therefore, if a firm reduces its dividend yield, investors may perceive it as a signal of lower future growth prospects, which could lead to a higher required return. To offset this effect, the firm must increase its growth rate by more than the reduction in dividend yield to keep the required return constant, other things held constant. This is known as the "dividend irrelevance proposition" in finance.

Quiz 15: Distributions to Shareholders: Dividends and Share Repurchases