Question 1

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, a firm's dividend policy has no impact on its cost of capital or stock price.

Question 2

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

False

Question 3

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

False

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 argued that in a perfect capital market, the value of the firm is independent of its dividend policy. The increase in stock price could simply be due to the fact that the market expects higher future cash flows due to the increase in dividend, but this does not necessarily indicate a preference for dividends over retained earnings.

Question 5

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

The residual dividend model prioritizes funding the capital budget before distributing dividends. If a company has better investment opportunities, it may require more equity to fund those opportunities, leaving less available for dividend payments and resulting in a lower payout ratio.

Question 6

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

The answer of The federal government sometimes taxes dividends and...

Question 7

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

The answer of The federal government sometimes taxes dividends and...

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

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, it means that they prefer firms with a low payout ratio, which leaves more earnings for the company to invest in future growth opportunities. Therefore, in order to maximize its stock price, a firm should set a low payout ratio to appeal to these investors.

Question 10

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 the "bird-in-the-hand fallacy" is incorrect and that most dividends are reinvested in stocks, exposing them to the same risks as reinvested earnings. Therefore, investors preferring high-payout companies solely for the perceived lower risk of dividends may not be entirely accurate.

Question 11

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 less retained earnings it has available for investment in growth opportunities. Therefore, a higher payout ratio is typically associated with a lower expected growth rate.

Question 12

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 outstanding shares, which dilutes the value of each individual share. As a result, the stock price should adjust to reflect the increase in supply of shares and maintain the overall market capitalization of the company. Therefore, the effects on the stock price should be similar for both actions.

Question 13

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/signaling hypothesis, a change in a firm's dividend policy can signal important information to investors, which can result in changes in stock price and cost of equity. Therefore, the statement is true.

Question 14

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

Accepted Answer

This statement is true as the ultimate goal of any company is to maximize its stock price and it can be achieved by finding the optimal balance between current dividends and reinvesting profits for future growth that will lead to capital gains.

Question 15

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 16

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

Accepted Answer

In a reverse split, the number of shares outstanding is reduced and the value of each share is increased proportionally.

Question 17

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

This implication is true according to the bird-in-the-hand theory of dividends, which suggests that investors value a current dividend payout more than the potential for future growth, requiring a higher rate of return for investments with lower dividend yields. Therefore, a reduction in dividend yield must be offset by a more than proportionate increase in growth to maintain a firm's required return, other things held constant.

Question 18

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 proposed that the value of the firm is determined by its basic earning power and its business risk, and that dividends are irrelevant to determining the firm's value.

Question 19

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

This statement is true. Establishing a consistent dividend policy helps a company attract investors who prefer that type of investment strategy.

Question 20

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

This statement is true. A retired individual who relies on investment income would benefit from high-paying stocks as it would provide cash without the need to sell stocks. On the other hand, an individual who plans to reinvest dividends would benefit from low-payout companies to save on taxes and brokerage costs.

Quiz 14: Distribution to Shareholders: Dividends and Share Repurchases