Question 1

Which circumstance should NOT influence a firm's dividend policy decision?
A) the firm's ability to accelerate or delay investment projects
B) a strong preference by most shareholders for current cash income versus capital gains
C) Constraints imposed by the firm's bond indenture
D) the fact that much of the firm's equipment has been leased, rather than bought and owned

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. This is because the decision to lease or own equipment is typically made separately from the decision on how much to pay out in dividends, and leasing does not directly affect the firm's cash position or ability to pay dividends.

Question 2

Which of the following statements is correct?
A) If a firm repurchases some of its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes.
B) An open-market dividend reinvestment plan will be most attractive to companies that need new equity and would otherwise have to issue additional shares of common stock through investment bankers.
C) Stock repurchases tend to reduce financial leverage.
D) If a company declares a 2-for-1 stock split, its stock price should roughly double.

Accepted Answer

When shareholders sell their stock for more than they paid for it, they realize a capital gain, which is subject to capital gains taxes. Therefore, statement A is correct. Statement B is incorrect as an open-market dividend reinvestment plan does not provide new equity to the company, rather it provides an option for shareholders to reinvest their dividends to purchase additional shares of the company's stock. Statement C is also incorrect as stock repurchases tend to increase financial leverage, not reduce it. Statement D is incorrect as a 2-for-1 stock split does not change the underlying value of the company or its shares, it only increases the number of outstanding shares and reduces the price per share proportionally.

Question 3

You own 100 shares of Troll Brothers stock, which currently sells for $120 a share. The company is contemplating a 2-for-1 stock split. What will your position be after such a split takes place?
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 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.

Accepted Answer

A 2-for-1 stock split means that for every one share you own, you will receive two shares of stock. Therefore, your 100 shares will become 200 shares after the split. However, the stock price will also adjust accordingly, meaning that the new price per share will be half of the original price per share. Therefore, after the split, the stock will trade at or near $60 a share.

Question 4

If a firm adheres strictly to the residual dividend policy, what would the issuance of new common stock suggest?
A) The dividend payout ratio has remained constant.
B) The dividend payout ratio is increasing.
C) No dividends were paid during the year.
D) The dividend payout ratio is decreasing.

Accepted Answer

With a strict adherence to the residual dividend policy, new common stock issuance would suggest that the firm did not generate enough funds for its planned capital expenditures and dividend payments. As a result, it would have to issue new common stock to raise the necessary funds, indicating that no dividends were paid during the year.

Question 5

Which of the following statements is correct?
A) Firms with a lot of good investment opportunities and a relatively small amount of cash tend to have above-average payout ratios.
B) One advantage of the residual dividend policy is that it leads to a stable dividend payout, which investors like.
C) An increase in the stock price when a company decreases its dividend is consistent with signalling theory as postulated by MM.
D) Stock repurchases make the most sense at times when a company believes its stock is undervalued.

Accepted Answer

Stock repurchases make the most sense when a company believes its stock is undervalued because it allows the company to buy back its own shares at a lower price and reduce the number of outstanding shares, which can increase the earnings per share and potentially increase the stock price in the future. A is incorrect because firms with a lot of good investment opportunities may retain more earnings for future investments rather than paying out dividends. B is incorrect because the residual dividend policy does not necessarily lead to a stable payout since dividends are only paid out from leftover earnings after investment opportunities have been funded. C is incorrect because signaling theory suggests that a decrease in dividend may indicate negative information about the company, leading to a decrease in stock price.

Question 6

Which of the following statements best describes stock splits?
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) 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.
C) When a company declares a stock split, the price of the stock typically declines-by about 50% after a 2-for-1 split-and this necessarily reduces the total market value of the equity.
D) 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 10-for-1 so as to bring the price down to something close to $50. Moreover, if the price is relatively low-say, $2 per share-then it can declare a "reverse split" of, say, 1-for-25 so as to bring the price up to somewhere around $50 per share.

Accepted Answer

Option D correctly describes stock splits and provides a specific example of a 10-for-1 split to bring the price down and a reverse split to bring the price up. Option A is incorrect because the size of the split does not necessarily determine the after-split price. Option B is incorrect because stock splits do not create significant administrative problems for investors and are still used frequently. Option C is incorrect because the price decline after a stock split is not necessarily 50%.

Question 7

Which statement about dividend policies is correct?
A) Stock splits, stock dividends, and reverse splits are all designed to make the firm's shares more appealing to the average investor.
B) Dividend reinvestment plans are designed to aid in the distribution of stock dividends.
C) The key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy.
D) The main goal of the share repurchases is solely to avoid taxes for investors.

Accepted Answer

Stock splits, stock dividends, and reverse splits are methods companies use to adjust the number of shares outstanding and the share price, making the stock more appealing or accessible to investors. These actions can influence investor perception and stock market performance, but they do not directly impact the company's value.

Question 8

Suppose a firm adheres strictly to the residual dividend policy and 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). What should the firm pay?
A) no dividends except out of past retained earnings
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 selling off fixed assets

Accepted Answer

Under a residual dividend policy, a firm pays dividends from the leftover (residual) earnings after all optimal investment opportunities are funded. If all earnings are needed for the optimal capital budget, there would be no residual earnings to pay dividends, hence no dividends to common stockholders.

Question 9

Which circumstance 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 R&D 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.

Accepted Answer

If a firm's R&D efforts pay off and it now has more high-return investment opportunities, it may choose to reinvest its earnings back into the company rather than distribute them as dividends. This would lead to a decrease in the dividend payout ratio.

Question 10

Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. On which assumption is their argument based?
A) that investors require that the dividend yield and capital gains yield equal a constant
B) that capital gains are taxed at a higher rate than dividends
C) that investors view dividends as being less risky than potential future capital gains
D) that investors value a dollar of expected capital gains more highly than a dollar of expected dividends because of the lower tax rate on capital gains

Accepted Answer

Gordon and Lintner's argument is based on the assumption that investors perceive dividends as less risky than future capital gains. This is because dividends provide immediate, tangible returns, whereas capital gains are dependent on future market conditions and thus are considered more uncertain.

Question 11

Which of the following statements is correct?
A) Current Canadian tax law encourages companies to pay dividends rather than retain earnings.
B) If a company uses the residual dividend model to determine its dividend payments, dividend payouts will tend to increase whenever the company's profitable investment opportunities increase.
C) The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model.
D) Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm's financial risk.

Accepted Answer

Large stock repurchases financed by debt can indeed increase a company's earnings per share (EPS) because they reduce the number of outstanding shares. However, financing these repurchases with debt increases the company's leverage, which in turn increases its financial risk.

Question 12

Which of the following statements is correct?
A) One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive.
B) If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should NOT follow the strict residual dividend policy.
C) If a firm follows a strict residual dividend policy, then, holding all else constant, its dividend payout ratio will tend to rise whenever the firm's investment opportunities improve.
D) Despite its drawbacks, following the residual dividend policy will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees.

Accepted Answer

Dividend reinvestment plans do not allow investors to avoid taxes on dividends. A strict residual dividend policy would not align with a high dividend payout preference. A strict residual dividend policy would decrease the payout ratio with more investment opportunities. The residual dividend policy does not stabilize dividends.

Question 13

Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is correct?
A) Firm M probably has a lower debt ratio than Firm N.
B) Firm M probably has a higher dividend payout ratio than Firm N.
C) If the corporate tax rate increases, the debt ratio of both firms is likely to decline.
D) Firm N is likely to have a clientele of shareholders who want to receive consistent, stable dividend income.

Accepted Answer

Firm M, being in a mature industry with stable and high net income but limited growth prospects, is more likely to distribute a higher portion of its earnings as dividends. This contrasts with Firm N, which, being in a growth phase, would likely reinvest most of its earnings to fuel further growth.

Question 14

Which of the following statements is correct?
A) One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends.
B) Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend, and as a result, share prices fall when dividend increases are announced. The reason for this is that investors interpret the increase as a signal that the firm has relatively few good investment opportunities.
C) If a company wants to raise new equity capital steadily over time, a new stock dividend reinvestment plan would make sense. However, if the firm does not want or need new equity, then an open market purchase dividend reinvestment plan would probably make more sense.
D) Dividend reinvestment plans have not caught on in most industries, and today about 99% of all companies with DRIPs are utilities.

Accepted Answer

A new stock dividend reinvestment plan allows a company to issue new shares, raising new equity capital. If a company does not need new equity, an open market purchase plan, where shares are bought on the market, is more appropriate.

Question 15

Which of the following statements is correct?
A) One disadvantage of dividend reinvestment plans is that they increase transaction costs for investors who want to increase their ownership 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) One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding.

Accepted Answer

Stock repurchases can be used by a firm to adjust its capital structure, including increasing its debt ratio. When a company buys back its own shares, it can finance this action through debt, effectively increasing the proportion of debt relative to equity in its capital structure.

Question 16

Trenton Publishing follows a strict residual dividend policy. All else being equal, which circumstance 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) Earnings are unchanged, but the firm issues new shares of common stock.

Accepted Answer

Since Trenton Publishing follows a strict residual dividend policy, the dividend per share will increase only if there is an increase in net income. This is because residual dividend policy states that dividends are paid only after all profitable projects have been financed and retained earnings requirements have been met. Therefore, an increase in net income will result in more funds being available for dividends. The other options do not directly impact the dividend per share policy.

Question 17

Which of the following statements is correct?
A) If a company has a 2-for-1 stock split, its stock price should roughly double.
B) Capital gains earned in a share repurchase are taxed less favourably than dividends; this explains why companies typically pay dividends and avoid share repurchases.
C) Very often, a company's stock price will rise when it announces that it plans to commence a share repurchase program. Such an announcement could lead to a stock price decline, but this does not normally happen.
D) The clientele effect is the best explanation for why companies tend to vary their dividend payments from quarter to quarter.

Accepted Answer

C) This statement is correct because a share repurchase announcement often signals to the market that the company's management believes its stock is undervalued, which can lead to an increase in stock price. The other options contain inaccuracies regarding stock splits, taxation of capital gains vs. dividends, and dividend payment patterns.

Question 18

Which statement about dividend policies is correct?
A) 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.
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) The 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.

Accepted Answer

The clientele effect suggests that companies attract a certain type of investor based on their dividend policy, and thus, it supports the idea that companies should maintain a stable dividend policy to keep their investor base satisfied.

Question 19

What are automatic dividend reinvestment plans designed to do?
A) aid shareholders in creating their preferred dividend policy
B) raise new equity capital for the firm through market repurchases
C) eliminate excess illiquid shares from the open market
D) help investors avoid paying taxes on dividends

Accepted Answer

Automatic dividend reinvestment plans are designed to aid shareholders in creating their preferred dividend policy by automatically using dividends to purchase additional shares of the company's stock, thus reinvesting their earnings back into the company.

Question 20

What is the chronology of a dividend payment?
A) declaration date, holder-of-record date, ex-dividend date, payment date
B) declaration date, ex-dividend date, holder-of-record date, payment date
C) declaration date, holder-of-record date, payment date, ex-dividend date
D) holder-of-record date, declaration date, ex-dividend date, payment date

Accepted Answer

1. Declaration date: This is when the company declares that it will be paying a dividend to its shareholders.
2. Ex-dividend date: This is the date on or after which any new buyers of the stock will not receive the upcoming dividend. The stock price will typically decrease by the amount of the dividend on this day.
3. Holder-of-record date: This is the date by which investors must be on the company's books as a shareholder to receive the dividend.
4. Payment date: This is when the dividend is actually paid out to the shareholders who were on record as of the holder-of-record date.

Quiz 13: Distributions to Shareholders: Dividends and Repurchases

Which circumstance should NOT influence a firm's dividend policy decision?

Which of the following statements is correct?

You own 100 shares of Troll Brothers stock, which currently sells for $120 a share. The company is contemplating a 2-for-1 stock split. What will your position be after such a split takes place?

If a firm adheres strictly to the residual dividend policy, what would the issuance of new common stock suggest?

Which of the following statements is correct?

Which of the following statements best describes stock splits?

Which statement about dividend policies is correct?

Suppose a firm adheres strictly to the residual dividend policy and 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) . What should the firm pay?

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

Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. On which assumption is their argument based?

Which of the following statements is correct?

Which of the following statements is correct?

Which of the following statements is correct?

Which of the following statements is correct?

Trenton Publishing follows a strict residual dividend policy. All else being equal, which circumstance would be most likely to lead to an increase in the firm's dividend per share?

Which of the following statements is correct?

Which statement about dividend policies is correct?

What are automatic dividend reinvestment plans designed to do?

What is the chronology of a dividend payment?