Chapter 13 - Distributions To Shareholders Dividends And Repurchases PDF

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: s: e:CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES The dividend irrelevance theory, proposed by Miller and Modigliani, says that provided a firm pays at least some dividends, how much it pays does not affect either its cost of capital or its stock price. a. Trueb. Fals e AN...

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES 1. The dividend irrelevance theory, proposed by Miller and Modigliani, says that provided a firm pays at least some dividends, how much it pays does not affect either its cost of capital or its stock price. a. True b. Fals e ANSWER: Fals e 2. MM’s dividend irrelevance theory says that while dividend policy does not affect a firm’s value, it can affect the cost of capital. a. True b. Fals e ANSWER: Fals e 3. 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. a. True b. Fals e ANSWER: Fals e 4. Given perfect capital mobility and a global economy, dividend yields in different stock markets are similar throughout the world. a. True b. Fals e ANSWER: Fals e 5. If a firm adopts a residual distribution policy, distributions are determined as a residual after funding the capital budget. Therefore, the better the firm’s investment opportunities, the lower its payout ratio should be. a. True b. Fals e ANSWER: True 6. 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. a. True b. Fals e ANSWER: True Copyright Cengage Learning. Powered by Cognero.

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES 7. 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. a. True b. Fals e ANSWER: True 8. If the information content, or signalling, hypothesis is correct, then changes in dividend policy can have an important effect on the firm’s value and capital costs. a. True b. Fals e ANSWER: True 9. 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 distribution policy. a. True b. Fals e ANSWER: Fals e 10. If the shape of the curve depicting a firm’s WACC versus its debt ratio is more like a sharp “V,” as opposed to a shallow “U,” it will be easier for the firm to maintain a steady dividend in the face of varying investment opportunities or earnings from year to year. a. True b. Fals e ANSWER: Fals e 11. Avoiding dividend cuts and maintaining target D/E ratio are the two underlying objectives in the residual dividend policy. a. True b. Fals e ANSWER: True 12. Share repurchases result in a decrease in EPS. a. True b. Fals e ANSWER: Fals e 13. Which of the following theories is supported by the argument that shareholders can transform a company dividend Copyright Cengage Learning. Powered by Cognero.

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES policy into a different policy by means of investors buying and selling on their own account? a. “bird-in-the-hand” theory b. dividend irrelevance theory c. residual distribution model d. tax preference theory ANSWER: b 14. Which statement regarding dividends is true? a. They are usually more stable than earnings. b.They fluctuate more widely than earnings. c. They tend to be a lower percentage of earnings for mature firms. d.They are usually changed every year to reflect earnings changes, and these changes are randomly higher or lower, depending on whether earnings increased or decreased. ANSWER: a 15. A company planning to pay a cash dividend in excess of the regular dividend does not want investors to believe that such an extra dividend will be repeated. What will the firm likely call this extra dividend? a. a stock dividend b. a cash-liquidating dividend c. a special dividend d. a residual dividend ANSWER: c 16. 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 ANSWER: b 17. 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. ANSWER: b 18. 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 Copyright Cengage Learning. Powered by Cognero.

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES 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 ANSWER: c 19. 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 ANSWER: d 20. 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. ANSWER: d 21. 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. ANSWER: a 22. 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. ANSWER: c 23. 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. Copyright Cengage Learning. Powered by Cognero.

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES d. Earnings are unchanged, but the firm issues new shares of common stock. ANSWER: a 24. 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 ANSWER: b 25. 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. ANSWER: c 26. 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 ANSWER: a 27. 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. ANSWER: c 28. Which of the following statements is correct? a. One 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 Copyright Cengage Learning. Powered by Cognero.

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES 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. ANSWER: c 29. 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. ANSWER: d 30. 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. ANSWER: c 31. 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. ANSWER: d 32. 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. Copyright Cengage Learning. Powered by Cognero.

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES 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. ANSWER: b 33. 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. ANSWER: b 34. 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. ANSWER: d 35. 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. Copyright Cengage Learning. Powered by Cognero.

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES 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. ANSWER: a 36. Which action will best enable a company to raise additional equity capital? a. Declare a stock split. b. Begin an open-market purchase dividend reinvestment plan. c. Initiate a stock repurchase program. d. Begin a new-stock dividend reinvestment plan. ANSWER: d 37. Which of the following statements is NOT true? a. Stock repurchases can be used by a firm as part of a plan to change its capital structure. b.After a 3-for-1 stock split, a company’s price per share should fall, but the number of shares outstanding will rise. c. Investors can interpret a stock repurchase program as a signal that the firm’s managers believe the stock is undervalued. d.Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan. ANSWER: d 38. Which of the following statements is correct? a. If a firm follows the residual dividend policy, then a sudden increase in the number of profitable projects is likely to reduce the firm’s dividend payout. b.The clientele effect can explain why so many firms change their dividend policies so often. c. One advantage of adopting the residual dividend policy is that this policy makes it easier for corporations to develop a specific and well-identified dividend clientele. d.New-stock dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don’t change the firm’s total amount of book equity. ANSWER: a 39. Brammer Corp.’s projected capital budget is $1,000,000, its target capital structure is 60% debt and 40% equity, and its forecasted net income is $550,000. If the company follows a residual dividend policy, what total dividends, if any, will it pay out? a. $128,606 b. $135,375 c. $142,500 d. $150,000 ANSWER: d 40. Blease Inc. has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% Copyright Cengage Learning. Powered by Cognero.

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CHAPTER 13 - DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio? a. 40.61 % b. 42.75 % c. 45.00 % d. 47.37 % ANSWER: d 41. P&D Co. has a capital budget of $1,000,000. The company wants to maintain a target capital structure of 30% debt and 70% equity. The company forecasts that its net income this year will be $800,000. If the company follows a residual dividend policy, what will be its total dividend payment? a. $100,000 b. $200,000 c. $300,000 d. $400,000 ANSWER: a 42. Pate & Co. has a capital budget of $3,000,000. The company wants to maintain a target capital structure that is 15% debt and 85% equity. The company forecasts that its net income this year will be $3,500,000. If the company follows a residual dividend policy, what will be its total dividend payment? a. $205,000 b. $500,000 c. $950,000 d. $2,550,000 ANSWER: c 43. D&P Co. has a capital budget of $2,000,000. The company wants to maintain a target capital structure that is 35% debt and 65% equity. The company forecasts that its net income this year will be $1,800,000. If the company follows a residual dividend policy, what will be its total dividend payment? a. $200,000 b. $300,000 c. $400,000 d. $500,000 ANSWER: d 44. Becker Financial recently completed a 7-for-2 stock split. Prior to the split, its stock sold for $90 per share. If the total market value was unchanged by the split, what was the price of the stock following the split? a. $23.21 b. $24.43 c. $25.71 d. ...