IFM10 Ch 17 Test Bank - This document is used for Intermeiate financial management course by E. F. Brigham PDF

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CHAPTER 17 DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: (17) Optimal distribution policy Answer: a Diff: E 1 . The optimal distribution policy for a firm strikes a balance between current dividends and capital gains, and ...

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CHAPTER 17 DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES (Difficulty: E = Easy, M = Medium, and T = Tough)

True-False Easy: (17.3) Optimal distribution policy Answer: a Diff: E 1 . The optimal distribution policy for a firm strikes a balance between current dividends and capital gains, and results in the maximization of stock price. a. True b. False (17.3) Dividend irrelevance Answer: b Diff: E 2 . The dividend irrelevance theory, proposed by Miller and Modigliani, says that as long as a firm pays a dividend, how much it pays does not affect either its cost of capital or its stock price. a. True b. False (17.3) Dividend irrelevance Answer: b Diff: E 3 . MM's dividend irrelevance theory says that dividend policy does not affect a firm's value but can affect its cost of capital. a. b.

True False

(17.3) Investor's dividend preference Answer: a Diff: E 4 . If investors do, in fact, prefer that firms retain most of their earnings, then firms that want to maximize stock price should hold dividend payments to low levels. a. b.

True False

(17.3) Dividends and stock prices Answer: b Diff: E 5 . The announcement of an increase in the cash dividend always causes an increase in the price of the firm's common stock. a. True b. False

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(17.7) Residual distribution policy Answer: a Diff: E 6 . If a firm adopts a residual distribution policy, distributions are determined as a residual item. Therefore, the better the firm's investment opportunities, the lower its distributions should be. a. True b. False (17.13) Stock dividends and splits Answer: a Diff: E 7 . A stock dividend and a stock split should, at least conceptually, have the same effect on shareholders’ wealth. a. True b. False (17.13) Reverse split Answer: a 8 . A reverse split reduces the number of shares outstanding.

Diff: E

a. True b. False

Medium: (17.3) Dividend irrelevance Answer: a Diff: M 9 . 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. False (17.3) Dividend irrelevance Answer: b Diff: M 10 . A firm that follows a residual distribution policy must believe that the dividend irrelevance theory is correct. a. True b. False

(17.3) Dividend-growth tradeoff Answer: a Diff: M . One implication of the bird-in-the-hand theory of dividends is that a 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.

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a. True b. False

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(17.3) WACC and dividend policy Answer: b Diff: M 12 . 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", the easier it will be for the firm to maintain a steady dividend in the face of varying investment opportunities from year to year. a. True b. False (17.5) Signaling hypothesis Answer: a Diff: M . If the information content, or signaling, hypothesis is correct, then changes in dividend policy can be important with respect to firm value and capital costs.

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a. True b. False (17.13) Stock split Answer: a Diff: M . Even if a stock split has no information content, and even if the dividend per share adjusted for the split does not increase, there can still be a real benefit (i.e., a higher value for shareholders) from such a split, but any such benefit is probably small.

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a. True b. False

Multiple Choice: Conceptual Easy: (17.3) Dividends versus capital gains Answer: d Diff: E 15 . Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that a. Investors are indifferent between dividends and capital gains. b. Investors require that the dividend yield and capital gains yield equal a constant. c. Capital gains are taxed at a higher rate than dividends. d. Investors view dividends as being less risky than potential future capital gains. e. 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.

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(17.3) Dividend theories 16 . Which of the following statements best investors’ preferences for dividends?

describes

Answer: e Diff: E the theories of

a. Modigliani and Miller argue that investors prefer dividends to capital gains. b. The bird-in-hand theory suggests that a company can reduce its cost of equity capital by reducing its dividend payout ratio. c. The tax preference theory suggests that a company can increase its stock price by increasing its dividend payout ratio. d. One key advantage of a residual distribution policy (with all distributions as dividends) is that it enables a company to follow a stable dividend policy. e. The clientele effect suggests that companies should follow a stable dividend policy. (17.3) Dividend theory and policy 17 . Which of the following statements is most correct?

Answer: c

Diff: E

a. The bird-in-the-hand theory implies that a company can reduce its WACC by reducing its dividend payout. b. The bird-in-the-hand theory implies that a company can increase its stock price by reducing its dividend payout. c. One problem with following a residual distribution policy (with all distributions in the form of dividends) is that it can lead to erratic dividend payouts that may prevent the firm from establishing a reliable clientele of investors who prefer a particular dividend policy. d. Statements a and c are correct. e. All of the statements above are correct. (17.3) Optimal distribution policy Answer: e Diff: E 18 . Which of the following would not have an influence on the optimal distribution policy? a. The possibility of accelerating or delaying investment projects. b. A strong shareholders' preference for current income versus capital gains. c. Bond indenture constraints. d. The costs associated with selling new common stock. e. All of the statements above can have an effect on dividend policy. (17.6) Dividend payout 19 . In the real world, we find that dividends a. b. c. d. e.

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Answer: a

Diff: E

Usually exhibit greater stability than earnings. Fluctuate more widely than earnings. Tend to be a lower percentage of earnings for mature firms. Are usually changed every year to reflect earnings changes. Are usually set as a fixed percentage of earnings.

Chapter 17: Distributions to Shareholders

(17.6) Dividend payout Answer: c Diff: E 20 . A decrease in a firm's willingness to pay dividends is likely to result from an increase in its a. b. c. d. e.

Earnings stability. Access to capital markets. Profitable investment opportunities. Collection of accounts receivable. Stock price.

(17.13) Stock split Answer: e Diff: E . A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?

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a. b. c. d. e.

Cash. Common stock. Paid-in capital. Retained earnings. None of the above.

(17.13) Stock split Answer: b Diff: E . You currently own 100 shares of stock in Beverly Brothers Inc. The stock currently trades at $120 a share. The company is contemplating a 2-for-1 stock split. Which of the following best describes your position after the proposed stock split takes place?

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a. You will have 200 shares near $120 a share. b. You will have 200 shares near $60 a share. c. You will have 100 shares near $60 a share. d. You will have 50 shares of $120 a share. e. You will have 50 shares of $60 a share.

of stock, and the stock will trade at or of stock, and the stock will trade at or of stock, and the stock will trade at or stock, and the stock will trade at or near stock, and the stock will trade at or near

(17.14) Stock repurchases and DRIPs 23 . Which of the following statements is most correct?

Answer: a

Diff: E

a. One advantage of stock repurchases is that they are generally taxed more favorably than dividend payments. b. One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive. c. Stock repurchases make sense if a company is interested in increasing its equity ratio. d. Stock repurchases make sense if a company believes that its stock is overvalued and that it has a lot of profitable projects to fund over the next year. e. One advantage of an open market dividend reinvestment plan is that it increases the number of shares the company has outstanding.

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(17.14) Dividends, DRIPs, and repurchases 24 . Which of the following statements is most correct?

Answer: d

Diff: E

a. In general, stock repurchases are taxed the same way as dividends. b. One nice feature of dividend reinvestment plans is that they enable investors to reduce the taxes paid on their dividends. c. On average, companies send a negative signal to the marketplace when they announce an increase in their dividend. d. If a company is interested in issuing new equity capital, a new stock dividend reinvestment plan probably makes more sense than an open market dividend reinvestment plan. e. Statements b and d are correct. (17.14) Repurchases, DRIPs, and stock splits 25 . Which of the following statements is most correct?

Answer: e

Diff: E

a. One reason that companies tend to avoid stock repurchases is that dividend payments are taxed more favorably than stock repurchases. 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. If a company announces a 2-for-1 stock split and the overall value of the firm remains unchanged, the company’s stock price must have doubled. d. All of the statements above are correct. e. None of the statements above is correct. (Comp.) Miscellaneous dividend concepts 26 . Which of the following statements is most correct?

Answer: c

Diff: E

a. If a company puts in place a 2-for-1 stock split, its stock price should roughly double. b. Share repurchases are taxed less favorably than dividends; this explains why companies typically pay dividends and avoid share repurchases. c. On average, a company’s stock price tends to rise when it announces that it is initiating a share repurchase program. d. Statements a and b are correct. e. All of the statements above are correct.

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Chapter 17: Distributions to Shareholders

(Comp.) Miscellaneous concepts 27 . Which of the following statements is most correct?

Answer: e

Diff: E

a. The tax preference hypothesis suggests that companies can reduce their costs of capital by increasing their dividend payout ratios. b. One advantage of the residual distribution policy (with all distributions as dividends) is that it leads to a stable dividend payout, which is desired by investors. c. Firms with a large number of investment opportunities and a relatively small amount of cash tend to have above average dividend payouts. d. Answers a and b are correct. e. None of the answers above is correct.

Medium: (17.3) MM dividend theory Answer: d Diff: M . If the MM hypothesis about dividends is correct, and if one found a group of companies that differed only with respect to dividend policy, which of the following statements would be most correct?

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a. The residual distribution model should not be used, because it is inconsistent with the MM dividend hypothesis. b. The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends. c. If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D 1/P0 = a + b(g)) would be equal to +1.0. d. None of the statements above is true. e. All of the statements above are true.

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(17.3) Dividend theory 29 . Which of the following statements is most correct?

Answer: a

Diff: M

a. If the dividend irrelevance theory (which is associated with the names Modigliani and Miller) were exactly correct, and if this theory could be tested with "clean" data, then we would find, in a regression of dividend yield and capital gains, a line with a slope of -1.0. b. The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy. c. If a company raises its dividend by an unexpectedly large amount, the announcement of this new and higher dividend is generally accompanied by an increase in the stock price. This is consistent with the birdin-the-hand theory, and Modigliani and Miller used these findings to support their position on dividend theory. d. If it could be demonstrated that a clientele effect exists, this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs. e. Each of the statements above is false. (17.3) Dividend policy . Which of the following statements is most correct?

Answer: a

Diff: M

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a. The bird-in-the-hand theory would predict that companies could decrease their cost of equity financing by raising their dividend payout. b. The clientele effect can explain why firms often change their dividend policies. c. One advantage of adopting a residual distribution policy (with all distributions in the form of dividends) is that it makes it easier for corporations to maintain dividend clienteles. d. Answers a and c are correct. e. None of the answers above is correct. (17.3) Dividends versus capital gains Answer: b Diff: M 31 . Modigliani and Miller (MM) argued that dividend policy is irrelevant. On the other hand, Gordon and Lintner (GL) argued that dividend policy does matter. GL's argument rests on the contention that a. rs = D1/P0 + g is constant for any dividend policy. b. Because of perceived differences in risk, investors value a dollar of dividends more highly than a dollar of expected capital gains. c. Investors, because of tax differentials, value a dollar of expected capital gains more highly than a dollar of dividends. d. Most investors will reinvest rather than spend dividends, so it would save investors money (taxes) if corporations simply reinvested earnings rather than paid them out as dividends. e. None of the answers above. (17.3) Theories of dividend preference 32 . Which of the following statements is most correct? Page 8

Answer: a

Diff: M

Chapter 17: Distributions to Shareholders

a. The tax preference theory states that, all else equal, investors prefer stocks that pay low dividends because retained earnings can lead to capital gains that are taxed preferentially. b. An increase in the cost of equity capital (r s) when a company announces an increase in its dividend per share would be consistent with the bird-in-the-hand theory. c. An increase in the stock price when a company decreases its dividend is consistent with the signaling theory. d. A dividend policy that involves paying a consistent percentage of net income is the best policy if the “clientele effect” is correct. e. Both statements a and d are correct. (17.3) Miscellaneous dividend concepts . Which of the following statements is most correct?

Answer: a

Diff: M

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a. Companies can repurchase shares either (1) to change their capital structures or (2) to distribute cash to stockholders without paying cash dividends. In the second situation, tax considerations will probably play a key role in the decision to repurchase stock versus to pay more cash dividends. b. Stock dividends provide investors with additional shares of stock, not cash, yet many investors must pay cash in the form of taxes on the value of the stock dividends. For this reason, stock dividends are rarely used today. c. The bird-in-the-hand theory of dividend policy could be rejected immediately if personal income taxes were abolished. d. If the curve relating the WACC and the debt ratio looks like a sharp 'V', this would make it more feasible for a firm to follow the residual dividend policy than if the curve looks like a shallow bowl (or a shallow 'U'). e. The open market type of dividend reinvestment plan is the best type for firms that need to bring in new equity capital. (17.7) Residual distribution policy Answer: c Diff: M 34 . If a firm adheres strictly to the residual distribution policy (with all distributions in the form of dividends), a sale of new common stock by the company would suggest that a. b. c. d. e.

The dividend payout ratio has remained constant. The dividend payout ratio is increasing. No dividends were paid for the year. The dividend payout ratio is decreasing. The dollar amount of investments has decreased.

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(17.7) Residual distribution policy Answer: b Diff: M 35 . If a firm adheres strictly to the residual distribution policy with all distributions in the form of dividends), then if its optimal capital budget requires the use of all earnings for that year (along with new debt according to the optimal debt/total assets ratio), the firm should pay a. b. c. d. e.

No dividends except out of past retained earnings. No dividends to common stockholders. Dividends, in effect, out of a new issue of common stock. Dividends by borrowing the money (debt). Either c or d above could be used.

(17.14) Taxes, dividends, and DRIPs 36 . Which of the following statements is most correct?

Answer: e

Diff: M

a. "New-stock" dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don't change the total equity of a firm. b. Investors receiving stock dividends must pay taxes on the new shares at the time the stock dividends are received. c. Stockholders pay no income tax on dividends reinvested in a dividend reinvestment plan. d. Both statements a and b are correct. e. None of the statements above is correct. (Comp.) Dividend policy . Which of the following statements is most correct?

Answer: b

Diff: M

37

a. The tax code encourages companies to pay large dividends to their shareholders. b. If your company has established a clientele of investors who prefer large dividends, the company is unlikely to adopt a residual dividend policy. c. If a firm follows a residual distribution policy (with all distributions in the form of dividends), holding all else constant, its dividend payout will tend to rise whenever the firm's investment opportunities improve. d. All of the statements above are correct. e. Answers b and c are correct.

(Comp.) Miscellaneous dividend concepts 38 . Which of the following statements is most correct?

Answer: d

Diff: M

a. If a firm repurchases its stock in the open market, the shareholders that tender ar...