Deck 14: Distributions to Shareholders: Dividends and Repurchases

Question 1

In the real world, dividends

A) are usually more stable than earnings.
B) fluctuate more widely than earnings.
C) tend to be a lower percentage of earnings for mature firms.
D) 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 1

A

Question 2

Which of the following 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.
E) Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.

Answer 2

C

Question 3

Which of the following 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.
E) The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains.

Answer 3

D

Question 4

If a firm adheres strictly to the residual dividend policy, then if 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), then the firm should 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 borrowing money (i.e., issue debt).
E) dividends only out of funds raised by selling off fixed assets.

Question 5

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.

Question 6

Trenton Publishing follows a strict residual dividend policy. All else equal, which of the following factors 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) Congress lowers the tax rate on capital gains. The remainder of the tax code is not changed.
E) Earnings are unchanged, but the firm issues new shares of common stock.

Question 7

MM's dividend irrelevance theory says that while dividend policy does not affect a firm's value, it can affect the cost of capital.

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.

Question 9

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.

Question 10

Even if a stock split has no information content, and even if the dividend per share adjusted for the split is not increased, 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.

Question 11

A reverse split reduces the number of shares outstanding.

Question 12

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.

Question 13

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.

Question 14

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.

Question 15

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.

Question 16

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.

Question 17

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

Question 18

If the information content, or signaling, hypothesis is correct, then changes in dividend policy can have an important effect on the firm's value and capital costs.

A) Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
B) Accruals are "free" in the sense that no explicit interest is paid on these funds.
C) A conservative approach to working capital management will result in most if not all permanent current operating assets being financed with long-term capital.
D) The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt.

Question 19

Stock dividends and stock splits should, at least conceptually, have the same effect on shareholders' wealth.

Question 20

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.

Question 21

Which of the following statements is CORRECT?

A) Under the tax laws as they existed in 2008, a dollar received for repurchased stock must be taxed at the same rate as a dollar received as dividends.
B) One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends.
C) 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 is that investors interpret the increase as a signal that the firm has relatively few good investment opportunities.
D) If a company wants to raise new equity capital rather 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.

Question 22

If a firm adheres strictly to the residual dividend policy, the issuance of new common stock would suggest that
A) One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company.

A) the dividend payout ratio has remained constant.
B) One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account.
B) the dividend payout ratio is increasing.

Question 23

Which of the following statements is CORRECT?

A) below average inventory turnover ratio.
B) low incidence of production schedule disruptions.
C) below average total assets turnover ratio.
D) relatively high current ratio.

Question 24

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 favorably 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) Stock repurchases increase the number of outstanding shares.
E) The clientele effect is the best explanation for why companies tend to vary their dividend payments from quarter to quarter.

Question 25

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 signaling theory as postulated by MM.
D) If the "clientele effect" is correct, then for a company whose earnings fluctuate, a policy of paying a constant percentage of net income will probably maximize the stock price.
E) Stock repurchases make the most sense at times when a company believes its stock is undervalued.

Question 26

Which of the following statements is CORRECT?

A) 31 days
B) 34 days
C) 38 days
D) 42 days