Deck 13: Distribution of Retained Earnings: Dividends and Stock Repurchases

Question 1

If the _____ is correct, there exists no optimal dividend policy, because dividend policy does not affect the value of a firm.

A) value dividend policy
B) dividend irrelevance theory
C) clientele effect
D) signaling hypothesis
E) free cash flow theory

Answer 1

B

Question 2

A firm repurchases stock to distribute excess funds.

Answer 2

True

Question 3

According to the information content hypothesis, a lower-than-expected dividend increase, or an unexpected reduction, generally would result in a price decline.

Answer 3

True

Question 4

Firms following the constant payout ratio dividend policy:

A) will have a stable dividend payment when earnings fluctuate.
B) will have a fluctuating dividend payment when earnings are stable.
C) will have a higher cost of equity when earnings are stable compared to other similar firms.
D) will have a lower cost of equity when earnings are stable compared to other similar firms.
E) will have a fluctuating dividend payment when earnings fluctuate.

Question 5

Firms using the constant payout ratio dividend policy offer to reinvest dividends in the stocks of the dividend-paying firm.

Question 6

The information content hypothesis proposes that a firm's dividend policy can provide information about management's behavior with respect to wealth maximization.

Question 7

A firm following the _____ makes payment of a specific dollar dividend each year or periodically increases the dividend at a constant rate.

A) free cash flow hypothesis
B) residual dividend policy
C) constant payout ratio dividend policy
D) stable, predictable dividend policy
E) extra dividend policy

Question 8

The residual dividend policy implies that investors prefer to have the firm retain and reinvest earnings rather than pay them out in dividends if the rate of return the firm can earn on reinvested earnings:

A) exceeds the cost of retained earnings that can be invested in projects with negative net present value.
B) is less than the weighted average cost of capital (WACC) that is composed of both debt and equity.
C) exceeds the cost of debt that will be taken from banks as loans or by issuing bonds to the public.
D) exceeds the rate investors, on average, can earn themselves on other investments of similar risk.
E) is less than the discount rate offered by the firm for dividend reinvestment.

Question 9

The dividend policy that strikes a balance between current dividends and future growth is called the:

A) optimal dividend policy.
B) dividend irrelevance policy.
C) clientele effect policy.
D) signaling policy.
E) free cash flow policy.

Question 10

Which of the following is true about the dividend relevance theory?

A) If investors prefer capital gain on their investment, then the tax effect of dividend receipts does not have any effect on the price of stocks.
B) If investors prefer current income on their investment, then the tax effect of dividend receipts does not have any effect on the price of stocks.
C) If investors prefer current income on their investment, the required return on equity should decrease as the dividend payout is increased.
D) If investors prefer capital gain on their investment, free cash flows to equity should decrease.
E) If investors prefer both capital gain and current income, the net income of the firm should decrease.

Question 11

According to the free cash flow hypothesis, cash flows that cannot be reinvested in positive net present value projects should be kept as retained earnings.

Question 12

A firm will set a low payout ratio and finance by retaining earnings rather than through the sale of new common stock when the:

A) cost of external equity is higher than the cost of internal equity.
B) management wants to dilute the ownership.
C) firm has no constraints in distributing dividends.
D) firm has excess cash to distribute.
E) firm has less investment opportunities to use its earnings.

Question 13

Which of the following policies represents a compromise between a stable, predictable dividend and a constant payout ratio?

A) The Free cash flow policy
B) The Residual dividend policy
C) The Dividend reinvestment policy
D) The Constant payout ratio policy
E) The Low regular dividend plus extras policy

Question 14

Which of the following statements is true about the free cash flow hypothesis?

A) Firms should distribute earnings based on investors' preferences toward current income and future income.
B) Firms should distribute earnings that can be reinvested at a very profitable rate.
C) Firms should pay dividends when free cash flows in excess of capital budgeting needs exist.
D) Firms that retain free cash flows have higher values than firms that distribute free cash flows.
E) Firms should never distribute their free cash flows.

Question 15

Firms with a large number of acceptable capital budgeting projects generally have high dividend-payout ratios.

Question 16

Everything else equal, if cash dividends are increased:

A) more money will be available for reinvestment in the company.
B) the expected growth rate will be lowered.
C) demand for the stock will decrease among investors looking for current income.
D) the net income of a firm will decrease.
E) the operating income of the firm will increase.

Question 17

A _____ effect might exist if investors are attracted to certain companies because they have particular dividend policies.

A) residual
B) clientele
C) signal
D) free cash flow
E) relevance

Question 18

The theory that investors regard dividend changes as signals of management's earnings forecasts is called the _____.

A) information content hypothesis
B) dividend relevance theory
C) clientele effect
D) free cash flow hypothesis
E) residual dividend policy

Question 19

Which of the following is true of the dividend reinvestment plans?

A) The plan offers fixed dividends to its investors.
B) The plan offers a constant percentage of its earnings as dividends to its investors.
C) The plan offers to automatically invest dividends in the stocks of the dividend-paying firm.
D) The plan offers to give management rights to investors if they reinvest their dividends in the firm.
E) The plan offers extra dividends when it has less investment opportunities to generate profits.

Question 20

The level of risk associated with future expected dividends affects dividend policies of companies around the world.

Question 21

Which of the following acts as a constraint on dividend payments?

A) Low cost of equity
B) Non availability of investment opportunities
C) Debt contract restrictions
D) Removal of the impairment of capital rule
E) Excess availability of cash

Question 22

The distribution of earnings by a firm to stockholders by buying shares of its stock in the financial markets is known as a _____.

A) stock dividend
B) stock split
C) stock ratio
D) stock repurchase
E) stock effect

Question 23

Dividend payments cannot exceed the balance sheet item "Retained earnings." This is known as the _____.

A) stock split rule
B) free cash flow rule
C) constant payout rule
D) impairment of capital rule
E) dividend irrelevance rule

Question 24

If the stockholders of a firm prefer current income to future income, then the:

A) cost of equity decreases as dividend payout increases.
B) cost of equity decreases as the investment opportunities of the firm increase.
C) cost of equity increases as excess cash available to the firm increases.
D) cost of equity decreases as management's restriction on ownership dilution increases.
E) cost of equity increases as debt restrictions decrease.

Question 25

Sunshine Corp. announces a 2-for-1 stock split for its shares trading at $100. If the current number of shares outstanding is 200,000, then the new market price of the share will be _____.

A) $100
B) $300
C) $50
D) $20
E) $70

Question 26

Amber Corp. has 3 million shares outstanding, each selling at $30. If Amber announces a 20% stock dividend, then the transfer from retained earnings is equal to _____.

A) $45,000,000
B) $18,000,000
C) $12,000,000
D) $17,000,000
E) $32,000,000

Question 27

All else equal, a normal stock split or a stock dividend:

A) results in a significant increase in the per share price of the stock.
B) reduces the profits earned by a firm.
C) increases the number of shares of stock outstanding.
D) should not be recognized on the balance sheet of a corporation.
E) increases the dividend per share.

Question 28

A_____ is an action taken by a firm to decrease the per-share price of its stock.

A) stock appreciation
B) stock split
C) stock issue
D) stock repurchase
E) stock redemption

Question 29

Which of the following factors leads to a high dividend-payout ratio?

A) Existence of impairment of capital rule
B) Stockholders' desire for future income rather than current income
C) Management's preference for limited ownership control
D) Excess availability of cash in spite of investing in profitable projects
E) Debt contract restrictions to maintain certain financial measures

Question 30

One of the disadvantages of stock repurchases is that:

A) the company will spend its excess cash.
B) the company will not be able to change its capital structure.
C) the company will become vulnerable to takeovers.
D) the company will pay too much for stock that is repurchased.
E) the company will make it difficult for employee options to be exercised.

Question 31

Which of the following is an advantage of stock repurchases?

A) Stock repurchases signal that the stock is overpriced.
B) Companies cannot distribute excess cash through stock repurchases.
C) Stock repurchases are generally irregular in nature.
D) Stock repurchases provide protection against a takeover attempt.
E) Stock repurchases make it difficult to exercise employee options.

Question 32

Which of the following is an important factor that affects dividend policies of companies around the world?

A) Net present values
B) Tax structures
C) Management policies
D) Takeover threats
E) Capital structures