Deck 17: Payout Policy

Question 1

An alternate way to pay investors is when the firm uses cash to buy shares of its own outstanding stock,also known as

A) dividend investment.
B) retained earnings.
C) initial public offering.
D) share repurchases.
E) seasoned equity offering.

Answer 1

share repurchases.

Question 2

What is the difference between a regular dividend and a liquidating dividend?

Answer 2

A regular dividend comes from a firm's free cash flow,while a liquidating dividend uses cash from the liquidation of assets of a business operation that is being terminated.

Question 3

Another to method to repurchase shares is the ________,in which the firm lists different prices at which it is prepared to buy shares,and shareholders in turn indicate how many shares they are willing to sell at each price.

A) tender offer
B) Dutch auction share repurchase
C) targeted repurchase
D) open market share repurchase
E) greenmail repurchase

Answer 3

Dutch auction share repurchase

Question 4

What is the difference between an open market share repurchase and a targeted repurchase?

Question 5

The firm will pay the dividend to all shareholders of record on a specific date,set by the board,called the ________ date.

A) declaration
B) record
C) ex-dividend
D) distribution
E) payable

Question 6

The way a firm chooses between alternate uses of free cash flow is referred to as

A) retention ratio.
B) payout policy.
C) call policy.
D) debt policy.
E) investment policy.

Question 7

What is a firm's payout policy?

Question 8

Dividend payments that are the result of liquidation of assets are known as ________ and are taxed as capital gains.

A) return of capital
B) rolling dividends
C) alternate payments
D) private earnings
E) special dividends

Question 9

The date on which a firm pays out dividends is called the ________ date.

A) declaration
B) record
C) ex-dividend
D) distribution
E) dividend

Question 10

A(n)________ is the most common way that firms repurchase shares.

A) targeted repurchase
B) Dutch auction share repurchase
C) tender offer
D) open market share repurchase
E) greenmail repurchase

Question 11

What is the sequence of the four important dates for a dividend payment,from initial authorization to final payment?

Question 12

A one-time payment to shareholders that is much larger than a regular dividend is often referred to as a(n)________ dividend.

A) taxable
B) divesting
C) special
D) ex-day
E) extra

Question 13

When a firm purchases shares directly from a major shareholder it is also known as a(n)

A) open market purchase.
B) tender offer.
C) targeted repurchase.
D) greenmail.
E) Dutch auction.

Question 14

A firm may decide to eliminate the threat of a takeover by a major shareholder by purchasing shares from him at a premium also known as a(n)

A) open market purchase.
B) tender offer.
C) targeted repurchase.
D) greenmail.
E) Dutch auction.

Question 15

The date two business days prior to the date on which all shareholders of record receive a payment is called the ________ date.

A) declaration
B) record
C) ex-dividend
D) distribution
E) payable

Question 16

A(n)________ may occur if a major shareholder desires to sell a large number of shares but the market for the shares is not sufficiently liquid to sustain such a large sale without severely affecting the price.

A) open market share repurchase
B) Dutch auction share repurchase
C) tender offer
D) targeted repurchase
E) closed offer

Question 17

The date on which the board of directors of a company authorizes the dividend is called the ________ date.

A) declaration
B) record
C) ex-dividend
D) distribution
E) payable

Question 18

When a firm offers to buy its shares at a prespecified price during a short time period it is also known as a(n)

A) open market purchase.
B) tender offer.
C) targeted repurchase.
D) greenmail.
E) Dutch auction.

Question 19

The Record Date falls before the Ex-Dividend Date.

Question 20

A firm may announce its intention to buy its own shares in the open market like any other investor,also known as a(n)

A) open market purchase.
B) tender offer.
C) targeted repurchase.
D) greenmail.
E) Dutch auction.

Question 21

A firm has $500 million of assets that includes $50 million of cash and 10 million shares outstanding.The firm uses $50 million of its cash to pay dividends.If an investor has 1000 shares,how many shares must he sell to create a homemade dividend of $6575?

A) 25 shares
B) 30 shares
C) 35 shares
D) 40 shares
E) 45 shares

Question 22

Suppose a firm does not pay a dividend but repurchases stock using $20 million of cash.The market value of the firm decreases by

A) $20 million.
B) -$20 million.
C) 0.
D) $40 million.
E) -$40 million.

Question 23

Modigliani and Miller Dividend Irrelevance states that in perfect capital markets,holding ________ policy fixed,the firm's choice of dividend policy is irrelevant and does not affect the initial share price.

A) debt
B) investment
C) interest rate
D) equity issuance
E) payout

Question 24

BC Brewery has a current share price of $37.50,and has announced a dividend payment of $1.25 per share.Assuming perfect capital markets,what should the price of BC Brewery be once the stock begins trading ex-dividend?

A) $37.50
B) $36.25
C) $38.75
D) $35
E) $38

Question 25

A firm has $200 million of assets that includes $50 million of cash and 8 million shares outstanding.If the firm uses $20 million of its cash to repurchase shares,what is the new price per share?

A) $25
B) $27
C) $30
D) $32
E) $35

Question 26

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Omicron's enterprise value is closest to:

A) $500 million
B) $900 million
C) $450 million
D) $400 million
E) $300 million

Question 27

The share price falls when a dividend is paid because the reduction in cash decreases the

A) liabilities of the firm.
B) current account of the firm.
C) market value of assets.
D) equity of the firm.
E) present value of future dividends.

Question 28

What are the characteristics of special dividend?

Question 29

With perfect capital markets,investors prefer share repurchases to receiving dividends.

Question 30

A firm has $400 million of assets that includes $50 million of cash and 10 million shares outstanding.The firm uses $40 million of its cash to pay dividends.If an investor has 1000 shares,how many shares must she sell to create a homemade dividend of $4900?

A) 25 shares
B) 30 shares
C) 35 shares
D) 40 shares
E) 45 shares

Question 31

What are the different ways a firm can repurchase shares?

Question 32

When a firm repurchases shares,the supply of shares is ________,but at the same time,the firm's assets ________.

A) reduced, decline
B) increased, decline
C) reduced, increase
D) increased, increase
E) reduced, are unchanged

Question 33

A firm has $300 million of assets that includes $50 million of cash and 10 million shares outstanding.The firm uses $30 million of its cash to pay dividends.If an investor has 1000 shares,how many shares must he sell to create a homemade dividend of $3900?

A) 33.3 shares
B) 40.2 shares
C) 50.5 shares
D) 60.3 shares
E) 65.6 shares

Question 34

A firm has $300 million of assets that includes $50 million of cash and 10 million shares outstanding.If the firm uses $30 million of its cash to repurchase shares,what is the new price per share?

A) $25
B) $27
C) $30
D) $32
E) $35

Question 35

A firm has $400 million of assets that includes $50 million of cash and 10 million shares outstanding.If the firm uses $40 million of its cash to repurchase shares,what is the new price per share?

A) $38
B) $40
C) $42
D) $44
E) $48

Question 36

Homemade dividend refers to the process by which an investor

A) can take on more debt.
B) chooses between equity and debt.
C) can sell shares to create a dividend policy to suit his preferences.
D) reinvests dividend payments.
E) automatically withdraws money from his investment account.

Question 37

What is greenmail?

Question 38

With perfect capital markets,an open market repurchase increases the stock price as the number of outstanding shares is decreased.

Question 39

A firm has assets of $250 million,of which $25 million is cash.It has debt of $100 million.If the firm were to repurchase $10 million of its stock,what would its new debt-to-equity ratio be?

A) 71.4%
B) 28.6%
C) 80%
D) 20%
E) 30%

Question 40

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Including its cash,Omicron's total market value is closest to:

A) $500 million
B) $900 million
C) $400 million
D) $450 million
E) $300 million

Question 41

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend.Omicron's cum-dividend price is closest to:

A) $50.00
B) $40.00
C) $5.00
D) $45.00
E) $35.00

Question 42

The fact that firms continue to issue dividends despite their tax disadvantage is often referred to as the

A) issuance puzzle.
B) dividend puzzle.
C) payback puzzle.
D) policy puzzle.
E) capital structure puzzle.

Question 43

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend.The amount of the special dividend is closest to:

A) $5.00
B) $9.00
C) $4.00
D) $4.50
E) $3.00

Question 44

Long-term investors can defer capital gains tax until they sell and,therefore,there is a tax advantage for share repurchases over dividends.

Question 45

Corporations enjoy a tax advantage associated with dividends due to

A) personal tax exemptions.
B) the 100% exclusion allowance.
C) laddered tax rates.
D) concave tax structure.
E) tax carryforwards.

Question 46

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $50 million to repurchase shares.Suppose you are unhappy with Omicron's decision and would prefer that Omicron used the excess cash to pay a special dividend.The number of shares that you would have to sell in order to receive the same amount of cash as if Omicron paid the special dividend is closest to:

A) 275
B) 310
C) 125
D) 250
E) 175

Question 47

Different investor groups have differing dividend policy preferences that create clientele effects in which dividend policy of a firm is optimized for its investors.

Question 48

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend.Omicron's ex-dividend price is closest to:

A) $40.00
B) $5.00
C) $50.00
D) $45.00
E) $35.00

Question 49

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that Omicron uses the entire $50 million to repurchase shares.The amount of the regular yearly dividends in the future is closest to:

A) $9.00
B) $5.00
C) $4.50
D) $4.00
E) $5.50

Question 50

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that Omicron uses the entire $50 million to repurchase shares.The number of shares that Omicron will repurchase is closest to:

A) 1.0 million
B) 1.2 million
C) 1.1 million
D) 0.9 million
E) 1.5 million

Question 51

Share repurchases have a tax advantage over dividends because

A) dividend payments are tax deductible.
B) share repurchases increase the value of debt.
C) capital gains can be deferred by long-term investors.
D) repurchases are associated with increased customer loyalty.
E) dividends are not taxed.

Question 52

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend.The amount of the regular yearly dividends in the future is closest to:

A) $4.50
B) $5.00
C) $4.00
D) $9.00
E) $3.00

Question 53

Historical evidence shows that over the last few decades a larger proportion of firms have used ________ for payouts.

A) repurchases
B) dividends
C) stock reverse splits
D) stock splits
E) seasoned equity offerings

Question 54

What is the bird-in-the-hand fallacy in dividend theory under perfect capital markets?

Question 55

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $50 million to pay a special dividend.Suppose you are unhappy with Omicron's decision and would prefer that Omicron used the excess cash to repurchase shares.The number of shares that you would have to buy in order to undo the special cash dividend that Omicron paid is closest to:

A) 125
B) 275
C) 250
D) 310
E) 200

Question 56

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
Assume that Omicron uses the entire $50 million to repurchase shares.The number of shares that Omicron will have outstanding following the repurchase is closest to:

A) 8.8 million
B) 1.2 million
C) 9.0 million
D) 8.9 million
E) 7.8 million

Question 57

The optimal dividend policy when dividend tax rates exceed capital gains tax rates is to pay dividends only.

Question 58

Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock.
A firm has $75 million of assets that includes $12 million of cash and 25 million shares outstanding.If the firm uses $12 million of cash to repurchase shares,what is the new price per share?

A) $1
B) $2
C) $3
D) $4
E) $5

Question 59

What is the effect on the stock price when a firm repurchases its shares?

Question 60

When a firm pays out a dividend,the share price ________,and when it conducts a share repurchase at the market price,the share price ________.

A) increases, increases
B) is unchanged, decreases
C) decreases, decreases
D) decreases, is unchanged
E) decreases, increases

Question 61

Malibu Mannequins is an all-equity firm with 40 million shares outstanding.Malibu has $20 million in cash,and expects future free cash flows of $5 million per year.The cash can be used to expand the firm's future operations,increasing future free cash flows to $8 million per year.If Malibu's cost of capital for the expansion is 5%,what will be the difference in the firm's share price compared to using the cash for a share repurchase?

A) Share price is $1.00 higher with expansion.
B) Share price is $1.00 higher with repurchase.
C) Share price is the same with both options.
D) Share price is $1.50 higher with expansion.
E) Share price is $1.50 higher with repurchase.

Question 62

Palo Alto Enterprises has $200,000 in cash.They wish to invest the money in Treasury bills at 5% and use the returns to pay dividends to shareholders after a year.Alternately they can pay a dividend and allow shareholders to make the investment.In perfect capital markets,which option will shareholders prefer?

A) immediate cash dividend
B) dividend after one year
C) prefer half from each source
D) indifferent between options
E) most paid now, the balance paid in one year

Question 63

Because the dividend tax will be paid whether the firm pays cash immediately or retains cash and pays the interest over time,the dividend tax rate does not affect the cost of retaining cash.

Question 64

Collingwood Costumes is an all-equity firm with 80 million shares outstanding.Collingwood has $75 million in cash,and expects future free cash flows of $15 million per year.The cash can be used to expand the firm's future operations,increasing future free cash flows to $16 million per year.If Collingwood's cost of capital for the expansion is 10%,what will be the difference in the firm's share price compared to using the cash for a share repurchase?

A) Share price is $0.12 higher with expansion.
B) Share price is $0.12 higher with repurchase.
C) Share price is the same with both options.
D) Share price is $0.81 higher with expansion.
E) Share price is $0.81 higher with repurchase.

Question 65

Fireball Furnaces is an all-equity firm with 50 million shares outstanding.Fireball has $10 million in cash,and expects future free cash flows of $2 million per year.The cash can be used to expand the firm's future operations,increasing future free cash flows to $3.5 million per year.If Fireball's cost of capital for the expansion is 7%,what will be the difference in the firm's share price compared to using the cash for a share repurchase?

A) Share price is $0.43 higher with expansion.
B) Share price is $0.43 higher with repurchase.
C) Share price is the same with both options.
D) Share price is $0.23 higher with expansion.
E) Share price is $0.23 higher with repurchase.

Question 66

The largest proportion of investors in common stock are

A) mutual funds.
B) pension funds.
C) corporations.
D) individual investors.
E) hedge funds.

Question 67

Firms may retain large amounts of cash to cover future potential needs that allows a firm to avoid

A) transaction costs and financial distress costs.
B) tax payments.
C) clientele effects.
D) agency costs.
E) share price reductions.

Question 68

Use the information for the question(s) below.
The JRN Corporation will pay a constant dividend of $3 per share per year in perpetuity. Assume that all investors pay a 20% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 12%.
Assume that management makes a surprise announcement that JRN will no longer pay dividends but will use the cash to repurchase stock instead.The price of a share of JRN's stock is now closest to:

A) $20.00
B) $25.00
C) $18.00
D) $24.00
E) $16.00

Question 69

Explain the different effects on a firm's share price for a dividend payment versus a share repurchase.

Question 70

According to the ________ theory of payout policy,managers pay out cash only when pressured to do so by investors.

A) agency
B) supply
C) price pressure
D) managerial entrenchment
E) pecking order

Question 71

Use the information for the question(s) below.
Luther Industries has $5 million in excess cash and 1 million shares outstanding. Luther is considering investing the cash in one-year Treasury bills that are currently paying 5% interest and then using the cash to pay a dividend next year. Alternatively, Luther can pay the cash out as a dividend immediately and the shareholders can invest in the Treasury bills themselves. Assume that capital markets are perfect.
If Luther decides to pay the dividend immediately the dividend per share will be closest to:

A) $1.05
B) $5.25
C) $5.00
D) $4.75
E) $4.50

Question 72

Use the information for the question(s) below.
The JRN Corporation will pay a constant dividend of $3 per share per year in perpetuity. Assume that all investors pay a 20% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 12%.
The WTC Corporation will pay a constant dividend of $3.20 per share,per year,in perpetuity.If all investors pay a 15% tax on dividends,there is no capital gains tax,and the cost of capital for investing in WTC stock is 9%,what is the price for a share of WTC stock?

A) $30.22
B) $26.67
C) $18.77
D) $16.45
E) $15.76

Question 73

Use the information for the question(s) below.
Consider the following tax rates:

In 2006,Luther Incorporated paid a special dividend of $5 per share for the 1 million shares outstanding.If Luther has instead retained that cash permanently and invested it into Treasury bills earning 6%,then the present value (PV)of the additional taxes paid by Luther would be closest to:

A) $.35 million
B) $2.90 million
C) $1.75 million
D) $5.85 million
E) $3.25 million

Question 74

When a firm has excessive cash,managers may make use of the funds in an inefficient manner.This is also referred to as the ________ cost of retaining cash.

A) fixed
B) agency
C) interest
D) special
E) hidden

Question 75

Use the information for the question(s) below.
The JRN Corporation will pay a constant dividend of $3 per share per year in perpetuity. Assume that all investors pay a 20% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 12%.
The price of a share of JRN's stock is closest to:

A) $20.00
B) $24.00
C) $25.00
D) $18.00
E) $26.00

Question 76

In perfect capital markets,buying and selling securities is a zero-NPV transaction,so retaining cash versus paying it out does not affect firm value.

Question 77

Apex Analytics is an all-equity firm with 50 million shares outstanding.Apex has $30 million in cash,and expects future free cash flows of $8 million per year.The cash can be used to expand the firm's future operations,increasing future free cash flows to $10 million per year.If Apex's cost of capital for the expansion is 8%,what will be the difference in the firm's share price compared to using the cash for a share repurchase?

A) Share price is $0.10 higher with expansion.
B) Share price is $0.10 higher with repurchase.
C) Share price is the same with both options.
D) Share price is $0.50 higher with expansion.
E) Share price is $0.50 higher with repurchase.

Question 78

Use the information for the question(s) below.
Luther Industries has $5 million in excess cash and 1 million shares outstanding. Luther is considering investing the cash in one-year Treasury bills that are currently paying 5% interest and then using the cash to pay a dividend next year. Alternatively, Luther can pay the cash out as a dividend immediately and the shareholders can invest in the Treasury bills themselves. Assume that capital markets are perfect.
If Luther invests the excess cash in Treasury bills,then the dividend per share next year will be closest to:

A) $5.00
B) $5.25
C) $4.75
D) $1.05
E) $4.50

Question 79

When a firm retains cash,it pays corporate tax on the interest it earns and the investor will owe capital gains tax on the increased firm value-in essence the interest on retained cash is taxed

A) once.
B) at a rate of zero.
C) twice.
D) only at the corporate level.
E) only at the investor level.

Question 80

Why do firms still pay dividends,despite their tax disadvantage?