Deck 11: Developing a Dividend Policy

Question 1

What does the term Record Date for dividends refer to?

A) The date on which the names of the company owners who will receive dividends appear in the company share register.
B) The date when the financial position of the company is assessed to compute the dividend payable.
C) The date that the auditors sign their release of the company's financial statements.
D) The date that the company auditors authorize the dividend payout.
E) The date on which the quoted share price excludes the accrued dividend.

Answer 1

A

Question 2

Sunshine Day Care Inc.'s balance sheet indicates that it has current assets of $40,000, Capital Assets net of depreciation of $150,000, current liabilities of $23,000, long-term liabilities of $54,000, paid-in capital of $60,000 worth of common shares and $53,000 in retained earnings. Assuming the book value is a reliable indication of market value of the assets, how much is the maximum dividend that the shareholders can legally vote for themselves?

A) $113,000.
B) $53,000.
C) $190,000.
D) $136,000.
E) $153,000.

Answer 2

B

Question 3

Michael can choose to hold 500 shares trading for $62.50 in Company A or 1,000 shares trading in Company B trading for $31.25 each. Both companies announced their earnings on December 31st at $5.00 per share and $2.50 per share, respectively. Company A's payout ratio is 100%. Company B will retain 100% of its earnings this year. Next year it will return to its usual 100% payout ratio. (Company B's common share dividend is not cumulative). Both companies return 8% to their common shareholders. Michael will by bonds with any cash received from dividends, providing an interest income at 8%. He faces a marginal income tax rate of 40% and a dividend tax rate of 37%. Assuming Michael does not liquidate his investments, which company will provide him the higher after tax income at the end of the second year?

A) Company B provides $50.40 more income.
B) Company A provides $75.60 more income.
C) Company A provides $162.00 more income.
D) Company B provides $1,175.40 more income.
E) Company B provides $6.00 more income.

Answer 3

A

Question 4

When managers and executives know more about the future plans of a company than its shareholders, what is this phenomenon called?

A) Insider trading.
B) Information Asymmetry.
C) Asynchronous Information.
D) Data Discordance
E) Insider Advantage.

Question 5

CapiCal Industries Inc. is hoping to sell its upcoming share issue to its current investor base which includes funds that generate income and those whose income is derived from dividends. In determining a payout ratio that will suit its investors, what is CapiCal is considering?

A) The Priority Segment.
B) The Agency Target.
C) The Clientele Effect.
D) The Key Stakeholders.
E) The Investor Impact.

Question 6

A major forest products company with a cost of capital of 12% has raised $15 million in financing and is considering three projects that are divisible, are not mutually exclusive and will have no residual value at the end of their 10 year term. Project A will cost a company $12 million providing $2.45 million in annual income before depreciation. Project B, costing $10.8 million, has annual projected savings before depreciation of $1.8 million. Project C costs $7.3 million and will bring in $1.7 million annually before depreciation. Assuming markets operate in the theoretical Modernist manner, if the company expects to earn a 12% return on their investments, in which project(s) should the company invest?

A) All three projects.
B) All of C and 60% of A
C) B only
D) All of A and all of C
E) All of B and 84% of C

Question 7

If a company has 14 million common and 5 million preferred shares outstanding with dividend per share of $2.8, reported earnings of $70 million and a dividend payout ratio of 25%, what was the dividend paid per share?

A) $0.50
B) $1.00
C) $2.50
D) $4.00
E) $5.00

Question 8

ABC is selling for $45.60 and is expected to continue its 5.5% growth rate in dividends. Using the Dividend Growth model, what is its expected dividend if its target return to investors is 18%?

A) $2.50
B) $2.96
C) $5.70
D) $8.20
E) $8.66

Question 9

Using a Fair Value Balance Sheet, a company's financial position is as follows: cash of $30,000, total assets, net of cash, of $330,000, total debt of $200,000 and $160,000 worth of owners' equity, comprised of 100,000 common shares and $60,000 of retained earnings. If the company pays out its total cash in dividends, what happens to a shareholder's financial position?

A) It diminishes as the share value drops from $1.60 to $1.30.
B) It increases as share price is unchanged as dividends reduce retained earnings, and dividend payout equal $0.30 a share.
C) It diminishes as dividends at $0.30 a share do not offset decreases in share value by $0.60 a share.
D) It is unchanged as the $0.30 reduction in share value will be offset by the $0.30 in dividends.
E) It diminishes as leverage will cause a reduction in equity to be more than offset by a loss in income.

Question 10

After being spun-off by a venture capital company, Web Dynamics Ltd., an e-commerce site design company, has had difficulty finding debt financing due to high rates of its hardware and software obsolescence. How much dividends should Web Dynamics pay out?

A) No or low dividends to use the cash for reinvestment in the company.
B) High dividends to increase the profile of the company and improve chances for debt financing.
C) No or low dividends to increase equity, improving the ROCE ratio and its appeal to lenders.
D) Pay high dividends to attract financing through common share issue.
E) Pay high dividends to reduce taxes by writing off the cost of dividends against income, thus, freeing up income for reinvestment in the company.

Question 11

Beryl Corporation has 15 million common shares outstanding trading on October 1 at a cum dividend price of $22.15 a share. Its EPS at that time, the end of the third quarter, is $1.80 per share. If the ex dividend price drops to $21.95 on Oct. 2, what dividend was declared?

A) No dividend was necessarily declared.
B) $2.7 million
C) $3 million
D) $27 million
E) $30 million

Question 12

What does the Modernist (Modigliani and Miller) view of dividend policy say about a higher payout ratio if taxes are ignored?

A) It will produce a higher share value as shareholders can choose between reinvestment in the company or investment at a higher rate elsewhere.
B) It will not impact share value as investors can get cash from their shares even if there is no dividend distributed.
C) It will reduce the share value as there will be less cash for the company to invest in income-generating projects maximizing net present value (NPV).
D) It will not impact share value as investors are indifferent as to whether they receive cash today or cash in the future.
E) It will reduce share value as investors seek long term holdings to avoid transactions costs.

Question 13

A company's shares trade at a P/E ratio of 10 and have a consistent growth in earnings of 4.5%. The company has a 30% payout ratio and dividends are paid at the end of each year. In December the company declared its dividend based on an EPS of $6.50. When the markets opened in January and investor purchased 100 shares. The investor's marginal tax rate is 42%. The dividend tax rate is 36%. Capital gains tax applies. If the entire investment is sold at the end of the year and the investor requires a 10% return, what is the after-tax net present value of her investment?

A) $113.46
B) $251.52
C) $328.63
D) $361.00
E) $397.64

Question 14

Which of the following do the Modernists accept as the best measure of improving shareholder wealth?

A) Return on equity > 0.
B) Return on Capital Employed (ROCE) > 0.
C) NPV > 0.
D) Dividend payout > 0.
E) Dividend yield > 0.

Question 15

The PetroTracking and Extraction Ltd.'s, a Calgary-based company, is experiencing double-digit growth in earnings. Given that its Board of Directors has adopted a traditional view of dividend policy, what should the company's dividend policy be?

A) Retain its earnings to provide shareholders with immediate capital gains.
B) Retain its earnings, to be used for immediate investment, to provide shareholders with greater future earnings.
C) Target a 15% dividend payout ratio to balance the conflicting needs of shareholders who want capital gains with those who want immediate income.
D) Target a maximum dividend payout to provide shareholders with cash now instead of in the future.
E) Decide on dividend levels in each period based primarily on the dividend policies of competing companies.

Question 16

RAJ Industries earned an income of $4,000,000 and distributed $850,000 as dividends. A year later, earnings had risen by 5% and RAJ distributed earnings of $700,000. What may investors have concluded about RAJ?

A) RAJ is retaining earnings to improve share prices.
B) RAJ is paying a dividend in order to improve share prices.
C) RAJ is indicating an expectation of significant future earnings growth.
D) RAJ is going to retire debt and and replace it by issuing preferred shares.
E) RAJ is signalling a concern that their Brazilian facilities would be taken over and nationalized.

Question 17

How is a dividend is paid out?

A) Only in cash.
B) In cash and/or common shares.
C) In cash and/or preferred shares.
D) In cash, common shares and/or preferred shares.
E) In cash, common shares and/or other assets.

Question 18

Which is the minimum assumption that must exist to support the Modernist view that dividend policy should have no effect on shareholder wealth?

A) No assumption about market efficiency needs to exist.
B) Weak form of capital market efficiency.
C) Semi-strong form of capital market efficiency.
D) Strong form of capital market efficiency.
E) Perfect capital market efficiency.

Question 19

Felicity Trust has a dividend cover ratio of 5.0 on net income of $6.3 million. The company's EPS is $2.10 and its cum dividend price is $22.50. What is the expected ex dividend price of the shares?

A) $18.00
B) $20.82
C) $21.24
D) $22.08
E) 27.00

Question 20

What does the traditional view of dividend policy say about a higher payout ratio?

A) It will depress the share value as shareholders must engage in the cost of searching out new investment opportunities.
B) It will artificially depress the share value of a company as the growth in dividends will be lower when the absolute amount of dividends is higher.
C) It will increase the share value of a company as shareholders will be attracted to the investment flexibility provided by liquidity.
D) It will depress the share value of a company as transactions cost must be subtracted from earnings for those shareholders who wish to retain their investment in the company.
E) It will increase the share value of a company as the rate of return demanded by investors will drop as the uncertainty of receiving dividends diminishes.

Question 21

What does dividend smoothing refers to?

A) Adopting a consistent, rising dividend over time.
B) Declaring an EPS that does not change much in value from year to year.
C) Offsetting declines in income with higher dividend payouts.
D) Providing a DRIP (dividend reinvestment programs) to absorb unwanted cash payouts.
E) Ensuring that the dividend yield ratio is the same from year to year.

Question 22

Kaylea Co. Ltd. has perpetual debt with a face value of $20 million at 5% and a market value of $18 million. It has no preferred shares. Ten million common shares were issued at $12.50 and are now trading for $15.00 each from a high three years ago of $24.00. Common shareholders are demanding a 9% return from companies of equal risk. The company has a tax rate of 35%. It wishes to repurchase four million common shares to reduce the threat of a hostile take-over. Kaylea Co. will use all of its retained earnings of $32 million and fund the balance with perpetual debt at 7% where the market value will equal face value. Assume the cost of Kaylea's old debt will remain unchanged and that share price remains the same. If the repurchase goes through, in absolute terms, what will be the change in the company's cost of capital?

A) Unchanged
B) Lower by 1.3%
C) Lower by 1.1%
D) Higher by 0.6%
E) Higher by 0.34%

Question 23

Almonte SoftTech Inc. has 20 million common shares outstanding whose dividend has been $3.50 per quarter. It also has 7.5 million preferred shares outstanding with a dividend of $4.50 per year and no voting rights. The newly elected Board has decided to retain all earnings for the next year to help fund the development expansion of their new web server software. What are the Agency costs?

A) $313.75 million, borne by all shareholders.
B) Zero as the value from the unpaid dividends will be reflected in increased share prices.
C) $33.75 million, borne by the preferred shareholders.
D) $70 million, borne by the common shareholders.
E) More than zero but less than $313.75 borne by shareholders opposed to the new dividend payout policy.

Question 24

Which of the following will tend to increase the proportion of earnings that are distributed as dividends?

A) Increasing profit volatility
B) Loan covenants
C) Threat of takeover
D) Market expectations
E) Legal limitations

Question 25

Merrick Manufacturing has been in a court battle over alleged patent infringement for several years. If Merrick has had generally paid out a consistent level of dividends and increases its dividend payout by 50%, how investors may interpret this move by Merrick?

A) As reorganizing its dividend policies based on company investment and tax requirements and correctly ignore the on-going case.
B) As distributing cash it no longer needs for investment as it anticipates losing the court case and its patent rights.
C) As attempting to placate investors who will sell off their shares once information about the loss of the court case is announced.
D) As winning the court case and being restricted by the settlement from officially announcing the company's good fortune.
E) As anticipating a settlement in its favour and distributing expected future earnings.

Question 26

Share prices of Emperor Oil Ltd. have been stagnant for the past five years at around $50.00. The company is in the final stretch of drilling and testing old oil fields located in northern Ontario using the latest tracking technology. Management is expects excellent results within six months but so far the market is unaware of these developments. Which of the following activities would be inequitable to current shareholders?

A) A 10% increase in the dividend.
B) A 10% share repurchase program.
C) A 10% stock dividend program.
D) A 1 for 10 stock split program.
E) A 10% dividend smoothing program.

Question 27

The embattled management team at Ram Inc. has promised a new low power consumption core microprocessor incorporating graphics capability for the past two years. The share price has declined from $25 to $17 in the same period even though earning have stayed the same. How might management convey success is at hand in a way that is believable to the market:

A) Call a press conference to announce success.
B) Announce that agency costs have been reduced.
C) Raise the dividend significantly.
D) Inform shareholders about information asymmetry.
E) Institute a share repurchase program.

Question 28

Which of these actions is an illustration of the residual theory of dividends?

A) Boosting EPS by buying back shares to reduce the pool of shareholders to whom dividends are distributed.
B) Reducing the Dividend Payout Ratio to improve EPS.
C) Retaining earnings in a reserve fund to ensure sufficient cash for distribution to shareholders.
D) Replacing distributed dividends with riskier debt capital to lower cost of capital.
E) Funding projects with a positive NPV and distributing the rest of the earnings as dividends.

Question 29

The management team of SoftWare Dreamworks Ltd. owns 35% of the outstanding shares of the company. the remainder are widely held by North American investors, with no on else owning more than 2% of the shares. However management is concerned about retaining control because there has been much takeover activity in the software industry recently. The firm's debt-Equity ratio sits at 60%. The current dividend payout ratio is 5%. How should management plan to obtain new funds for expansion into 4D research and development?

A) Issue new common shares.
B) Sell new bonds.
C) Issue new preferred shares.
D) Borrow long term from a bank.
E) Keep a high profit retention policy.

Question 30

At a time when the corporate tax rate is 22%, the government has raised taxes on individuals to 43% to meet its fiscal needs. The dividend tax rate is 32%. Interest rates are 8%. Which of the following applies to LED Ltd.'s dividend policy?

A) Shareholders would be better off by $31.08 per $1,000 of dividends if LED paid the dividend now and the investor invested the money.
B) Shareholders would be better off by $62.40 per $1,000 of dividends if LED paid the dividend now and the investor invested the money.
C) Shareholders would be indifferent as to whether LED deferred the dividend for 1 year and invested the money itself.
D) Shareholders would be better off by $20.67 per $1,000 of dividends if LED deferred the dividend for 1 year and invested the money itself.
E) Shareholders would be better off by $11.42 per $1,000 of dividends if LED deferred the dividend for 1 year and invested the money itself.

Question 31

Brekker Company has 40 million common shares outstanding and has consistently paid out 25% of its earnings over the past seven years. Last year, it announced earnings of $600 million and paid out a 25% stock dividend in lieu of cash, retaining its earnings to fund its expansion into China. Share price was maintained on news of positive cash flows from the expansion. The company would like to retain all this year's $690 million in earnings to consolidate its overseas investment. What is the minimum dividend per share to ensure investor confidence?

A) $3.45 million.
B) $3.75 million.
C) $4.69 million.
D) $13.
E) $15.00.

Question 32

To receive the current quarterly dividend, when must an investor buy shares in a company?

A) Before the record date.
B) Before the ex-dividend date.
C) Before the cum-dividend date.
D) Before the transaction date.
E) Before the settlement date.

Question 33

Which of the following represents a legal restriction on the payment of dividends?

A) The dividend must be paid prior to the ex-dividend date.
B) The total dividend cannot exceed shareholders' equity.
C) A loan covenant which restricts the dividend to 10% of net income.
D) A stock dividend is restricted to Canadian shareholders.
E) A takeover threat limits the dividend a company can pay.

Question 34

LaGuerre Computer Animation Ltd. has a tax rate of 30%, has been trading around $44.50 for three years and has a consistent dividend payout of 35%. Last year, it had common shares outstanding of 4.2 million, no preferred shares, interest payments of $8 million and an EBIT of $29 million. Over the following year, the company repurchased 1.2 million shares with a bond issue that increased its interest payments by $2.7 million. If its EBIT rose to $32 million, what is the degree of financial leverage for LaGuerre?

A) Insignificant at (0.36)
B) Insignificant at .27
C) Low at 3.2
D) High at .25
E) High at 4.06.

Question 35

Which of the following is the most important factor influencing the level of dividends?

A) Investment opportunities.
B) Residual theory of dividends.
C) Loan covenants.
D) Market expectations.
E) Profit stability.

Question 36

Lenders interested in ensuring a large cushion of cash to mitigate the risks of the loan may include restrictions in the contract to preclude the company from paying out dividends to common shareholders. Shareholders may have to vote in a block to oust a Board who has undertaken these loans. What is this situation is consistent with?

A) Theory of competition.
B) Agency Theory.
C) Lender Leverage.
D) Shareholder Activism.
E) Microeconomic transactions theory.

Question 37

Peanut Ltd. is in a takeover battle to acquire Oil Distributing. The new firm would be known as Peanut Oil Inc. if the takeover obtains shareholder approval. Peanut has argued in the press that Oil is not maximizing shareholder return because it pays no dividends. How should this argument be received by Oil investors?

A) It will be dismissed by sophisticated investors who realize the dividend represents only part of a shareholder's total return.
B) It will be accepted by sophisticated investors because the lack of dividend represents management's lack of confidence in the future.
C) It will be dismissed by novice investors who are mainly looking for a capital gain.
D) It will be accepted by novice investors because the lack of dividend signals a reduction in agency costs.
E) It will be accepted by the financial media because the lack of dividend signals poor management.

Question 38

A company has 21 million common shares outstanding at a price of $63.00 each and an EPS of $12.00 per share. If the company wishes to provide a stock dividend of 30%, how many shares will shareholders receive for every ten shares currently held?

A) 4.8 shares.
B) 5 shares.
C) 5.7 shares.
D) 3.33 shares.
E) 3 shares.

Question 39

At REL Ltd., earnings per share over a five year period were (from earliest to latest) $2.00, $0.50, $1.20, $2.40, $1.75. In the same period, dividends per share were $0.50, $0,50, $0,50, $0.75, $0.75. What best describes this result?

A) Stock dividends.
B) Share repurchases.
C) dividend signalling.
D) Dividend smoothing.
E) Residual dividends.

Question 40

The dividend cover ratio at Effortless Beauty has been 1.2, 1.1, 1.0, 0.9 starting from four years ago until now. Which of the following is most likely?

A) Dividend smoothing will occur.
B) The share price will fall.
C) The profit stability will decline.
D) The dividend will be cut.
E) The market exceptions will drop.