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

Question 1

A dividend reinvestment plan (DRIP):

A)offers fixed dividends to the firm's stockholders.
B)requires payment of a constant percentage of the firm's earnings as annual cash dividends.
C)enables stockholders to automatically reinvest cash dividends they receive in the stocks of the dividend-paying firm.
D)pays stockholders tax-free cash dividends.
E)pays extra cash dividends in years the firm has few acceptable investment opportunities.

Answer 1

  C

Question 2

Everything else equal, generally a firm will set a low dividend payout ratio and finance capital budgeting projects using retained earnings rather than through the sale of new common stock when the:

A)flotation costs associated with a stock issue are high.
B)senior management team wants to dilute the firm's ownership.
C)firm faces no constraints with regard to the distribution of earnings.
D)firm's annual earnings increase.
E)firm has fewer acceptable capital budgeting projects than in previous years.

Answer 2

  A

Question 3

Last year Universal Transportation retained $225,000 of the $750,000 net income it generated. This year Universal generated net income equal to $550,000. If Universal follows the constant payout ratio dividend policy, how much should it pay in total dividends this year?

A)$550,000
B)$385,000
C)$165,000
D)$715,000
E)$525,000

Answer 3

  B

Question 4

American Generation Ecology (AGE) expects to grow at a constant rate of 4 percent forever. Its target debt/asset ratio is 60 percent and it expects to have profitable investments of $300,000 this year. AGE plans to continue paying the same dividend that has been paid the past 20 years, $1.50 per share, long into the future. The firm has 400,000 shares of stock outstanding. If net income is expected to be $800,000, what should be AGE's dividend payout ratio this year?

A)15.4%
B)25.0%
C)75.0%
D)46.2%
E)60.0%

Question 5

Everything else equal, in which of the following situations will a firm generally have a high dividend-payout ratio?

A)The existence of the impairment of capital rule.
B)The firm's stockholders prefer capital gains rather than current income.
C)The firm's senior management wishes to limit the number of investors who own the company's stock.
D)The firm has excess cash after purchasing all acceptable independent capital budgeting projects.
E)The firm's bond indentures severely restrict the amount of earnings that can be distributed each year.

Question 6

The dividend policy that strikes a balance between current dividends and the firm's future growth is called the ______ policy. 

A)optimal dividend
B)dividend irrelevance
C)compromise dividend
D)dividend signaling
E)dividend preference

Question 7

According to the free cash flow hypothesis that has been proposed to explain investors' reactions to dividend policy changes, a firm:

A)should distribute earnings based solely on investors' preferences; i.e., whether they prefer current income or future income.
B)should pay out all earnings that it can reinvest in acceptable capital budgeting projects.
C)should pay dividends when it has cash flows that exceed its capital budgeting needs.
D)that retains free cash flows has a higher value than a firm that distributes its free cash flows to stockholders.
E)should never distribute its free cash flows, because these funds represent money the firm is free to invest as it pleases .

Question 8

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

A)Free cash flow dividend policy
B)Residual dividend policy
C)Dividend reinvestment policy (DRIP)
D)Equity dividend policy
E)Low regular dividend plus extras policy

Question 9

Pittsburgh Ecological Technology (PET) has been growing at a constant 4 percent rate for more than 10 years, and this growth is epxected to continue forever. Last year PET paid a dividend equal to $2.50 per share. If dividends grow at the same rate as the company's growth rate, what should be the per share dividend that PET pays this year?

A)$2.50
B)$2.40
C)$3.00
D)$3.50
E)$2.60

Question 10

Mom's Apple Pies (MAP) earned $500,000 this year. The company follows the residual dividend policy when paying dividends. MAP has determined that it needs a total of $600,000 for investment in capital budgeting projects this year. If the company's debt/asset ratio is 40 percent, what will its dividend payout ratio be this year? MAP has no preferred stock. 

A)40%
B)28%
C)72%
D)48%
E)52%

Question 11

If the dividend relevance theory is valid, which of the following statements must be correct?

A)Stockholders who prefer to earn capital gains on their investments rather than to receive dividends are not concerned with whether a firm pays dividends because such decisions do not affect the market price of its stock.
B)Stockholders who prefer to receive annual dividends rather than to earn capital gains on their investments are not concerned with whether a firm invests in acceptable capital budgeting projects because such decisions do not affect the annual income generated by the firm, and thus the dividends that are paid.
C)If most of the stockholders of a firm prefer to receive current income rather than to earn capital gains on their investments, the firm can reduce its required return on equity by increasing the dividend payout.
D)Stockholders who prefer to earn capital gains on their investments would like the firm to retain and reinvest any free cash flows that it generates.
E)A retired individual is more likely to invest in the stock of a company to earn capital gains than to get paid dividends.

Question 12

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)is less than its cost of retained earnings.
B)is less than its weighted average cost of capital (WACC).
C)exceeds its cost of debt.
D)exceeds the rate investors, on average, can earn themselves on other investments of comparable risk.
E)is less than the discount rate offered by the firm on its dividend reinvestment plan (DRIP).

Question 13

Abel Inc. applies the low regular dividend plus extras policy when determining how much of its income will be paid out as dividends each year. Abel's policy states that the minimum dividend that will be paid each year is $1.00 per share. But, when net income is greater than $80 million, the total dividend will be increased by 40 percent of the amount that exceeds $60 million. The firm currently has 10 million shares of stock outstanding. What will be the dividend per share if Abel earns $100 million?

A)$2.60
B)$1.80
C)$1.00
D)$5.00
E)$3.00

Question 14

The ______ effect is the tendency of a firm to attract the type of investor who prefers its dividend policy. 

A)residual dividend
B)clientele
C)signaling
D)investor
E)dividend preference

Question 15

Which of the following hypotheses/theories suggests that investors regard a change in dividend payments as a signal that the firm's management expects future earnings to also change?

A)Information content hypothesis
B)Clientele effect theory
C)Constant payout ratio hypothesis
D)Dividend modification hypothesis
E)Projected earnings hypothesis

Question 16

Firms that follow the constant payout ratio dividend policy have:

A)stable dividend payments, even when earnings fluctuate.
B)fluctuating dividend payments, even when earnings are stable.
C)higher costs of equity when earnings are stable than similar firms that have fluctuating earnings.
D)lower costs of retained earnings when earnings are volatile than similar firms that have stable earnings.
E)fluctuating dividend payments when earnings fluctuate.

Question 17

Which of the following hypotheses/theories asserts that there exists no optimal dividend policy, because a firm's dividend policy does not affect its value. 

A)Dividend relevance theory
B)Dividend irrelevance theory
C)Clientele effect theory
D)Signaling hypothesis
E)Free cash flow hypothesis

Question 18

A firm following the _____ dividend policy pays a specific dollar dividend each year or periodically increases the dividend at a constant rate. 

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

Question 19

Everything else equal, if a firm increases the dividend that it pays from $4 to $5:

A)more money will be available to invest in capital budgeting projects.
B)its future growth rate will decrease.
C)demand for the stock will decrease among investors who prefer to receive current income from their investments.
D)the firm should expect many of the investors who held the stock prior to the increase to sell their stock
E)its operating income will increase.

Question 20

Alabama Industrial Manufacturers (AIM) follows the constant payout ratio dividend policy by paying out 70 percent of earnings each year. This year AIM expects the dividend payment to be 5 percent higher than last year's payment, which was $280,000. What is the amount of net income that AIM expects to generate this year?

A)$294,000
B)$980,000
C)$420,000
D)$686,000
E)$400,000

Question 21

According to the information content hypothesis that has been proposed to explain how dividend policies affect stock prices, if a firm increases its dividend, but at a rate that is lower than investors expect, the price of its stock probably would decrease. 

Question 22

Amber Corp. has 3 million shares of common stock outstanding. The stock is selling at $30 per share. If Amber announces a 20 percent stock dividend, the transfer that must be made from retained earnings to the common stock account to account for the stock dividend will be _____. 

A)$3,600,000
B)$18,000,000
C)$14,400,000
D)$108,000,000
E)$6,000,000

Question 23

All else equal, a regular stock split:

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 firm's financial statements.
E)increases the dividend per share paid by a firm.

Question 24

Liquid Farms is considering a 1-for-2 reverse stock split. Its stock is currently selling for $10 per share. Liquid plans to pay a dividend equal to $0.40 per share after the split. But, it would like to pay an equivalent dividend per share even if the split does not take place. What should the per share dividend be if Liquid doesn't split the stock?

A)$0.40
B)$0.20
C)$0.80
D)$4.00
E)$2.00

Question 25

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 26

LTD, Inc. plans to initiate a 5-for-1 stock split. LTD's stock currently sells for $180 per share. What will be the per share price of the stock immediately following the split?

A)$36.00
B)$900.00
C)$72.00
D)$27.78
E)$12.96

Question 27

Last week, Grandma's Gardens Inc. split its stock 4-for-1. Today, Grandma's paid a dividend equal to $0.26 per new (post-split) share. The dividend payment was 4 percent greater than last year's pre-split dividend. What was last year's dividend per share?

A)$1.08
B)$0.25
C)$1.04
D)$1.00
E)$0.065

Question 28

Many firms offer to reinvest stockholders' cash dividends in new shares of its stock through dividend reinvestment plans (DRIP). 

Question 29

Which of the following is an advantage of stock repurchases?

A)Stock repurchases generally signal that the stock is overpriced.
B)A company carries out a stock repurchase when it wants to lower the market price of its common stock.
C)Stock repurchases generally occur at regular intervals during specified time periods.
D)Stock repurchases might help to fend off hostile takeover attempts.
E)Stock repurchases should be made only when the firm has cash deficiencies.

Question 30

A major disadvantage of stock repurchases is that the company:

A)spends most of its excess cash to repurchase the stock.
B)cannot change its capital structure through such an action.
C)becomes more vulnerable to takeovers after the stock repurchase.
D)might pay too much for stock that is repurchased.
E)makes it difficult for employees to exercise their stock options.

Question 31

If a firm wants to decrease the per-share price of its common stock, which of the following actions should it take? Assume everything else remains constant. 

A)Initiate a 1-for-3 reverse stock split
B)Initiate a 2-for-1 stock split
C)Increase the per share dividend that it pays
D)Repurchase some of its stock, and use the proceeds to pay off long-term bonds
E)Issue a substantial amount of new bonds to finance capital budgeting projects that have negative net present values (NPVs)

Question 32

Which of the following statements about stock splits is correct?

A)Stock splits have no effect on the per-share par value of the stock.
B)Stock splits do not affect a firm's financial statements.
C)All else equal, a stock split generally leads to an increase in the total dividends paid by a company when the split occurs.
D)A company generally initiates a stock split to decrease the proportion of common stock contained in its capital structure.
E)Stock splits should have no effect on a firm's market value.

Question 33

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

A)dividend
B)split
C)adjustment
D)repurchase
E)realignment

Question 34

What effect does a stock dividend have on the financial statements of the company that pays the dividend?

A)The current market value of the stock "paid" as the dividend must be transferred from the Retained earnings account to the Common stock account and the Additional paid-in capital account.
B)The par value of the stock"paid" as the dividend must be transferred from the Retained earnings account to the Common stock account and the Additional paid-in capital account.
C)No entry is made on the financial statements, because stock dividends do not affect the firm's market value.
D)The retained earnings account will increase and the balance in the Cash account will decrease by the market value of the stock "paid" as the dividend.
E)The amount in the Common stock account will increase, but the number of common shares outstanding will not change.

Question 35

Centurion Alarms recently declared a 10 percent stock dividend. Prior to the stock dividend, the equity section on Centurion's balance sheet was:


$\begin{array}{lr}\text { Common stock ( } 100,000 \text { shares outstanding, \$1 par value) } & \$ 100,000 \\\text { Additional paid-in capital } & 60,000 \\\text { Retained earnings } & \underline{90,000} \\\text { Total common shareholders' equity } & \underline{\$ 250,000}\end{array}$


Centurion's stock currently sells for $4 per share. After the stock dividend is paid, the amount in the Common stock account should be _______ and the amount in the Retained earnings account should be ______. 

A)$110,000; $50,000
B)$100,000; $90,000
C)$140,000; $50,000
D)$100,000; $50,000
E) $90,000; $110,000

Question 36

Sunshine Corp. announced a 2-for-1 stock split of its common stock, which currently is selling for $10 per share. Currently, 200,000 shares of stock are outstanding. What should be the market price per share of the stock immediately after the split is initiated?

A)$10
B)$15
C)$5
D)$20
E)$50

Question 37

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

A)Language differences
B)Tax structures
C)Marketing campaigns
D)Takeover threats
E)Manufacturing process

Question 38

According to the free cash flow hypothesis that has been proposed to explain how dividend policies affect stock prices, cash flows that cannot be reinvested in positive net present value projects should be retained and reinvested by the firm. 

Question 39

Everything else equal, if stockholders prefer current income to future income (i.e., capital gains), a firm's cost of equity will:

A)decrease if its dividend payout increases.
B)decrease if its eliminates all dividend payments.
C)decrease if its excess (free) cash increases.
D)decrease if management promotes its wishes to restrict ownership in the firm.
E)increase if debt restrictions decrease.

Question 40

The clientele effect hypothesis that has been proposed to explain how dividend policies affect stock prices suggests that a firm's dividend policy can provide information about management's behavior with respect to wealth maximization. 

Question 41

The primary factor that influences the dividend policies of companies around the world is the level of protection that exists for the rights of minority stockholders. 

Question 42

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

Question 43

One reason a firm repurchases its stock is to distribute excess funds.