Deck 11: Payout Policy

Question 1

The Modigliani and Miller dividend irrelevance argument does not rest on the assumption that:

A)investors are not indifferent between dividend income and capital gain income.
B)a firm's investment decision is independent of its dividend policy.
C)the costs of acquiring information of a firm's dividend policy are zero.
D)there are no taxes.

Answer 1

investors are not indifferent between dividend income and capital gain income.

Question 2

Under the Modigliani and Miller dividend irrelevance argument:

A)dividend policy is a trade-off between cash raised from new operations and new share issues whilst paying dividends.
B)dividend policy is a trade-off between cash raised from new operations and investment outlays whilst paying dividends.
C)dividend policy is a trade-off between retaining profit and making new share issues whilst paying dividends.
D)dividends are paid to maximise shareholder wealth.

Answer 2

dividend policy is a trade-off between retaining profit and making new share issues whilst paying dividends.

Question 3

Under the classical tax system,dividends were taxed in the hands of the investor at the:

A)standard rate of 35%.
B)standard rate of 30%.
C)withholding tax rate.
D)investor's marginal tax rate.

Answer 3

investor's marginal tax rate.

Question 4

Dividend-payout ratio can be best defined as:

A)percentage of profits used by a company to buy back its own shares.
B)percentage of profits paid out as dividends to shareholders.
C)percentage of profits paid out as dividends to debtholders.
D)none of the given options.

Question 5

Which section of the Corporations Act 2001 generally precludes a company from purchasing its own shares?

A)Section 25A.
B)Section 29A.
C)Section 295A.
D)Section 259A.

Question 6

A pure residual dividend policy requires:

A)that dividends be paid on a constant year-to-year basis.
B)dividends to be paid only if profits are in excess of investment needs.
C)extra finance to be raised externally to meet dividend needs.
D)franked dividends to be paid if a positive balance exists in the franking account.

Question 7

Under the Modigliani and Miller dividend irrelevance argument:

A)a firm's investment decision is a function of the dividend policy.
B)share prices are dependent upon a firm's dividend policy.
C)shareholders prefer capital gain income to dividend income.
D)shareholders are indifferent between the payment of dividends and the retention of profits because cash paid out as dividends can be replaced without cost by issuing additional shares.

Question 8

In Australia companies generally pay dividends:

A)twice a year.
B)three times a year.
C)four times a year.
D)at least twice a year.

Question 9

A reason why management may have a long-term dividend payout ratio is that:

A)investors have a long-term investment horizon.
B)the present value of taxes paid on future dividend income is less than the present value of taxes paid on current dividend income.
C)management views dividends as a function of sustainable profits.
D)it assists management in long-term planning.

Question 10

Companies are able to repurchase up to 10 per cent of their ordinary shares in a 12-month period often known as the:

A)12/10 rule.
B)10/12 rule.
C)12/10 limit.
D)10/12 limit.

Question 11

The amount of dividend that can be paid to shareholders:

A)depends on how profitable a business is and on the current assets of the business.
B)is limited to the amount of current period profits.
C)is limited to the amount of current period profits and accumulated profits.
D)is limited to the amount of current period profits,accumulated profits and paid up capital.

Question 12

N Ltd shares have a closing price of $10.85 on 8 November 2005.On the next day they will begin trading on an ex-dividend basis.The dividend is 40 cents per share fully franked at the company tax rate of 30 per cent.What is the expected ex-dividend share price?

A)$10.82
B)$10.20
C)$10.28
D)Cannot be calculated as sufficient information is not available.

Question 13

A constant payout policy for dividends involves:

A)a constant total amount of dividends paid each year.
B)a constant ratio of dividends to profit and a constant amount of dividends paid from year to year.
C)consideration given to profitable investment proposals.
D)a constant ratio of dividends to profit but not a constant amount of dividends paid from year to year.

Question 14

A residual dividend policy differs from a stable dividend policy in the following respect:

A)Dividends can only be stable under a residual policy if profits are constant.
B)Dividends under the residual policy method fluctuate from year to year depending on profits.
C)Dividends are a function of profits under the stable policy method but are a function of investment needs under the residual policy method.
D)Dividends are a function of long-term profits under the stable policy method but are a function of investment needs under the residual policy method.

Question 15

For shares listed on the ASX,an ex-dividend date is:

A)four business days after the record date.
B)four business days before the record date.
C)seven business days after the record date.
D)seven business days before the record date.

Question 16

Which system allows companies to pay dividends that carry credits for income tax paid by the company?

A)Classical tax system.
B)Clientele system.
C)Imputation system.
D)None of the given options.

Question 17

Under the Modigliani and Miller dividend irrelevance argument,a company's value:

A)is independent of its dividend policy.
B)is dependent on its dividend policy.
C)and investment policies are mutually exclusive.
D)and investment policies are independent.

Question 18

Which type of dividend carries a credit for income tax paid by the company?

A)Special dividend.
B)Cum dividend.
C)Liquidating dividend.
D)Franked dividend.

Question 19

To be entitled to receive a dividend,an investor must purchase shares:

A)before the ex-dividend date.
B)after the ex-dividend date.
C)after the ex-dividend date but before the 'books closing' date.
D)before the ex-dividend date but before the 'books closing' date.

Question 20

The imputation system was introduced in:

A)June 1987.
B)July 1987.
C)June 1988.
D)July 1988.

Question 21

Which statement is true regarding dividend reinvestment plans?

A)They were introduced after the introduction of the imputation system.
B)They do not allow tax credits to be transferred to shareholders.
C)They allow shareholders to purchase additional shares without incurring transaction costs.
D)They allow shareholders to purchase additional shares without a discount.

Question 22

If a company earns income of $1 million before company tax,has tax deductions of $0.2 million,has additional taxable income of $0.1 million related to previous years and is on a marginal tax rate of 30%,what is its effective marginal tax rate on current income?

A)30%
B)32.7%
C)24%
D)27%

Question 23

Which of the following statements is false?

A)Resident investors,who have marginal tax rates equal to or less than the company tax rate,will always prefer that companies pay dividends instead of retaining profits.
B)The payment of dividends,franked or unfranked,can reduce future capital gains tax.
C)An unexpected increase in dividends should cause an increase in the market's expectation of future earnings.
D)None of the given options.

Question 24

A characteristic of franked dividends that differentiates them from unfranked dividends is:

A)franked dividends carry tax credits related to the income tax paid by the company.
B)the gross amount of dividends paid is different.
C)franked dividends are indexed for inflation,while unfranked dividends are not.
D)the amount of payment received by the shareholder from the company.

Question 25

Which of the following statements is true?

A)Capital gains tax applies only to gains on assets acquired on or after 21 September 1999.
B)Capital gains tax for all assets sold (assuming they realise capital gains)after 11.45am on 21 September 1999 must be determined using the discount method.
C)Only resident individual investors can claim imputation tax credits.
D)None of the given options.

Question 26

In a perfect market,dividend policy has no effect on shareholders' wealth because:

A)transactions are costless.
B)any cash paid out as dividends must be replaced by issuing additional shares.
C)directors fix share prices during dividend announcements.
D)any cash paid out as dividends can be costlessly replaced by issuing new shares.

Question 27

Which of the following statements best represents the 'bird in the hand' argument?

A)Debt increases share price.
B)A company's share price will decrease if dividends are reduced now,in order to increase the growth in future profits and dividends.
C)Investors are indifferent between a dollar of dividends compared to the capital gains expected from a dollar of retained profits.
D)Expected capital gains are seen as uncertain because their eventual realisation depends on the returns from risky initial investments.

Question 28

Share price changes around the time of announcements of dividend changes are positively related to the change in dividends.This evidence may not invalidate the dividend irrelevance theorem because:

A)investors are indifferent between capital gains and dividend income.
B)debt is not necessarily affected by such announcements.
C)share prices revert back to pre-dividend levels following the announcement.
D)it is not the dividend payments that determine the value of shares but information about the future cash flows that is conveyed by the announcement.

Question 29

One reason that may explain why dividend policy is relevant to investors is that:

A)shareholders are indifferent between dividend income and capital gains income.
B)valuable inside information is conveyed by announcements of dividend changes.
C)investors,in general,prefer investments in companies that pay dividends.
D)investors do not trust dividend projections.

Question 30

If taxes on dividend income and capital gains income were a major determinant of dividend payout ratio policies,then under the classical tax system we would expect:

A)there to be many companies with large dividend payout ratios.
B)investors on high marginal tax rates to prefer companies that pay dividends.
C)a target payout ratio large enough to warrant new share issues to finance expenditures.
D)tax-exempt investors,such as super funds,to invest in companies with high dividend payout ratios.

Question 31

A reason why shareholders may prefer dividend income to expected capital gains is because:

A)of the 'bird in the hand' argument.
B)shareholders who require current income can always sell a portion of their portfolio.
C)transaction costs such as brokerage fees make selling shares less attractive.
D)they distrust future projections.

Question 32

Which of the following is an unlikely reason as to why a company would not pay a high franked dividend payout ratio?

A)Shareholders may be tax-exempt.
B)It is running short of cash to finance new investments.
C)Shareholders may not be residents.
D)Shareholders are on the same marginal tax rate as the company.

Question 33

Which of the following statements best describes the tax clientele argument?

A)Investors subject to high personal tax rates would prefer shares of companies that pay low dividends.
B)Investors subject to high personal tax rates would prefer shares of companies that pay high dividends.
C)Investors subject to high personal tax rates are indifferent to the dividend payout rate.
D)Investors subject to high personal tax rates would prefer shares of companies that promise low capital gains.

Question 34

The dividend imputation system has encouraged Australian companies to adopt higher dividend payout ratios because:

A)tax on dividend income compared to capital gains is effectively lower for resident shareholders.
B)tax on dividend income compared to capital gains is effectively higher for resident shareholders.
C)tax on dividend income compared to capital gains is effectively no different for resident shareholders.
D)resident companies now have higher after-tax profits from which to pay dividends.

Question 35

The tax clientele effect implies that share price is indifferent to dividend policy because:

A)share price depends on the value of assets in place.
B)investors have no say in dividend policy.
C)in equilibrium,the range of dividend policies available satisfies the needs of investors so that one clientele is as good as another.
D)investors in high marginal tax brackets would pay a premium for shares of companies that pay no dividends.

Question 36

Which statement most accurately describes dividend irrelevance?

A)Dividends are irrelevant because investors are only interested in company profits,not cash distributions from those profits.
B)For each dollar received as dividends,the original shareholders give up future dividends with a present value of one dollar,which reduces the value of their shares by one dollar.
C)For each dollar received in dividend,the original shareholders give up future dividends with a present value of one dollar,which maintains the value of their shares.
D)None of the given options.

Question 37

A reason why shareholders may prefer dividend income to expected capital gains is because:

A)of the 'bird in the hand' argument.
B)shareholders who require current income can always sell a portion of their portfolio.
C)transaction costs such as brokerage fees make selling shares less attractive.
D)they distrust future projections.

Question 38

Assume the current share price of Company A is $4.50 and on the following day these shares will begin trading ex-dividend.If the dividend is 40 cents per share fully franked,and the company tax rate is 30 per cent,what is the expected ex-dividend share price?

A)$4.10
B)$4.50
C)$3.93
D)$4.03

Question 39

If managers commit themselves to paying out cash in excess of investment needs as dividends rather than retaining it within the company,shareholders' wealth may increase because:

A)it indicates that management will not waste resources.
B)shareholders prefer dividends now rather than in the future.
C)it reflects badly on future investments.
D)it reflects positively on future investments.

Question 40

Assume the current share price of Company A is $4.50 and on the following day these shares will begin trading ex-dividend.If the dividend is 20 cents per share,what is the expected ex-dividend share price?

A)$4.50
B)$4.70
C)$4.30
D)$3.60

Question 41

A dividend ___________ is a class of investors who have a particular preference towards a certain dividend policy.

Question 42

Miller and Modigliani hypothesised that dividend policy has a significant impact on shareholder wealth,as it involves a trade-off between higher or lower dividends and issuing or repurchasing ordinary shares.

Question 43

Share buybacks are a means by which a company can improve its performance measures,particularly earnings per share and net assets per share.

Question 44

Dividends reduce agency costs by providing an internal source of financing and increasing free cash flows.

Question 45

Kangaroo Ltd had a closing share price of $15 the day before shares in the company began trading on an ex-dividend basis.The dividend is 60 cents per share,fully franked at the company tax rate of 30 per cent.Assuming franking credits are fully valued,the expected ex-dividend share price is $14.14.

Question 46

Which of the following statements is true?

A)Announcements of dividend reinvestment plans,prior to the introduction of imputation,were associated with a significantly positive market response.
B)Announcements of dividend reinvestment plans,after the introduction of imputation,were associated with a significantly positive market response.
C)Dividend election schemes were more popular prior to the introduction of imputation.
D)None of the given options.

Question 47

Dividends may provide a credible _________ about a company's quality because the payment of dividends is evidence that the company generates sufficient cash flows,as well as providing information on management's future expectations.

Question 48

A __________________________ is an arrangement made by a company which gives shareholders the option of receiving their dividends in one or more forms.

Question 49

A share buyback:

A)could be used by management to signal that shares are not overvalued.
B)is an indication that the company has good investment opportunities,thus leading to an increase in the share price.
C)has the same tax treatment as dividend.
D)none of the given options apply.

Question 50

A key limitation of Miller and Modigliani's theory of dividend irrelevance is that they assume there is a perfect capital market with no ___________.

Question 51

Dividend reinvestment schemes are a form of payout policy that can satisfy the desire of resident investors for the payment of the maximum possible franked dividends,while ensuring the company does not run short of cash to finance new investments.

Question 52

A __________ share buyback is a type of buyback where offers are made to only some of the shareholders in a company.

Question 53

Under the imputation tax system,dividends are only taxed once at the company tax rate.