Deck 13: Dividend Policy and Internal Financing

Question 1

Expected dividends and share repurchases are the cash flow that underlies stock valuation.

Answer 1

True

Question 2

An investor who pays no tax would be more likely to accept the view that high dividends increase stock values rather than the view that low dividends increase stock values.

Answer 2

True

Question 3

Memory,Inc.expects earnings per share this year to be $8.If earnings per share grow at an average annual rate of 6 percent and if Baker pays 60 percent of its earnings as dividends,what will the expected dividend per share be in 7 years?

Answer 3

$8 (1 + 0.06)⁷ = $12.03 = Earnings per share in 7 years
$12.03 × 0.6 = $7.22 = Expected dividends per share

Question 4

Low dividends may increase stock value due to the advantage of tax deferral that comes with capital gains.

Question 5

The information effect suggests dividend policy matters because dividends act as a persuasive communications tool,signaling investors about the financial condition of the firm.

Question 6

One potential rationale for paying dividends is that the payment of dividends indirectly results in a closer monitoring of management's investment activities,hence lowering agency costs.

Question 7

As a corporation's investment opportunities increase,the dividend payout ratio should decrease so that the corporation can avoid flotation costs.

Question 8

Dividends per share divided by earnings per share equal the dividend payout ratio.

Question 9

According to the clientele effect,dividend policy matters even if capital markets are perfect because investors self-select into dividend preference groups.

Question 10

According to the expectations theory,the actual dividend must equal the expected dividend,or lese the stock price will decrease after the dividend amount is announced.

Question 11

Share repurchases are not part of the stock valuation process because by definition the cash flow from a share repurchase ends the investment as the stock is no longer owned by the shareholder.

Question 12

A firm's dividend policy includes two basic components:
the dividend payout ratio and the profit retention ratio.

Question 13

A closely-held company whose owners are trying to maintain control would be less likely to pay dividends so that all earnings may be retained to finance future growth.

Question 14

Corporations distribute cash back to their owners (stockholders)either as cash dividends or by repurchasing shares of stock in the open market.

Question 15

A firm's dividend policy includes two basic components:
the dividend payout ratio and dividend stability.

Question 16

Because of the overriding importance of cash flows to valuation,one basic tenet of finance is that dividends increase the value of a company's common stock.

Question 17

According to the "bird-in-the-hand" dividend theory,the required return for a stock that pays its entire return from dividends is higher than the required return for a high-growth stock that pays no dividend.

Question 18

In order to maximize shareholder value,a corporation must earn a higher rate of return on a dollar that is retained in the corporation than the shareholders can earn by investing the dollar elsewhere.

Question 19

The residual dividend theory is based on the observation that flotation costs make the cost of new common stock significantly higher than the cost of retained earnings.

Question 20

A fast-growing company with many high net present value projects may maximize shareholder wealth by NOT paying a dividend.

Question 21

An investor who requires an 18% percent return for a stock that pays no dividends and requires a 12% return for a stock that pays its entire return from dividends may be following the bird-in-the-hand dividend theory.

Question 22

The clientele effect does not imply that either high or low dividends are optimal,rather that firm's should not make significant and arbitrary changes in their existing dividend policy.

Question 23

If the tax rate on dividends and the tax rate on capital gains are the same,then investors are indifferent to dividend policy.

Question 24

The existence of taxes can directly affect a common shareholder's preference for capital gains or dividend income.

Question 25

If a firm were to unexpectedly omit payment of its quarterly dividend,that firm's stock price would probably drop.

Question 26

A firm's dividend policy provides information pertaining to the firm's payout ratio and its stability.

Question 27

If a company in a perfect capital market decreased its dividend per share,an investor would be forced to sell his common stock at a depressed price.

Question 28

Since stock dividends do not require payment in cash,their impact on a corporation's share price can be only positive (if there is an information effect)or neutral,but not negative.

Question 29

When Firm X makes the decision to pay dividends,they also make the decision not to reinvest the cash in the firm.

Question 30

According to the bird-in-the-hand dividend theory,investors value a dollar of expected capital gain more highly than a dollar of expected dividends because capital gains are more unpredictable than dividends.

Question 31

Security markets are considered to be perfect when firms can issue securities at no cost and the investor incurs no brokerage commissions.

Question 32

The residual dividend theory implies that internally generated funds (i.e.,retained earnings)should be used to fund all new investment projects before the company uses any additional debt.

Question 33

When an unexpected change in dividend policy develops,investors may attach informational content to the events.

Question 34

In a perfect market,investors are only concerned with total returns and are not concerned whether it is in capital gains or dividend income.

Question 35

We typically expect to find rapidly growing firms to have high payout ratios.

Question 36

Federal tax law is irrelevant to corporate dividend policy because dividends are not tax deductible.

Question 37

When considering taxes,most investors prefer capital gains over dividend income.

Question 38

The residual dividend theory suggests that dividends should be paid to stockholders first and then what is left can be reinvested by the firm.

Question 39

Under the ideal conditions of perfect capital markets,dividend policy has no effect upon share price.

Question 40

The residual theory of dividends connects a firm's dividend policy and its level of capital investments.

Question 41

In order to reduce agency costs,managers may decrease dividends,thus shifting the focus of investors to future capital gains than can only be attained by a well-run corporation.

Question 42

A corporation with very high growth prospects and many positive NPV projects to fund may want to increase its dividend based on

A) the tax bias against capital gains.
B) the residual dividend theory.
C) the information effect.
D) the very low agency costs of the corporation.

Question 43

CDE Corporation declared a $2 per share dividend on October 1.The date of record is October 20^th,the ex-dividend date is October 18^th,and the payment date is October 31^st.Joe owns a share of stock on October 1.Joe sells his share to Mary on October 18^th,Mary sells the share to Tom on October 20^th,and Tom sells the share to William on October 30^th.Who will receive the dividend?

A) Joe
B) Mary
C) Tom
D) William

Question 44

Willows Corporation is experiencing high demand for its products and high growth rates.The company just reported earnings per share of $5 for the most recent year and has many positive NPV projects to fund.One vice president wants to pay a dividend of $5 per share,arguing that this will maximize shareholder value.You argue that a much smaller dividend will maximize value.Your argument may be based on

A) the bird-in-the-hand theory.
B) the residual dividend theory.
C) the information effect.
D) the very high agency costs of the corporation.

Question 45

The residual dividend theory suggests that dividends will only be paid

A) if the tax rate on capital gains is higher than the tax rate on dividends.
B) if the corporation has more positive NPV projects than it can fund.
C) if interest rates available to shareholders are higher than the required return on the company's stock.
D) if current retained earnings exceed the equity portion of the firm's capital budget.

Question 46

Which of the following supports the "bird-in-the-hand dividend theory?

A) investors prefer dividends to capital gains because of the time value of money
B) increasing a firm's dividends transfers risk and ownership from the current shareholders to new owners
C) investment decisions are not influenced by dividend policy
D) capital mix decisions are not influenced by dividend policy

Question 47

JB Corporation has a retained earnings balance of $2,000,000.The company reported net income of $600,000,sales of $4,000,000,and has 200,000 shares of common stock outstanding.The company announced a dividend of $2.00 per share.Therefore,the company's dividend payout ratio is

A) 66.7%.
B) 50%.
C) 20%.
D) 10%.

Question 48

The "bird-in-the-hand" dividend theory suggests that

A) high dividends increase stock value because shareholders believe they can earn a higher return than the company.
B) high dividends increase stock value because shareholders are more certain of the dividend yield than of potential future capital gains.
C) high dividends increase stock value because capital markets are inefficient and dividends are the only sure way to get money from an equity investment.
D) high dividends decrease stock value because dividend payments take money out of the corporate "nest" and reduce the ability of the corporation to function effectively.

Question 49

Dividend changes may be used by management as a credible communication tool to signal investors about future earnings under which of the following dividend policy theories?

A) the clientele effect
B) the residual dividend theory
C) the information effect
D) the expectations theory

Question 50

The dividend irrelevance hypothesis is based on all of the following assumptions except:

A) investment decisions will not be altered by the amount of dividend payments.
B) investors do not need cash dividends to supplement their current income.
C) perfect capital markets.
D) borrowing decisions will not be altered by the amount of dividend payments.

Question 51

An increase in flotation costs will most likely result in which of the following?

A) smaller dividend payments so that less external equity financing is needed
B) larger dividend payments so shareholders are able to earn their required returns
C) larger dividend payments to offset higher taxes paid by investors
D) no change in dividend policies because flotation costs are paid by purchasers of common stock

Question 52

All of the following factors support the proposition that dividend policy matters except:

A) investors desire to minimize and defer taxes, and capital gains get preferential tax treatment over dividend income.
B) perfect capital markets.
C) information asymmetry exists between shareholders and managers.
D) flotation costs significantly increase the cost of new common stock compared to retained earnings.

Question 53

JBC Corp.declared a dividend of $2 per share,which was an increase of 25% from the prior year,yet JBC Corp.stock declined by 3% the day of the announcement.RBG Corp.declared a dividend of $2 per share,which was the same as the prior year,and its stock increased in value by 2% on the day of the announcement.These events could be most readily explained by the

A) information effect.
B) clientele effect.
C) expectations theory.
D) residual dividend theory.

Question 54

The information effect hypothesis implies that increasing dividends provides a more credible signal of higher future earnings than does management's assertion that future earnings will be higher.

Question 55

Corporation A announces is quarterly dividend will increase from $3.80 to $4.00.After the announcement,the price of Corporation A's stock drops.The most likely explanation is that

A) the stock market is a perfect market.
B) investors are irrational.
C) investors were expecting a larger increase.
D) Corporation A's debt ratio decreased.

Question 56

Low dividends may increase stock value according to the

A) bird-in-the-hand theory.
B) information effect.
C) impact of agency costs.
D) tax bias in favor of capital gains.

Question 57

An investor who requires a 17% percent return for a stock that pays no dividends and requires a 13% return for a stock that pays its entire return from dividends is most likely a proponent of

A) the bird-in-the-hand dividend theory.
B) the residual dividend theory.
C) the clientele effect.
D) the information effect.

Question 58

A corporation announces a significant increase in its annual dividend and its stock price increases on the news.This could be explained most directly by

A) residual dividend theory.
B) bird-in-the-hand theory.
C) perfect capital markets.
D) MM"s indifference theorem.

Question 59

The payment of dividends may indirectly result in closer monitoring of management's investment activities,thus increasing shareholder value by

A) reducing agency costs.
B) increasing information asymmetry.
C) increasing a company's amount of free cash flow.
D) reducing auditing fees.

Question 60

A corporation announces a large increase in its annual dividend,but its stock price declines.This could result from

A) residual dividend theory.
B) Bird-in-the-Hand Theory.
C) perfect capital markets.
D) MM's indifference theorem.

Question 61

According to the perfect markets approach to dividend policy

A) other things equal, the greater the payout ratio, the greater the share price of the firm.
B) the price of a share of stock is unrelated to dividend policy.
C) the firm should retain earnings so stockholders will receive a capital gain.
D) the firm should pay a dividend only after current equity financing needs have been met.

Question 62

The viewpoint that low dividends increase stock value is based on which of the following principles?

A) Time Value of Money
B) Risk-Return Trade-off
C) Taxes Bias Business Decisions
D) The Agency Problem

Question 63

Assume that a firm has a steady record of paying high dividends for years.A new management team decided to cut the current year's dividend in half without disclosing why.The market value of the stock fell 35% on the day the dividend cut was announced.Which of the following would best explain the stock market's reaction to the announcement?

A) Empirical theory
B) Dividend Irrelevance theory
C) Residual Dividend theory
D) Information effect

Question 64

Dividends generally

A) are paid as a fixed percentage of earnings.
B) fluctuate more than earnings.
C) are guaranteed by the SEC.
D) are more stable than earnings.

Question 65

Which of the following is (are)true?

A) In general, the higher the number of positive NPV investment opportunities for a firm, the lower the dividend payout ratio.
B) If the clientele effect is correct, firms should follow a constant dividend payout ratio policy.
C) According to the informational content of dividends, an increase in dividends is always a positive signal.
D) In industries with volatile earnings, the residual dividend policy results in the most consistent dividend stream.

Question 66

The "bird-in-the-hand dividend theory" supports which view of the effect of dividend policy on company value?

A) A firm's dividend policy is irrelevant.
B) High dividends increase stock values.
C) Low dividends increase stock values.
D) Constant dividends increase stock values.

Question 67

Assume that the tax on dividends and the tax on capital gains is the same.All else equal,what would a prudent investor prefer?

A) The prudent investor would be indifferent between receiving dividends or capital gains.
B) The prudent investor would prefer dividends a dollar today is always worth more than a dollar to be received in the future.
C) The prudent investor would prefer capital gains the capital gain tax liability can be deferred until gains are realized.
D) More information is needed.

Question 68

Which of the following statements would be consistent with the bird-in-the-hand dividend theory?

A) Investors are indifferent whether stock returns come from dividend income or capital gains income.
B) Dividends are more certain than capital gains income.
C) Wealthy investors prefer corporations to defer dividend payments because capital gains produce greater after-tax income.
D) Dividends are less certain than capital gains.

Question 69

In perfect capital markets there

A) is no informational content assigned to a particular dividend policy.
B) are no income taxes.
C) are no flotation costs.
D) all of the above.

Question 70

A justification for no dividend payments that would be pleasing to shareholders could be

A) insufficient cash available for dividend payments.
B) positive NPV investment projects that require the firm to retain cash for investment purposes.
C) an investor clientele that prefers current liquidity.
D) cash will be used for a stock dividend.

Question 71

A firm's dividend payout ratio is

A) the ratio of dividends to sales.
B) the ratio of dividends to market equity.
C) the ratio of dividends to earnings.
D) the ratio of dividends to book equity.

Question 72

According to the clientele effect,

A) companies should have dividend payout ratios of either 100% or 0%.
B) companies should avoid making capricious changes in their dividend policies.
C) companies should change their dividend policies to please their target group of investors.
D) even if capital markets are perfect, dividend policy still matters.

Question 73

Which of the following is true if dividend policy is irrelevant?

A) Perfect capital markets exist.
B) The clientele effect exists.
C) The information effect exists.
D) Tax deferral on capital gains exists.

Question 74

High dividends may increase stock values due to all of the following reasons except:

A) dividends are more certain than capital gains.
B) higher dividends are used to signal higher expected future earnings.
C) dividends are used as a tool to minimize agency costs.
D) higher dividends allow companies to increase their proportion of external equity financing.

Question 75

The viewpoint that high dividends increase stock values is based on which of the following principles?

A) Time Value of Money
B) Risk-Return Trade-Off
C) Taxes Bias Business Decisions
D) The Agency Problem

Question 76

Assume that a firm has a steady record of paying stable dividends for years.Market analysts had expected management to increase the dividend by 7.5% in the latest quarter.However,management announced a 15% increase in the current year's dividend.The market value of the stock rose 20% on the day of the announcement.Which of the following would best explain the stock market's reaction to the announcement?

A) Expectations theory
B) Dividend Irrelevance theory
C) Residual Dividend theory
D) Agency theory

Question 77

All of the following may influence a firm's dividend payment except:

A) investment opportunities.
B) investor transaction costs.
C) common stock par value.
D) flotation costs.

Question 78

According to the residual theory of dividends

A) dividends are a residual after investment financing needs have been met.
B) earnings remaining after payment of preferred stock dividends should be paid to common stockholders.
C) dividend payments are a constant percentage of earnings per share.
D) a dividend is the residual above the payout ratio.

Question 79

Which of the following statements would be consistent with the residual dividend theory?

A) Wealthy investors prefer corporations to defer dividend payments because capital gains produce greater after-tax income.
B) Dividends are more certain than capital gains.
C) Dividends should only be paid if a firm has profits in excess of the amount needed to finance the current year's capital investments.
D) Investors are indifferent whether stock returns come from dividend income or capital gains income.

Question 80

Which of the following statements would be consistent with the Dividend Irrelevance Theory?

A) There is no relationship between a firm's dividend policy and the value of its common stock.
B) Perfect capital markets are assumed to exist which allow investors to buy and sell stock without incurring any transaction costs.
C) Investors are indifferent whether stock returns come from dividend income or capital gains income.
D) All of the above.