Deck 17: Payout Policy

Question 1

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. omicrons 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

Answer 1

$5.00

Question 2

The firm will pay the dividend to all shareholders who are registered owners on a specific date, set by the board, called the:

A)declaration date.
B)record date.
C)distribution date.
D)ex-dividend date.

Answer 2

record date.

Question 3

Use the following information to answer the question(s)below.
Wyatt Oil has assets with a market value of $600 million, $70 million of which are cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect capital markets.
If Wyatt Oil distributes the $70 million as a dividend, then its debt-to-equity ratio after the dividend will be closest to:

A)0.7
B)0.9
C)1.0
D)1.1

Answer 3

0.9

Question 4

Use the following information to answer the question(s)below.
Wyatt Oil has assets with a market value of $600 million, $70 million of which are cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect capital markets.
If Wyatt Oil distributes the $70 million as a share repurchase, then the number of shares outstanding after the repurchase will be closest to:

A)16.0 million
B)16.5 million
C)17.5 million
D)18.0 million

Question 5

Use the following information to answer the question(s)below.
Wyatt Oil has assets with a market value of $600 million, $70 million of which are cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect capital markets.
If Wyatt Oil distributes the $70 million as a dividend, then its stock price after the dividend will be closest to:

A)$12.50
B)$14.00
C)$17.50
D)$26.50

Question 6

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. omicrons 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

Question 7

A firm can repurchase shares through a(n)________ in which it offers to buy shares at a prespecified price during a short time period-generally within 20 days.

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

Question 8

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 repurchases

Question 9

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 repurchases
B)Dutch auction share repurchase
C)tender offer
D)targeted repurchase

Question 10

Use the following information to answer the question(s)below.
Wyatt Oil has assets with a market value of $600 million, $70 million of which are cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect capital markets.
If Wyatt Oil distributes the $70 million as a share repurchase, then its debt-to-equity ratio after the share repurchase will be closest to:

A)0.9
B)1.0
C)1.1
D)1.4

Question 11

Taggart Transcontinental has announced a $2 dividend. If Taggart's last price cum-dividend is $45, then, assuming perfect capital markets, what should its first ex-dividend price be?

A)$0
B)$2
C)$43
D)$45

Question 12

The date on which the board authorizes the dividend is the:

A)declaration date.
B)distribution date.
C)record date.
D)ex-dividend date.

Question 13

Use the following information to answer the question(s)below.
Wyatt Oil has assets with a market value of $600 million, $70 million of which are cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect capital markets.
Wyatt Oil's current stock price is closest to:

A)$11.00
B)$12.50
C)$14.00
D)$17.50

Question 14

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. omicrons 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

Question 15

Anyone who purchases the stock on or after the ________ date will not receive the dividend.

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

Question 16

The firm mails dividend checks to the registered shareholders on the:

A)ex-dividend date.
B)declaration date.
C)distribution date.
D)record date.

Question 17

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 repurchases

Question 18

Use the following information to answer the question(s)below.
Wyatt Oil has assets with a market value of $600 million, $70 million of which are cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect capital markets.
If Wyatt Oil distributes the $70 million as a share repurchase, then its stock price after the share repurchase will be closest to:

A)$11.00
B)$12.50
C)$14.00
D)$17.50

Question 19

Which of the following statements is FALSE?

A)In perfect capital markets, holding fixed the investment policy of a firm, the firm's choice of dividend policy is irrelevant and does not affect the initial share price.
B)In a perfect capital market, when a dividend is paid, the share price drops by the amount of the dividend when the stock begins to trade ex-dividend.
C)In perfect capital markets, an open market share repurchase has no effect on the stock price, and the stock price is the same as the ex-dividend price if a dividend were paid instead.
D)In perfect capital markets, investors are indifferent between the firm distributing funds via dividends or share repurchases. By reinvesting dividends or selling shares, they can replicate either payout method on their own.

Question 20

Which of the following statements is FALSE?

A)From an accounting perspective, dividends generally reduce the firm's current (or accumulated)retained earnings.
B)The way a firm chooses between paying dividends and retaining earnings is referred to as its payout policy.
C)Most companies that pay dividends pay them semiannually.
D)Occasionally, a firm may pay a one-time, special dividend that is usually much larger than a regular dividend.

Question 21

Assume that you own 4000 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 have preferred that Omicron used the excess cash to pay a special dividend. Detail exactly how you could create a homemade dividend that will provide you with the same combination of cash and stock that you would have received if Omicron paid the special dividend.

Question 22

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

Question 23

Assume that you own 4000 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 have preferred that Omicron used the excess cash to repurchase stock. Detail exactly how you could undo the dividend in a way that will provide you with the same combination of cash and stock that you would have received if Omicron had not paid the special dividend.

Question 24

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

Question 25

Use the following information to answer the question(s)below.

Wyatt Oil pays a regular dividend of $2.50 per share. Typically the stock price drops by $2.00 per share when the stock goes ex-dividend. Suppose the capital gains tax rate is 20%, but investors pay different tax rates on dividends. Absent transactions cost, the highest dividend tax rate of an investor who could gain from trading to capture the dividend is closest to:

A)0%
B)20%
C)24%
D)36%

Question 26

Use the following information to answer the question(s)below.

In which years were dividends NOT tax disadvantaged?

A)1987 - 2002
B)1987, 1993 - 2002
C)1987, 1991 - 2002
D)1988 - 1990, 2003 - 2009

Question 27

Use the following information to answer the question(s)below.

The effective dividend tax rate in 1999 is closest to:

A)0%
B)20%
C)25%
D)30%

Question 28

Use the following information to answer the question(s)below.

Which of the following statements is FALSE?

A)While firms do still pay dividends, substantial evidence shows that many firms have recognized their tax disadvantage.
B)The fact that firms continue to issue dividends despite their tax disadvantage is often referred to as the dividend puzzle.
C)At the end of the 1990s dividend payments exceeded the value of repurchases for U.S. industrial firms.
D)While evidence is indicative of the growing importance of share repurchases as a part of firms' payout policies, it also shows that dividends remain a key form of payouts to shareholders.

Question 29

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. omicrons 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

Question 30

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. omicrons 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

Question 31

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. omicrons 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

Question 32

Use the following information to answer the question(s)below.

Which of the following statements is FALSE?

A)Unlike with capital structure, taxes are not an important market imperfection that influence a firm's decision to pay dividends or repurchase shares.
B)If dividends are taxed at a higher rate than capital gains, which has been true until the most recent change to the tax code, shareholders will prefer share repurchases to dividends.
C)Shareholders typically must pay taxes on the dividends they receive. They must also pay capital gains taxes when they sell their shares.
D)But because long-term investors can defer the capital gains tax until they sell, there is still a tax advantage for share repurchases over dividends.

Question 33

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. omicrons 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

Question 34

Use the following information to answer the question(s)below.

In which years were dividends tax disadvantaged?

A)1987 - 2002
B)1987, 1993 - 2002
C)1987, 1991 - 2002
D)1988 - 1990, 2003 - 2009

Question 35

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. omicrons 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

Question 36

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. omicrons 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

Question 37

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. omicrons 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

Question 38

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. omicrons 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

Question 39

Use the following information to answer the question(s)below.

Which of the following statements is FALSE?

A)When a firm pays a dividend, shareholders are taxed according to the dividend tax rate. If the firm repurchases shares instead, and shareholders sell shares to create a homemade dividend, the homemade dividend will be taxed according to the capital gains tax rate.
B)When the tax rate on dividends exceeds the tax rate on capital gains, shareholders will pay lower taxes if a firm uses share repurchases for all payouts rather than dividends.
C)Firms that use dividends will have to pay a lower after-tax return to offer their investors the same pre-tax return as firms that use share repurchases.
D)The optimal dividend policy when the dividend tax rate exceeds the capital gain tax rate is to pay no dividends at all.

Question 40

Use the following information to answer the question(s)below.

The effective dividend tax rate in 1989 is closest to:

A)0%
B)20%
C)25%
D)30%

Question 41

Use the following information to answer the question(s)below.
Suppose that all capital gains are taxed at a 20% rate, and that the dividend tax rate is 40%. Rearden Metal is currently trading for $40 per share, and is about to pay a $5 special dividend.
The effective dividend tax rate for an investor in Rearden Metal is closest to:

A)0%
B)20%
C)25%
D)30%

Question 42

Use the following information to answer the question(s)below.
Suppose that all capital gains are taxed at a 20% rate, and that the dividend tax rate is 40%. Rearden Metal is currently trading for $40 per share, and is about to pay a $5 special dividend.
Absent any other trading frictions or news, Rearden's share price just after the dividend is paid will be closest to:

A)$35
B)$36
C)$37
D)$40

Question 43

Use the information for the question(s)below.
Consider the following tax rates:
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the highest bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a one-year individual investor in 1999 is closest to:

A)0%
B)20%
C)25%
D)40%

Question 44

Consider the following equation: P_cum - P_ex = Div × The term τ_d is:

A)the price per share after a dividend is paid.
B)the price per share before a dividend is paid.
C)the personal tax rate for capital gains.
D)the personal tax rate for dividend.

Question 45

Which of the following statements is FALSE?

A)Individuals in the highest tax brackets have a preference for stocks that pay high dividends, whereas tax-free investors and corporations have a preference for stocks with no or low dividends.
B)To compare investor preferences, we must quantify the combined effects of dividend and capital gains taxes to determine an effective dividend tax rate for an investor.
C)The dividend-capture theory states that absent transaction costs, investors can trade shares at the time of the dividend so that non-taxed investors receive the dividend.
D)Differences in tax preferences create clientele effects, in which the dividend policy of a firm is optimized for the tax preference of its investor clientele.

Question 46

Use the following information to answer the question(s)below.
Suppose that all capital gains are taxed at a 20% rate, and that the dividend tax rate is 40%. Rearden Metal is currently trading for $40 per share, and is about to pay a $5 special dividend.
Suppose that Rearden Metal made a surprise announcement that it would do a share repurchase rather than pay a special dividend, the net tax savings per share for an investor that would result from this decision is closest to:

A)$1.25
B)$3.75
C)$4.00
D)$5.00

Question 47

Use the information for the question(s)below.
Consider the following tax rates:
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the highest bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a pension fund in 1999 is closest to:

A)40%
B)20%
C)0%
D)25%

Question 48

Use the information for the question(s)below.
Consider the following tax rates:
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the highest bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a one-year individual investor in 2006 is closest to:

A)20%
B)15%
C)35%
D)0%

Question 49

Consider the following equation: P_cum - P_ex = Div × The term P_ex is:

A)the personal tax rate for dividend.
B)the price per share before a dividend is paid.
C)the price per share after a dividend is paid.
D)the personal tax rate for capital gains.

Question 50

Which of the following equations is INCORRECT?

A)P_cum - P_ex = Div ×
B)P_cum - P_ex = Div ×
C) =

D)(P_cum - P_ex)(1 - τ_d)= Div(1 - τ_g)

Question 51

Consider the following equation: P_cum - P_ex = Div × The term P_cum is:

A)the personal tax rate for capital gains.
B)the price per share after a dividend is paid.
C)the price per share before a dividend is paid.
D)the personal tax rate for dividend.

Question 52

Use the information for the question(s)below.
Consider the following tax rates:
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the highest bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a buy and hold individual investor in 2006 is closest to:

A)0%
B)35%
C)15%
D)20%

Question 53

Using the available tax information for 2002, calculate the effective dividend tax rate for a:
(1)one-year individual investor
(2)buy and hold individual investor
(3)pension fund

Question 54

Which of the following statements is FALSE?

A)Tax rates vary by income, by jurisdiction, and by whether the stock is held in a retirement account. Because of these differences, firms may attract different groups of investors depending on their dividend policy.
B)While many investors have a tax preference for share repurchases rather than dividends, the strength of that preference depends on the difference between the dividend tax rate and the capital gains tax rate that they face.
C)Long-term investors are more heavily taxed on capital gains, so they would prefer dividend payments to share repurchases.
D)One-year investors, pension funds, and other non-taxed investors have no tax preference for share repurchases over dividends, they would prefer a payout policy that most closely matches their cash needs.

Question 55

Use the following information to answer the question(s)below.
d'Anconia Copper has $200 million in cash that it can use for a share repurchase. Suppose instead that d'Anconia Copper invests the funds in an account paying 5% interest for one year. Assume that the corporate tax rate is 35%, the individual capital gains rate is 15% and the individual rate on ordinary income is 30%.
The amount of additional cash that d'Anconia Copper will have at the end of the year net of corporate taxes is closest to:

A)$2.0 million
B)$5.5 million
C)$6.5 million
D)$7.0 million

Question 56

Use the following information to answer the question(s)below.
d'Anconia Copper has $200 million in cash that it can use for a share repurchase. Suppose instead that d'Anconia Copper invests the funds in an account paying 5% interest for one year. Assume that the corporate tax rate is 35%, the individual capital gains rate is 15% and the individual rate on ordinary income is 30%.
Net of capital gains taxes, the amount the total value of d'Anconia Copper shares increase is closest to:

A)$5.5 million
B)$6.5 million
C)$7.0 million
D)$10.0 million

Question 57

Use the following information to answer the question(s)below.
d'Anconia Copper has $200 million in cash that it can use for a share repurchase. Suppose instead that d'Anconia Copper invests the funds in an account paying 5% interest for one year. Assume that the corporate tax rate is 35%, the individual capital gains rate is 15% and the individual rate on ordinary income is 30%.
Net of ordinary income taxes, the amount that investors would have if they invested the $200 million on their own is closest to:

A)$5.5 million
B)$6.5 million
C)$7.0 million
D)$10.0 million

Question 58

Use the information for the question(s)below.
Consider the following tax rates:
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the highest bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a buy and hold individual investor in 1999 is closest to:

A)25%
B)0%
C)20%
D)40%

Question 59

Consider the following equation: P_cum - P_ex = Div × The term τ_g is:

A)the personal tax rate for dividend.
B)the personal tax rate for capital gains.
C)the price per share before a dividend is paid.
D)the price per share after a dividend is paid.

Question 60

Use the information for the question(s)below.
Consider the following tax rates:
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the highest bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a pension fund in 2006 is closest to:

A)20%
B)0%
C)25%
D)15%

Question 61

Consider the following equation: P_retain = P_cum × The term P_retain in this equation represents:

A)the price of the stock if it retains and invests the cash.
B)the percentage of net income retained or reinvested back into the firm.
C)the percentage of net income paid out as a cash dividend.
D)the price of the stock if it retains cash to use in a share repurchase.

Question 62

Use the information for the question(s)below.
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free cash flows of $75 million per year. Management plans to use the cash to expand the firm's operations, which in turn will increase future free cash flows by 12%. Iota's cost of capital is 10% and assume that capital markets are perfect.
The NPV of Iota's expansion project is closest to:

A)-$110 million
B)-$137.5 million
C)$0
D)$75 million

Question 63

Use the information for the question(s)below.
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free cash flows of $75 million per year. Management plans to use the cash to expand the firm's operations, which in turn will increase future free cash flows by 12%. Iota's cost of capital is 10% and assume that capital markets are perfect.
The value of Iota if they do not to use the $200 million to expand and hold the cash instead is closest to:

A)$840 million
B)$825 million
C)$950 million
D)$688 million

Question 64

Use the following information to answer the question(s)below.
d'Anconia Copper has $200 million in cash that it can use for a share repurchase. Suppose instead that d'Anconia Copper invests the funds in an account paying 5% interest for one year. Assume that the corporate tax rate is 35%, the individual capital gains rate is 15% and the individual rate on ordinary income is 30%.
Which of the following statements is FALSE?

A)A firm must balance the tax costs of holding cash with the potential benefits of having to raise external funds in the future.
B)Paying out excess cash through dividends or share repurchases can boost the stock price by reducing managers' ability and temptation to waste resources.
C)If there is a reasonable likelihood that future earnings will be insufficient to fund future positive-NPV investment opportunities, a firm may start accumulating cash to make up the difference.
D)According to the managerial entrenchment theory of payout policy, managers pay out cash only when pressured to do so by the firm's investors.

Question 65

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

The effective tax disadvantage for retaining cash in 2006 is closest to:

A)14.75%
B)12.50%
C)35.00%
D)15.00%

Question 66

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.
In 2006, Luther Incorporated paid a special dividend of $5 per share for the 100 million shares outstanding. If Luther has instead retained that cash permanently and invested it into treasury bills earning 5%, then the present value of the additional taxes paid by Luther would be closest to:

A)$35 million
B)$290 million
C)$175 million
D)$585 million

Question 67

Consider the following equation: P_retain = P_cum × The term τ_c in this equation represents:

A)the corporation's tax rate on interest income.
B)the investor's tax rate on interest income.
C)the investor's tax rate on cumulative dividends.
D)the investor's tax rate on capital gains.

Question 68

Use the information for the question(s)below.
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free cash flows of $75 million per year. Management plans to use the cash to expand the firm's operations, which in turn will increase future free cash flows by 12%. Iota's cost of capital is 10% and assume that capital markets are perfect.
The value of Iota if they use the $200 million to expand is closest to:

A)$825 million
B)$688 million
C)$840 million
D)$950 million

Question 69

Use the information for the question(s)below.
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free cash flows of $75 million per year. Management plans to use the cash to expand the firm's operations, which in turn will increase future free cash flows by 12%. Iota's cost of capital is 10% and assume that capital markets are perfect.
The price per share of Iota if they not to use the $200 million to expand and hold the cash instead is closest to:

A)$16.50
B)$16.80
C)$19.00
D)$13.75

Question 70

Suppose that Iota is able to invest the $200 million in excess cash into a project that will increase future free cash flows by 30%. If you were advising the board, what course of action would you recommend, investing the $200 million in an expansion project that will raise future free cash flows by 30% or use the $200 million to repurchase shares? Which provides the higher stock price?

Question 71

Use the information for the question(s)below.
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free cash flows of $75 million per year. Management plans to use the cash to expand the firm's operations, which in turn will increase future free cash flows by 12%. Iota's cost of capital is 10% and assume that capital markets are perfect.
The price per share of Iota if they use the $200 million to expand is closest to:

A)$13.75
B)$16.50
C)$19.00
D)$16.80

Question 72

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

The effective tax disadvantage for retaining cash in 2002 is closest to:

A)15.00%
B)14.75%
C)30.00%
D)35.00%

Question 73

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

Question 74

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

The effective tax disadvantage for retaining cash in 2000 is closest to:

A)15.00%
B)13.35%
C)14.75%
D)35.00%

Question 75

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

Question 76

Use the following information to answer the question(s)below.
d'Anconia Copper has $200 million in cash that it can use for a share repurchase. Suppose instead that d'Anconia Copper invests the funds in an account paying 5% interest for one year. Assume that the corporate tax rate is 35%, the individual capital gains rate is 15% and the individual rate on ordinary income is 30%.
Which of the following statements is FALSE?

A)In perfect capital markets, buying and selling securities is a zero-NPV transaction, so it should not affect firm value.
B)Making positive-NPV investments will create value for the firm's investors, whereas saving the cash or paying it out will not.
C)In perfect capital markets, if a firm invests excess cash flows in financial securities, the firm's choice of payout versus retention is irrelevant and does not affect the initial share price.
D)After adjusting for investor taxes, there remains a substantial tax advantage for the firm to retain excess cash.

Question 77

Consider the following equation: P_retain = P_cum × The term τ_i in this equation represents:

A)the corporation's tax rate on interest income.
B)the investor's tax rate on capital gains.
C)the investor's tax rate on interest income.
D)the investor's tax rate on cumulative dividends.

Question 78

Which of the following formulas is INCORRECT?

A)τ*_retain =
B)P_retain =
C)P_retain = P_cum ×
D)P_retain = P_cum × (1 - τ*_retain)

Question 79

A member of Iota's board of directors suggests that Iota's stock price would be higher if they used the $200 million to repurchase shares instead of funding the expansion. If you were advising the board, what course of action would you recommend, expansion or repurchase? Which provides the higher stock price?

Question 80

Use the following information to answer the question(s)below.
d'Anconia Copper has $200 million in cash that it can use for a share repurchase. Suppose instead that d'Anconia Copper invests the funds in an account paying 5% interest for one year. Assume that the corporate tax rate is 35%, the individual capital gains rate is 15% and the individual rate on ordinary income is 30%.
Suppose that d'Anconia Copper retained the $200 million in cash so that it would not need to raise new funds from outside investors for an expansion it has planned for next year. If it did raise new funds, it would have to pay issuance fees. Assuming that these fees can be expensed for corporate tax purposed, the amount that d'Anconia Copper needs to save in issuance fees to make retaining the cash beneficial for its investors is closest to:

A)$2.0 million
B)$5.5 million
C)$6.5 million
D)$7.0 million