Deck 17: Dividends and Dividend Policy

Question 1

Share buy-backs are a stronger indication of high cash flow than dividends.

Answer 1

False

Question 2

A regular dividend occurs when a company distributes a one-time payment to its shareholders.

Answer 2

False

Question 3

In a realistic situation, dividend policy does not affect company value.

Answer 3

False

Question 4

In a minimum holding buy-back the company offers to buy unmarketable parcels of shares from shareholders.

Question 5

Distributions to shareholders in the form of a standing discount for products or services that the company produces are often not thought of as dividends.

Question 6

Consider an investor who purchases a dividend-paying share of a public company the day prior to the dividend record date. We would expect this investor to receive a dividend distribution.

Question 7

A large regular dividend always denotes a company with a high level of cash that also has many new project alternatives.

Question 8

If there is no tax on dividends, then the price of a share will not drop on the ex-dividend date.

Question 9

On-market share buy-backs are a convenient way for the company to distribute large amounts of cash.

Question 10

Share prices react to dividend announcements because the amount of the dividend sends a signal to investors about management's view of the company's prospects.

Question 11

When a company distributes dividends to shareholders, the amount of equity capital invested in the company is reduced.

Question 12

Dividend policy can help a company maintain a desired capital structure.

Question 13

Equal access buy-backs are usually conducted on-market.

Question 14

Dividends reduce the shareholder's investment in the company.

Question 15

The record date should never come before the ex-dividend date.

Question 16

Compared to raising regular cash dividends, initiating on-market share buy-backs are generally not as strong a positive signal to investors because the buy-back can easily be cancelled or scaled back before it is completed.

Question 17

Shareholders who choose not to sell back their shares in a share buy-back are losing money because the company is only distributing value to the participating shareholders.

Question 18

Share prices drop on the ex-dividend date, but usually the drop is less than the amount of the dividend.

Question 19

Private companies often don't announce dividend payments because private company shares are not frequently traded and the list of shareholders is relatively small.

Question 20

Under the Australian imputation tax system, a company's profits are taxed at the company tax rate, and dividends paid from profits are taxed again (in the hands of shareholders) at the investor's marginal personal tax rate.

Question 21

Dividend reinvestment programs allow investors to reinvest the dividends they receive back into a company's shares without paying tax on the dividends or a transaction fee on the share purchase.

Question 22

Which of the following is NOT correct regarding taxation in Australia?

A) Under the classical tax system, a company's profits were first taxed at the company tax rate, and dividends paid were taxed again at the investor's marginal tax rate.
B) The imputation tax system allows double taxation of dividends.
C) Franking credits can be used to offset the investor's other sources of taxable income.
D) Australian companies have greater incentives to initiate dividends and raise existing dividend payouts under the imputation tax system.

Question 23

If the three conditions of Modigliani and Miller hold, then dividend policy should not affect company value.

Question 24

Suppose that the government raises short- and long-term capital gains tax while leaving all other tax unchanged. This tax rate change would encourage companies to increase the use of share buy-backs rather than issuing dividends.

Question 25

The shares of Mildura Chem Ltd fell sharply today after the company announced that it is increasing its regular cash dividend distributions. Which one of the following explanations may explain investors' negative reaction?

A) Changes in regular cash dividends are made frequently so that the company's management can adjust for changes in short-term earnings. The decrease in the share price is probably related to some other negative event.
B) Investors previously believed the company had many lucrative growth opportunities. By announcing higher regular cash dividends, the company is sending a signal that it doesn't have enough positive-NPV projects to use all the money.
C) Investors expected that the company would announce a share buy-back rather than a cash dividend increase. Since a change in dividend policy is commonly viewed as a weaker signal than a share buy-back, the share price fell on the news of the dividend increase.
D) Share prices regularly fall upon announcement of the cash dividend distributions.

Question 26

The ex-dividend date: You own 10,000 shares of Harbourside Co which is currently trading for $11.50 per share. The company has announced that it will soon pay a special dividend of $1.50 per share. Tomorrow is the ex-dividend day. Ignoring tax, what do you expect your block of shares will be worth tomorrow?

A) $15,000
B) $100,000
C) $115,000
D) $130,000

Question 27

The ex-dividend date: Harbourside Co. share is currently trading at $25.70 per share. The company pays a regular cash dividend of $0.40 every quarter. Tomorrow is ex-dividend day for the upcoming regular dividend. The tax rate on dividends is 15 per cent. Assuming there is no new information released about the company, how much do you expect the company's share to trade for tomorrow?

A) $25.70
B) $25.24
C) $25.30
D) $25.36

Question 28

Surveys conducted of managers tell us that they primarily see regular cash dividends as a way to precisely adjust their leverage ratio to the target suggested by the trade-off theory of capital structure.

Question 29

Which type of dividend is most likely to be used to distribute the revenue from a one-time sale of a large asset?

A) Regular cash dividend
B) Unusual dividend
C) Special dividend
D) Interim dividend

Question 30

Which one of these examples does NOT meet the strict definition for a dividend?

A) Steel Gen Company regularly distributes $0.05 to each shareholder for every share they own.
B) Chalone Vineyards once offered their investors discounts on wine in proportion to the number of shares they owned.
C) Sippy Downs, Ltd., which operates several horse racing tracks, including the location for the Deagon Derby, distributes two free general admission tickets to every investor who holds more than 100 shares in the company (as of 2013).
D) Both b and c do not meet the definition for a dividend.

Question 31

Which step in the dividend payment process for a public company usually results in a change in the company's share price? Assume the dividend has changed from the last dividend paid.

A) Public announcement
B) Ex-dividend date
C) Payable date
D) Both a and b

Question 32

Some companies have been known to pay dividends to current shareholders while simultaneously raising capital through a new equity issue. Generally, this behaviour is explained by the need to discipline managers in regularly exposing the company to the extra scrutiny involved in an equity issue.

Question 33

Although share splits do not add any value to the company, investors tend to react positively to share splits because management is not likely to initiate a share split if the company's prospects are poor.

Question 34

A bonus share issue does not actually transfer any value to the company's shareholders.

Question 35

Traditionally, capital gains tax has been higher than the tax on dividends.

Question 36

Which of the following is the dividend at the end of the first half of the financial year?

A) Regular cash dividend
B) Unusual dividend
C) Special dividend
D) Interim dividend

Question 37

The ex-dividend date: Cronulla Brewing Co. has announced it will pay its regular cash dividend of $0.45 per share. If dividends are taxed at 15 per cent, about how much do you expect the price of Cronulla Brewing to drop on the ex-dividend day?

A) $0.07
B) $0.38
C) $0.45
D) $0.52

Question 38

It is possible for a large investor to get a controlling interest in a company without actually buying any additional shares.

Question 39

Types of dividends: Cronulla Brewing Co. will be distributing $40 million to shareholders through a special dividend. The company has 160 million shares outstanding. If you own 100 shares of Cronulla Brewing Co., how much will you receive? Ignore tax.

A) $400
B) $100
C) $25
D) $250

Question 40

It is unethical for a corporate board to conduct a large tender-offer share buy-back when the board members have private information indicating that the company's share price is too high.

Question 41

Which of the following is NOT a possible result of a share buy-back?

A) Removing a large number of shares from circulation can change the ability of certain shareholders to control the company.
B) If the number of remaining shares is relatively small, the remaining shares will be less liquid.
C) The company will decrease its leverage ratio (debt-to-equity ratio).
D) By repurchasing shares when they are undervalued, managers can effectively transfer value from selling shareholders to shareholders who don't take part in the buy-back.

Question 42

The ex-dividend date: Mildura Chem Co is currently trading at $22.00 per share. The company is paying a regular cash dividend of $0.30 per share, and a special dividend of $0.05 per share. Tomorrow is the ex-dividend day. The tax rate on dividends is 15 per cent. Assuming there is no new information released about the company, how much do you expect the company's shares to trade for tomorrow?

A) $21.70
B) $21.65
C) $21.60
D) $22.00

Question 43

Types of dividends: Unlimited News Co. has a policy of returning a minimum of 40 per cent of earnings to shareholders every year through dividend issues and on-market share buy-backs. In each quarter this year, the company earned $0.35 per share. In each of the first three quarters the company paid a regular cash dividend of $0.10 per share. What combination of dividends could the company's board approve to meet their target payout percentage?

A) A regular cash dividend of $0.10 per share.
B) A regular cash dividend of $0.10 per share and a special dividend of 0.35 per share.
C) A regular cash dividend of $0.10 per share and a special dividend of $0.45 per share.
D) A regular cash dividend of $0.10 per share and a special dividend of $0.16 per share.

Question 44

How share buy-backs differ from dividends: You purchased 3,000 shares of Space Paranormal Co. four years ago at $40 per share You have just received a mailing from the company announcing a share buy-back at $70 per share. Capital gains are taxed at 20 per cent. If you participate in the buy-back, how much will you receive?

A) $72,000
B) $192,000
C) $186,000
D) $210,000

Question 45

Types of dividends: Stressed Capital Ltd is being liquidated. The company's assets can be sold for $20 million. It will cost $18 million for the company to meet all its previous obligations and to pay-off debt holders. The company has 30 million shares outstanding. If you own 2,000 shares, how much do you expect to receive in dividends? Ignore tax.

A) $0.00
B) $133.33
C) $266.66
D) $1,333.33

Question 46

How a share buy-back happens: ABC Co has 3 million shares outstanding. The shares are currently selling for $40. If the company buy-backs $10 million at market prices, approximately how much will the shares be worth after the buy-back? Ignore tax.

A) $40
B) $38
C) $42
D) $36

Question 47

Dividend policy and company value: You own 7,000 shares of Irri-gate Co. The company has decided to pay a special dividend of $1.00 per share. Dividend payments are taxed at 15 per cent. You intend to reinvest your dividend back into the company, but the company does not have a dividend reinvestment program. To reinvest through your broker, you will have to pay a $46 commission. If the company's shares are trading at $12.43 following the dividend payment, how many additional shares will you be able to purchase?

A) 563 shares
B) 481 shares
C) 478 shares
D) 475 shares

Question 48

Types of dividends: Finessed Finance Co. has a policy of returning a minimum of 25 per cent of earnings to shareholders every year through dividend issues and on-market share buy-backs. In each quarter this year, the company earned $0.20 per share. In each of the first three quarters, the company paid a regular cash dividend of $0.05 per share. What combination of dividends could the company's board approve to meet their target payout percentage?

A) A regular cash dividend of $0.05
B) A regular cash dividend of $0.05 per share and a special dividend of $0.25 per share
C) A regular cash dividend of $0.05 per share and a special dividend of $0.10 per share
D) A regular cash dividend of $0.05 per share and a special dividend of $0.20 per share

Question 49

Which of the following explanations is NOT a possible benefit of dividends?

A) Some investors prefer dividend-paying shares and will be willing to pay a higher price for shares with regular dividends.
B) Paying out large regular dividends can force management to regularly raise more capital. The extra scrutiny involved in raising capital can increase the incentives of management to run the company efficiently.
C) Dividends can be used to manage the capital structure of the company.
D) Paying dividends reduces the probability that the company will enter financial distress.

Question 50

Galaxy House is currently trading for $10 with 1 million shares outstanding. Which of the following actions would be the most credible signal that management believes that the long-term prospects for a company has improved?

A) Pay a $0.20 special dividend in addition to the company's $0.20 regular quarterly dividend.
B) Increase the company's regular quarterly dividend from $0.20 to $0.40.
C) Initiate an on-market share buy-back of 2 per cent of the company's shares.
D) Initiate an equal access buy-back to buy-back for 2 per cent of the company's shares.

Question 51

The ex-dividend date: Harbourside Co is currently trading at $37.00 per share. The company is paying a regular cash dividend of $0.40 per share and a special dividend of $0.10 per share. Tomorrow is the ex-dividend day. The tax rate on dividends is 15 per cent. Assuming there is no new information released about the company, how much do you expect the company's shares to trade for tomorrow?

A) $36.43
B) $36.50
C) $36.58
D) $37.00

Question 52

How share buy-backs differ from dividends: Ace-IT Co. has a policy of returning a minimum of 25 per cent of earnings to shareholders every year through dividend issues and on-market share buy-backs. In each quarter this year, the company earned $0.25 per share. In each of the first three quarters, the company paid a regular cash dividend of $0.05 per share. The company has 2 million ordinary shares outstanding. What combination of dividends and share buy-backs could the company's board approve to meet their target payout percentage?

A) A regular cash dividend of $0.05
B) A regular cash dividend of $0.05 per share and an on-market share buy-back of $100,000 in shares
C) A regular cash dividend of $0.05 per share and an on-market share buy-back of $400,000 in shares
D) A regular cash dividend of $0.05 per share and an on-market share buy-back of $500,000 in shares

Question 53

Which of the following statements is NOT a possible benefit of dividend reinvestment programs (DRPs)?

A) Owners of shares that pay dividends do not have to pay brokerage fees if they want to reinvest the proceeds.
B) A company will sell new shares normally at a discount of 2.5 - 10 per cent off the market price.
C) DRPs allow a company to preserve its cash flows and receive a low cost source of capital.
D) Shareholders who choose not to participate in the DRP will find that their proportional ownership is eroded over time.

Question 54

How share buy-backs differ from dividends: You purchased 2,500 shares of DotCom.com several years ago for $40 per share. The company is offering a buy-back for $54 per share. What is the amount of after-tax proceeds you would receive from taking part in the buy-back if capital gains are taxed at 15 per cent?

A) $120,000
B) $121,250
C) $129,750
D) $135,000

Question 55

Which one of the following assumptions is NOT a condition under which capital structure does not affect company value?

A) There is no tax
B) There are no information or transaction costs
C) The real investment policy of the company is variable
D) The real investment policy of the company is fixed

Question 56

Types of dividends: You own 20,000 shares in Past Stays, Ltd., which has just sold one of its large resort hotels for $300 million. Management intends to return the entire revenue from the sale to shareholders by issuing a special dividend. If Past Stays has 20 million shares outstanding, how large a dividend payment do you expect to receive?

A) $20,000
B) $200,000
C) $300,000
D) $13,333

Question 57

How share buy-backs differ from dividends: You purchased 500 shares in Investors Choice, Ltd., several years ago for $20. The company previously announced it will be distributing cash to shareholders in a novel way. First, the company will have a tender offer share buy-back at $30 per share. After the buy-back, it will issue a special dividend of $5.00 per share to the remaining shareholders. Suppose that you want to convert your holdings in Investors Choice, Ltd., into cash. Assume the tax on dividends is 30 per cent and the tax on capital gains is 15 per cent. The shares are currently trading for $30. Assume no new information comes out about the company. How much cash will you receive from taking part in the buy-back?

A) You will receive $14,250 by taking part in the buy-back.
B) You will receive $15,000 by taking part in the buy-back.
C) You will receive $15,750 by taking part in the buy-back.
D) You will receive $16,000 by taking part in the buy-back.

Question 58

If the Australian government cut the tax rate on dividends to a flat 15 per cent instead of treating dividend payments as other income. All else being equal, how would we expect the number of companies paying dividends to change?

A) We would expect the number of dividend-paying companies to increase.
B) We would expect the number of dividend-paying companies to decrease.
C) We would expect the number of dividend-paying companies to stay relatively constant.
D) Both b and c.

Question 59

Suppose you are advising a retiree who holds 2,000 shares of Cronulla Brewing Company. The company is largely held by tax-paying institutional investors and has announced that it will shortly be issuing a large dividend. Because the shares are held in the retiree's superannuation fund, she will not incur tax on either capital gains or dividends. The retiree has decided to sell the shares sometime this year, and use the money for living expenses. You expect the only upcoming change in the share price will result from the dividend. Ignoring any discounting for time, what advice should you give?

A) Sell the shares now-the share price is likely to decrease more than just the dividend amount.
B) Sell the shares ex-dividend-the share price is likely to decline, but by less than the dividend amount.
C) Sell the shares now-it is always better to sell the shares immediately regardless of the tax consequences.
D) It doesn't matter when the shares are sold.

Question 60

JRS Co. has just announced that the board has reached a selective share buy-back agreement with a large shareholder. The company will buy-back all of the large investor's shares for 90 per cent of the current market value. When the share buy-back was announced, the shares of JRS Co. fell by 7 per cent. Which one of these explanations could reasonably explain the drop in share price?

A) The willingness of the large investor to accept the targeted share buy-back signals that the large investor believes the company will not do well in the future.
B) A targeted share buy-back essentially transfers value from the average investor to the targeted investor.
C) Investors believe that the company's management is entrenching itself by buying off any large block shareholders.
D) Both a and c are possible explanations.

Question 61

Which of the following statements about the relative advantages of share buy-backs over dividends is NOT true?

A) Share buy-backs send a stronger signal than dividends to the market about management's belief that the company's prospects are good.
B) On-market share purchases allow management more flexibility because investors are less likely to react if the management cuts back or ends a share buy-back as compared to cutting back on dividend payments.
C) Share buy-backs allow shareholders to choose whether or not to participate in the share buy-back. This allows shareholders to have more control over their tax burden.
D) Historically, tax on dividend payment have been higher than those on share buy-backs.

Question 62

Bonus share issue: Mildura Chem Co. shares are currently trading for $54. Assume there is no new information about the company. If the company does a 10 per cent bonus share issue, what will the approximate price of the share be after the issued?

A) $59.40 per share
B) $48.60 per share
C) $49.09 per share
D) $54.00 per share

Question 63

Share splits: You own 1,200 shares of Mildura Chem, Co. The company has recently announced a 1-for-3 bonus share issue. How many shares will you own after the bonus issue?

A) 400 shares
B) 1600 shares
C) 3,600 shares
D) 1,200 shares

Question 64

Which one of the following statements describes the finding from academic studies on corporate dividend policy?

A) Managers tend to increase regular cash dividends in response to unexpectedly high earnings.
B) Managers tend to maintain a level dividend payment at an amount that they are relatively certain they can maintain in the future.
C) Managers tend to focus on dividends rather than share buy-backs because institutional investors tend to prefer regular dividends.
D) Dividend policy doesn't matter because investors can re-create dividends by selling a fraction of their shares.

Question 65

Describe the two general types of cash dividends and the purpose of each.

Question 66

Generally, management undertakes a bonus share issue to:

A) send a signal to investors that the company is expected to perform poorly.
B) increase the liquidity of shares by decreasing the number of share available.
C) increase the liquidity of shares by increasing the number of share available.
D) reduce the administrative costs associated with investor relations.

Question 67

Which one of these actions could by itself have an impact on the control of the company?

A) A selective buy-back
B) A special dividend payment
C) A share split
D) A regular cash dividend payment

Question 68

Share splits: Split-Gram Ltd has announced a 4-to-1 share split. If the company currently has 1 million shares outstanding, how many outstanding shares will it have after the split?

A) 4 million
B) 250,000
C) 2 million
D) 1 million

Question 69

In the 2005 follow-up to the Lintner study, the researchers found that managers choose their company's dividend policies in a way that enables them to continue making the investments necessary for the company to complete in its product markets. What does this imply about a company that operates in a low-growth industry?

Question 70

Dividend policy and company value: You purchased 4,000 shares of High-Div Co. several years ago at $50 per share. The company has decided to pay a special dividend of $2.00 per share. Dividend payments are taxed at 15 per cent. You intend to reinvest in the company through the dividend reinvestment program. If the company's shares are trading at $48.20 following the dividend payment, how many additional shares can you buy through the dividend reinvestment program?

A) 166 shares
B) 141 shares
C) 134 shares
D) 125 shares

Question 71

Which of the following considerations should NOT be related to management's concerns when setting a dividend or share buy-back policy?

A) Over the long term, how much does the company's level of earnings exceed its investment requirements? How certain is this level?
B) Are the shares currently undervalued? Can the management add value to the company by initiating a share buy-back?
C) Does the company have enough financial reserves to maintain the dividend policy in periods when earnings are down or investment requirements are up?
D) Can the company quickly raise equity capital if necessary?

Question 72

Dividend policy and company value: You purchased 2,000 shares of Ace-IT several years ago at $50 per share. The company does not pay a regular cash dividend. You want to manufacture your own dividend by selling a little bit of shares each quarter. The company's shares are currently trading at $75. If capital gains are taxed at 15 per cent, how many shares would you have to sell to receive $3,420 in cash?

A) 27 shares
B) 46 shares
C) 48 shares
D) 51 shares

Question 73

Share splits: You own 3,000 shares of Split Holdings Co. The shares are currently selling for $48. The company has just announced a 4-for-1 share split. How many shares will you own after the split, and approximately what will your holdings in Split Holdings Co be worth?

A) 12,000 shares worth about $144,000
B) 12,000 shares worth about $576,000
C) 3,000 shares worth about $144,000
D) 3,000 shares worth about $576,000

Question 74

Suppose you own shares of 3For Ltd., which has just announced a 3-for-1 share split. Immediately after the announcement, the price of the company's shares rose by 5 per cent. You don't expect any new information about the company until after the share split. Ignoring any discounting for time, if you intend to sell your shares soon, you should:

A) sell the shares now-the single share you have now is likely to be worth more than the three shares you'll have after the split.
B) sell the shares after the split-typically, the marker reacts positively to share splits. The three shares you'll have after the split will be worth more than the single share you have now.
C) sell the shares now-the shares are likely to be more liquid before the split when there are fewer shares.
D) It doesn't matter when the shares are sold. If there is no new information about the shares, then the value of three shares after the split should be the same as the value of the single share you hold now.

Question 75

Bonus share issues and share splits: Split-Div Ltd has issued quarterly dividends of $0.10 per share each quarter over the last few years. This quarter Split-Div initiated a 2-for-1 share split. What is the minimum quarterly dividend the board of Split-Div should approve to avoid sending a bad signal to investors?

A) $0.02 per share
B) $0.05 per share
C) $0.10 per share
D) $0.20 per share

Question 76

Discuss why investors perceive share buy-backs are weaker than that of a cash dividend.

Question 77

Share price reactions to dividend announcements: The Double Boot Co. has paid a regular dividend of $0.25 quarterly for the last several years. The company has 1 million shares outstanding. Over the next year the company will have to spend $600,000 to service its debt and spend $500,000 in capital expenditures. The company has $600,000 of cash and cash equivalents. Over the next year how much cash must be provided from operations to continue to make the same quarterly dividend payment and still have $250,000 in cash at the end of the year?

A) $1,000,000
B) $1,100,000
C) $1,750,000
D) $2,100,000