Question 1

Lenders interested in ensuring a large cushion of cash to mitigate the risks of the loan may include restrictions in the contract to preclude the company from paying out dividends to common shareholders. Shareholders may have to vote in a block to oust a Board who has undertaken these loans. What is this situation is consistent with?

Accepted Answer

A)   Theory of competition.
B)   Agency Theory.
C)   Lender Leverage.
D)   Shareholder Activism.
E)   Microeconomic transactions theory. B

Question 2

What does the traditional view of dividend policy say about a higher payout ratio?

Accepted Answer

A)   It will depress the share value as shareholders must engage in the cost of searching out new investment opportunities.
B)   It will artificially depress the share value of a company as the growth in dividends will be lower when the absolute amount of dividends is higher.
C)   It will increase the share value of a company as shareholders will be attracted to the investment flexibility provided by liquidity.
D)   It will depress the share value of a company as transactions cost must be subtracted from earnings for those shareholders who wish to retain their investment in the company.
E)   It will increase the share value of a company as the rate of return demanded by investors will drop as the uncertainty of receiving dividends diminishes. E

Question 3

RAJ Industries earned an income of $4,000,000 and distributed $850,000 as dividends. A year later, earnings had risen by 5% and RAJ distributed earnings of $700,000. What may investors have concluded about RAJ?

Accepted Answer

A)   RAJ is retaining earnings to improve share prices.
B)   RAJ is paying a dividend in order to improve share prices.
C)   RAJ is indicating an expectation of significant future earnings growth.
D)   RAJ is going to retire debt and and replace it by issuing preferred shares.
E)   RAJ is signalling a concern that their Brazilian facilities would be taken over and nationalized. E

Question 4

Merrick Manufacturing has been in a court battle over alleged patent infringement for several years. If Merrick has had generally paid out a consistent level of dividends and increases its dividend payout by 50%, how investors may interpret this move by Merrick?

Accepted Answer

A)   As reorganizing its dividend policies based on company investment and tax requirements and correctly ignore the on-going case.
B)   As distributing cash it no longer needs for investment as it anticipates losing the court case and its patent rights.
C)   As attempting to placate investors who will sell off their shares once information about the loss of the court case is announced.
D)   As winning the court case and being restricted by the settlement from officially announcing the company's good fortune.
E)   As anticipating a settlement in its favour and distributing expected future earnings.

Question 5

A company has 21 million common shares outstanding at a price of $63.00 each and an EPS of $12.00 per share. If the company wishes to provide a stock dividend of 30%, how many shares will shareholders receive for every ten shares currently held?

Accepted Answer

A)   4.8 shares.
B)   5 shares.
C)   5.7 shares.
D)   3.33 shares.
E)   3 shares.

Question 6

LaGuerre Computer Animation Ltd. has a tax rate of 30%, has been trading around $44.50 for three years and has a consistent dividend payout of 35%. Last year, it had common shares outstanding of 4.2 million, no preferred shares, interest payments of $8 million and an EBIT of $29 million. Over the following year, the company repurchased 1.2 million shares with a bond issue that increased its interest payments by $2.7 million. If its EBIT rose to $32 million, what is the degree of financial leverage for LaGuerre?

Accepted Answer

A)   Insignificant at (0.36) 
B)   Insignificant at .27
C)   Low at 3.2
D)   High at .25
E)   High at 4.06.

Question 7

At a time when the corporate tax rate is 22%, the government has raised taxes on individuals to 43% to meet its fiscal needs. The dividend tax rate is 32%. Interest rates are 8%. Which of the following applies to LED Ltd.'s dividend policy?

Accepted Answer

A)   Shareholders would be better off by $31.08 per $1,000 of dividends if LED paid the dividend now and the investor invested the money.
B)   Shareholders would be better off by $62.40 per $1,000 of dividends if LED paid the dividend now and the investor invested the money.
C)   Shareholders would be indifferent as to whether LED deferred the dividend for 1 year and invested the money itself.
D)   Shareholders would be better off by $20.67 per $1,000 of dividends if LED deferred the dividend for 1 year and invested the money itself.
E)   Shareholders would be better off by $11.42 per $1,000 of dividends if LED deferred the dividend for 1 year and invested the money itself.

Question 8

At REL Ltd., earnings per share over a five year period were (from earliest to latest) $2.00, $0.50, $1.20, $2.40, $1.75. In the same period, dividends per share were $0.50, $0,50, $0,50, $0.75, $0.75. What best describes this result?

Accepted Answer

A)   Stock dividends.
B)   Share repurchases.
C)   dividend signalling.
D)   Dividend smoothing.
E)   Residual dividends.

Question 9

Michael can choose to hold 500 shares trading for $62.50 in Company A or 1,000 shares trading in Company B trading for $31.25 each. Both companies announced their earnings on December 31st at $5.00 per share and $2.50 per share, respectively. Company A's payout ratio is 100%. Company B will retain 100% of its earnings this year. Next year it will return to its usual 100% payout ratio. (Company B's common share dividend is not cumulative). Both companies return 8% to their common shareholders. Michael will by bonds with any cash received from dividends, providing an interest income at 8%. He faces a marginal income tax rate of 40% and a dividend tax rate of 37%. Assuming Michael does not liquidate his investments, which company will provide him the higher after tax income at the end of the second year?

Accepted Answer

A)   Company B provides $50.40 more income.
B)   Company A provides $75.60 more income.
C)   Company A provides $162.00 more income.
D)   Company B provides $1,175.40 more income.
E)   Company B provides $6.00 more income.

Question 10

Which of these actions is an illustration of the residual theory of dividends?

Accepted Answer

A)   Boosting EPS by buying back shares to reduce the pool of shareholders to whom dividends are distributed.
B)   Reducing the Dividend Payout Ratio to improve EPS.
C)   Retaining earnings in a reserve fund to ensure sufficient cash for distribution to shareholders.
D)   Replacing distributed dividends with riskier debt capital to lower cost of capital.
E)   Funding projects with a positive NPV and distributing the rest of the earnings as dividends.

Question 11

Using a Fair Value Balance Sheet, a company's financial position is as follows: cash of $30,000, total assets, net of cash, of $330,000, total debt of $200,000 and $160,000 worth of owners' equity, comprised of 100,000 common shares and $60,000 of retained earnings. If the company pays out its total cash in dividends, what happens to a shareholder's financial position?

Accepted Answer

A)   It diminishes as the share value drops from $1.60 to $1.30.
B)   It increases as share price is unchanged as dividends reduce retained earnings, and dividend payout equal $0.30 a share.
C)   It diminishes as dividends at $0.30 a share do not offset decreases in share value by $0.60 a share.
D)   It is unchanged as the $0.30 reduction in share value will be offset by the $0.30 in dividends.
E)   It diminishes as leverage will cause a reduction in equity to be more than offset by a loss in income.

Question 12

How is a dividend is paid out?

Accepted Answer

A)   Only in cash.
B)   In cash and/or common shares.
C)   In cash and/or preferred shares.
D)   In cash, common shares and/or preferred shares.
E)   In cash, common shares and/or other assets.

Question 13

Felicity Trust has a dividend cover ratio of 5.0 on net income of $6.3 million. The company's EPS is $2.10 and its cum dividend price is $22.50. What is the expected ex dividend price of the shares?

Accepted Answer

A)   $18.00
B)   $20.82
C)   $21.24
D)   $22.08
E)   27.00

Question 14

ABC is selling for $45.60 and is expected to continue its 5.5% growth rate in dividends. Using the Dividend Growth model, what is its expected dividend if its target return to investors is 18%?

Accepted Answer

A)   $2.50
B)   $2.96
C)   $5.70
D)   $8.20
E)   $8.66

Question 15

A major forest products company with a cost of capital of 12% has raised $15 million in financing and is considering three projects that are divisible, are not mutually exclusive and will have no residual value at the end of their 10 year term. Project A will cost a company $12 million providing $2.45 million in annual income before depreciation. Project B, costing $10.8 million, has annual projected savings before depreciation of $1.8 million. Project C costs $7.3 million and will bring in $1.7 million annually before depreciation. Assuming markets operate in the theoretical Modernist manner, if the company expects to earn a 12% return on their investments, in which project(s) should the company invest?

Accepted Answer

A)   All three projects.
B)   All of C and 60% of A
C)   B only
D)   All of A and all of C
E)   All of B and 84% of C

Question 16

What does the Modernist (Modigliani and Miller) view of dividend policy say about a higher payout ratio if taxes are ignored?

Accepted Answer

A)   It will produce a higher share value as shareholders can choose between reinvestment in the company or investment at a higher rate elsewhere.
B)   It will not impact share value as investors can get cash from their shares even if there is no dividend distributed.
C)   It will reduce the share value as there will be less cash for the company to invest in income-generating projects maximizing net present value (NPV) .
D)   It will not impact share value as investors are indifferent as to whether they receive cash today or cash in the future.
E)   It will reduce share value as investors seek long term holdings to avoid transactions costs.

Question 17

Which of the following is the most important factor influencing the level of dividends?

Accepted Answer

A)   Investment opportunities.
B)   Residual theory of dividends.
C)   Loan covenants.
D)   Market expectations.
E)   Profit stability.

Question 18

Beryl Corporation has 15 million common shares outstanding trading on October 1 at a cum dividend price of $22.15 a share. Its EPS at that time, the end of the third quarter, is $1.80 per share. If the ex dividend price drops to $21.95 on Oct. 2, what dividend was declared?

Accepted Answer

A)   No dividend was necessarily declared.
B)   $2.7 million
C)   $3 million
D)   $27 million
E)   $30 million

Question 19

Kaylea Co. Ltd. has perpetual debt with a face value of $20 million at 5% and a market value of $18 million. It has no preferred shares. Ten million common shares were issued at $12.50 and are now trading for $15.00 each from a high three years ago of $24.00. Common shareholders are demanding a 9% return from companies of equal risk. The company has a tax rate of 35%. It wishes to repurchase four million common shares to reduce the threat of a hostile take-over. Kaylea Co. will use all of its retained earnings of $32 million and fund the balance with perpetual debt at 7% where the market value will equal face value. Assume the cost of Kaylea's old debt will remain unchanged and that share price remains the same. If the repurchase goes through, in absolute terms, what will be the change in the company's cost of capital?

Accepted Answer

A)   Unchanged
B)   Lower by 1.3%
C)   Lower by 1.1%
D)   Higher by 0.6%
E)   Higher by 0.34%

Question 20

Which of the following will tend to increase the proportion of earnings that are distributed as dividends?

Accepted Answer

A)   Increasing profit volatility
B)   Loan covenants
C)   Threat of takeover
D)   Market expectations
E)   Legal limitations

Exam 11: Developing a Dividend Policy