Deck 19: Dividends and Other Payouts

Question 1

You purchased 200 shares of ABC stock on July 15^th. On July 20^th, you purchased another 100 shares and then on July 22^st you purchased your final 200 shares of ABC stock. The company declared a dividend of $1.10 a share on July 5^th to holders of record on Friday, July 23^rd. The dividend is payable on July 31^st. How much dividend income will you receive on July 31^st from ABC?

A) $0
B) $220
C) $330
D) $440
E) $550

Answer 1

$330

Question 2

Distributions to shareholders from capital are called:

A) earnings dividends.
B) a stock split.
C) liquidating dividends.
D) stock dividends.
E) regular cash dividends.

Answer 2

liquidating dividends.

Question 3

Two important elements of the dividend policy irrelevance proposition are:

A) all investors have homogeneous dividend needs and time horizons.
B) dividends are paid even if a positive NPV opportunity exists and investors can re-arrange their own dividend streams.
C) investors can re-arrange their own dividend streams and the investment policy is set and unaltered by the change in dividend policy.
D) all investors have homogeneous dividend needs and dividends are paid even if a positive NPV opportunity exists.
E) investors can re-arrange their own dividend streams and the source of financing must be debt.

Answer 3

investors can re-arrange their own dividend streams and the investment policy is set and unaltered by the change in dividend policy.

Question 4

If you have a choice of receiving a cash payment of $5 today:

A) you are indifferent to receiving $5.07 next year if your opportunity cost is 7%.
B) you are indifferent to receiving $5.00 next year if your opportunity cost is 7%.
C) you are indifferent to receiving $5.35 next year if your opportunity cost is 10%.
D) you are indifferent to receiving $5.35 next year if your opportunity cost is 7%.
E) you are indifferent to receiving $5.10 next year if your opportunity cost is 10%.

Question 5

On the date of record the stock price drop is:

A) a full adjustment for the dividend payment.
B) a partial adjustment for the dividend payment because of the tax effect.
C) zero because it happened on ex-dividend date.
D) zero because it happens on payment date.

Question 6

Dividends are relevant and dividend policy irrelevant when:

A) cash dividends are always constant and dividend policy is changed as management needs.
B) cash dividends are increased for one payment while others are held constant and dividend policy establishes the trade-off between dividends at different dates.
C) cash dividends are always constant and dividend policy establishes the trade-off between dividends at different dates.
D) cash dividends are increased for one payment while others are held constant and dividend policy is changed as management needs.

Question 7

A dividend is usually a cash distribution from:

A) current earnings or accumulated retained earnings
B) the capital surplus account
C) common stock account
D) liquidated capital

Question 8

Homemade dividends are described by Modigliani and Miller to be:

A) the dividend one pays oneself to avoid risky stocks.
B) the re-arrangement of the firm's dividend stream as management needs.
C) the re-arrangement of the firm's dividend stream by the investor in their holdings by buying or selling stock.
D) the present value of all dividends to be paid.

Question 9

The KatyDid Co. is paying a $1.25 per share dividend today. There are 120,000 shares outstanding with a par value of $1.00 per share. As a result of this dividend, the:

A) retained earnings will decrease by $150,000.
B) retained earnings will decrease by $120,000.
C) common stock account will decrease by $150,000.
D) common stock account will decrease by $120,000.
E) capital in excess of par value account will decrease by $120,000.

Question 10

If both dividends and capital gains are currently taxed at the same ordinary income tax rate, the effect of the tax is different because:

A) capital gains are actually taxed, while dividends are taxed on paper only.
B) dividends are actually taxed, while capital gains are taxed on paper only.
C) dividends are taxable when distributed while capital gains are deferred until the stock is sold.
D) capital gains are taxable when distributed while dividends are deferred until the stock is sold.

Question 11

Which one of the following is an argument in favor of a low dividend policy?

A) the tax on capital gains is deferred until the gain is realized
B) few, if any, positive net present value projects are available to the firm
C) a preponderance of stockholders have minimal taxable income
D) corporate tax rates exceed personal tax rates

Question 12

A firm with a 1,000 stockholders plans to terminate operations at the end of two years. Investors are certain that the firm will generate cash flows of $1,000 at the end of the first year and $50,000 at the end of the second year. The risk-free rate is 10%. Which of the following is true, ignoring transaction costs and taxes?

A) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will decrease if the firm borrows to increase payment at the end of the first year.
B) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will increase if the firm borrows to increase payment at the end of the first year.
C) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will remain the same if the firm borrows to increase payment at the end of the first year.
D) The present value of these payments is less than $42,231 if payments of $1,000 and $50,000 are made. This present value will change if the firm borrows to increase payment at the end of the first year. The direction of the change will depend on the type of investors that currently hold stock.
E) There is no way to calculate present value without being given the proper discount rate for the firm. The present value would change if the firm borrows to increase payments at the end of year one.

Question 13

In an efficient market, ignoring taxes and time value,

A) the price of stock should decrease by the amount of the dividend immediately on declaration date.
B) the price of stock should decrease by the amount of the dividend immediately on ex-dividend date.
C) the price of stock should increase by the amount of the dividend immediately on declaration date.
D) the price of stock should increase by the amount of the dividend immediately on ex-dividend date.

Question 14

The ability of shareholders to undo the dividend policy of the firm and create an alternative dividend payment policy via reinvesting dividends or selling shares of stock is called (a):

A) MM Proposition I.
B) capital structure irrelevancy.
C) homemade leverage.
D) homemade dividends.

Question 15

The dividend-irrelevance proposition of Miller and Modigliani depended on the following relationship between investment policy and dividend policy.

A) The level of investment does not influence or matter to the dividend decision.
B) Once dividend policy is set the investment decision can be made as desired.
C) The investment policy is set before the dividend decision and not changed by dividend policy.
D) Since dividend policy is irrelevant there is no relationship between investment policy and dividend policy.

Question 16

Which of the following is true?

A) A 10% stock dividend would increase stockholder wealth by $5 if the current price of stock is $50 (ignoring transaction costs).
B) Stock dividends are not true dividends.
C) Stock splits involve a small increase (splintering) in total stock outstanding.
D) The most common dividend policy involves regular cash payments with year-end bonuses.

Question 17

Your company has announced a dividend of $2.50 per share. You and the rest of the marginal investors are in the 35% tax bracket. What should happen to the stock price?

A) the price of stock should decrease by $1.625 immediately after the date of record.
B) the price of stock should decrease by $1.625 immediately after the ex-dividend date.
C) the price of stock should decrease by $3.85 immediately after the date of record.
D) the price of stock should decrease by $3.85 immediately after the ex-dividend date.

Question 18

A firm plans to pay dividends of $12.50 at time 0 and $14 at time 1. Ignoring transaction costs and assuming that the investor can earn 8% on investments, which statement is true?

A) An investor can spend up to $25.46 from dividends at time 0, and without decreasing the present value of all dividends received.
B) An investor can spend up to $27.50 from dividends at time 0, and without decreasing the present value of all dividends received.
C) An investor can spend up to $25.46 from dividends at time 0, but will decrease the present value of all dividends received.
D) An investor can spend up to $27.50 from dividends at time 0, but will decrease the present value of all dividends received.

Question 19

The important relationship between the ex-dividend date and the record date is:

A) it determines the timing of when the payment is made.
B) the record date occurs before ex-dividend date allowing you to sell your stock and still get the dividend payment.
C) the ex-dividend date occurs two business days before the date of record, if you purchase the stock before this date you are entitled to the dividend.
D) if you hold your stock past the record date and do not sell before the ex-dividend date then you will be taxed at the capital gain rate.

Question 20

Which of the following lists events in chronological order from earliest to latest?

A) Date of Record, Declaration Date, Ex-Dividend Date
B) Date of Record, Ex-Dividend Date, Declaration Date
C) Declaration Date, Date of Record, Ex-Dividend Date
D) Declaration Date, Ex-Dividend Date, Date of Record
E) Ex-Dividend Date, Date of Record, Declaration Date

Question 21

The increase in the stock price after a dividend increase is called the information content effect because:

A) the change in dividend was expected by shareholders.
B) the dividend increase signaled investors to adjust the expectations of future earning upward.
C) the dividend change signaled investors to adjust the risk of the firm downward.
D) the dividend change signaled shareholders that the firm could now payout more as they enter the mature phase of their business.

Question 22

John Madden is considering two investments of similar risk. Investment A is a stock that is expected to pay a dividend of $100 at the end of each year for two years, but no dividend in the third year. You expect to sell Investment A after three years for a capital gain of $400. Investment B is a stock that is not expected to pay any dividends, but you expect to sell the stock at the end of three years for a capital gain of $600. John is wealthy and is in the 50% tax bracket. Dividends are taxed at the personal tax rate, but capital gains are taxed at 40% of the personal tax rate. Given a discount rate of 10% for both investments, which would you recommend.

Question 23

Asquith and Mullins studied a sample of firms that either paid their first ever cash dividend or initiated a dividend after a 10 year period of no dividends. Healey, Palepu and Michaely, and Thaler and Womack found stock prices to fall when dividends are. Explain how these positive and negative stock price results fit with the dividend irrelevance argument of MM and the opposing effects of taxes and current income needs on stock price if future earnings are held constant.

Question 24

The Generous Cup Corporation and the Happy Mug Corporation have exactly the same operating risk. Investors expect Generous Cup to pay no dividends and to have a price of $70 in one year. Investors expect Happy Mug to pay a dividend of $4.00 in one year and to have a value of $40 in one year. Corporations pay no income tax. Investors pay 20% on dividends but no tax on capital gains. If the current price of Generous Cup is $62.50, what is the current price of Happy Mug?

Question 25

The observed empirical fact that stocks attract particular investors based on the firm's dividend policy and the resulting tax impact on investors is called the:

A) information content effect.
B) clientele effect.
C) efficient markets hypothesis.
D) MM Proposition I.

Question 26

Recent changes in the tax code have changed the taxation of cash dividends and capital gains as follows:

A) cash dividends are taxed at the ordinary rate and all capital gains at a special rate of 50%.
B) all cash dividends and capital gains as ordinary income.
C) capital gains as ordinary income and cash dividends for a stock owned more than 18 months at the special rate of 20%.
D) Short term gains and cash dividends as ordinary income, capital gains earned over less than 18 months at a maximum rate of 28% and capital gains earned over more than 18 months at a 20% rate.

Question 27

All else equal, the market value of a stock will tend to decrease by roughly the amount of the dividend on the:

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

Question 28

Although dividend payments reduce the total firm funds to pay bondholders the payment of dividends can reduce agency costs by:

A) doing so on a regular schedule.
B) sharing the dividend payments with the bondholders
C) reducing the free cash flows to reduce the perquisite consumption.
D) making sure that only shareholders of record receive the dividend.

Question 29

The empirical evidence on the relationship between the expected return on stocks and their dividend yields show:

A) conclusive evidence that dividends should be set as low as possible.
B) conclusive evidence that dividends should be set as high as possible.
C) conclusive evidence that dividends don't matter.
D) inconclusive evidence; some show evidence that high dividend payouts are best, others show the opposite.
E) inconclusive evidence, although all studies show that high dividend payouts are best.

Question 30

A corporation has cash flow in excess of investment needs and normal dividend payments. The corporation is considering two alternative uses of the excess funds. In Alternative 1, the corporation increases current dividends. In Alternative 2, the corporation makes a three-year loan and uses the loan proceeds to pay dividends at the end of three years. The following information may be used in choosing between the alternatives. Stockholders can earn 5% after taxes on their investments. The corporate tax rate is 30%. Stockholders currently have a 20% tax rate and will have a 25% tax rate next year. At what pretax return on the loan are stockholders indifferent between the alternatives?

A) 9.6%.
B) 10.0%.
C) 10.4%.
D) 10.8%.
E) 11.2%.

Question 31

Consider two corporations, G and H, that have exactly the same risk. They both have a current stock price of $60. Corporation G pays no dividend and will have a price of $66 one year from now. Corporation H pays dividends and will have a price of $63 one year from now after payment of a dividend. Corporations pay no income taxes. Investors pay no taxes on capital gains, but they pay a 30% income tax on dividends. What is the value of the dividend that investors expect Corporation B to pay?

A) $4.29.
B) $3.00.
C) $3.15.
D) $3.30.

Question 32

Which of the following statements is not true?

A) Dividend payments but not capital gains are costs to the firm.
B) Stockholder's expected return equals the firm's cost of equity.
C) Payments to current stockholders are the implicit cost of the infusion of new equity capital.
D) The security market line provides information as to the cost of equity for a firm.
E) The return that the investor in a security receives is the cost of that security to the company that issued the security.

Question 33

An open market purchase is:

A) an arrangement to buy back short term financial instruments sold to an investment dealer at a fixed price.
B) the buying back of shares from a particular group, usually large shareholders disenchanted with management.
C) the buying back of shares because management has few profitable investment opportunities.
D) arrangement in which company buys back its shares just like any other trader I the market.

Question 34

What is not an argument favoring high dividend payouts?

A) The tax rate on dividends is higher than that of capital gains.
B) Dividends meet the desire for current income.
C) Dividends resolve uncertainty.
D) It is possible to eliminate the tax disadvantage to dividends through tax arbitrage.

Question 35

Schaeffer Shippers announced that on May 1, 2010, that it will pay a dividend of $5.00 per share on June 15 to all holders on record as of May 31^st. The firm's stock price is currently at $70 per share. Assume that all investors are in the 33% tax bracket. Given that the ex-dividend date is May 29, what should happen to Schaeffer's stock price on May 29?

Question 36

If dividends are taxed at higher rates than are capital gains, then high dividend payout stocks should sell at lower prices, everything else equal, compared to low dividend paying stocks. One implication of this is that investors in _____ tax brackets will tend to prefer high dividend payout stocks.

A) slightly higher than average
B) average
C) slightly lower than average
D) zero

Question 37

For a firm to develop a sensible, useful dividend policy, the three things that should be considered are:

A) dividends should not be paid if positive NPV projects are available, stock should always be issued to pay dividends, repurchases with surplus cash should be considered if positive NPV projects exist.
B) dividends should not be paid if positive NPV projects are available, stock should always not be issued to pay dividends, repurchases with surplus cash should be considered if no positive NPV projects exist.
C) dividends should be paid if positive NPV projects are available, stock should always be issued to pay dividends, repurchases with surplus cash should be considered if positive NPV projects exist.
D) dividends should be paid if positive NPV projects are available, stock should always not be issued to pay dividends, repurchases with surplus cash should be considered if no positive NPV projects exist.
E) dividends should not be paid if positive NPV projects are available, stock should always not be issued to pay dividends, repurchases with surplus cash should be considered if positive NPV projects exist.

Question 38

The Smith Brothers Pharmaceutical Company has $250,000 in excess cash and is considering two alternatives. One is to pay the extra cash in the form of a dividend to their stockholders. The other is to invest the cash in a Tbill paying 5% interest after tax, and then distribute the cash as a dividend. The firm's stockholders can also invest in the Tbill for the same yield. If the corporate tax rate is 30% and the personal tax rate is 30%, which alternative would you recommend? (Show why!) If the personal tax rate was 40% what should you recommend?

Question 39

Investing in preferred stock in other companies might be an attractive use of the firm's cash because:

A) preferred stock is less risky than common stock.
B) holders of preferred stock usually receive promised payments.
C) preferred stock has a special tax advantage in this case.
D) preferred stock has no maturity.

Question 40

If stockholders care about taxes, then stocks should attract clienteles based on dividend yields. Surveys support this by showing that the highest dividend yield stocks are held by investors in the:

A) highest tax bracket.
B) average tax bracket.
C) lowest tax bracket.

Question 41

Lintner suggested that the level of dividends paid by a corporation are effected by management's estimation of permanent and temporary earnings. His work and the work of Fama and Babiak suggest that dividend policy is related to both the level of dividends and the change in dividends. Explain how a corporation would determine the level of dividends and incorporate the necessary changes in dividend if they were an aggressive company.

Question 42

It has been shown that in the absence of taxes and other market imperfections firm value will be unaffected by dividend policy. Explain the logic behind this conclusion. Next, describe three real-world factors that may cause one dividend policy to be preferable to another.