Answer: a. True
Question: Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk.
Answer Options:
a. True
b. False
Answer: True
Question: The Modigliani and Miller (MM) articles implicitly assumed that bankruptcy did not exist. That led to the development of the “trade-off” model, where the firm’s value first rises with the use of debt due to the tax shelter of debt, but later falls as more debt is added because the potential costs of bankruptcy begin to more than offset the tax shelter benefits. Under the trade-off theory, an optimal capital structure exists. a. True b. False
Answer: a. True
Question: Which of the following does NOT normally influence a firm’s dividend policy decision? a. The firm’s ability to accelerate or delay investment projects without adverse consequences. b. A strong preference by most of its shareholders for current cash income versus potential future capital gains. c. Constraints imposed by the firm’s bond indenture. d. The fact that much of the firm’s equipment is leased rather than bought and owned. e. The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains.
Answer: d
Question: Which of the following statements is CORRECT? a. Firms with a lot of good investment opportunities and a relatively small amount of cash tend to have above-average dividend payout ratios. b. One advantage of the residual dividend model is that it leads to a stable dividend payout, which investors like. c. An increase in the stock price when a company cuts its dividend is consistent with signaling theory as postulated by MM. d. If the “clientele effect” is correct, then for a company whose earnings fluctuate, a policy of paying a constant percentage of net income will probably maximize its stock price. e. Stock repurchases make the most sense at times when a company believes its stock is undervalued.
Answer: c
Question: Firm M is a mature company in a mature industry. Its annual net income and cash flows are consistently high and stable. However, M’s growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new company in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is CORRECT? a. Firm M probably has a lower target debt ratio than Firm N. b. Firm M probably has a higher target dividend payout ratio than Firm N. c. If the corporate tax rate increases, the debt ratio of both firms is likely to decline. d. The two firms are equally likely to pay high dividends. e. Firm N is likely to have a clientele of shareholders who want a consistent, stable dividend income.
Answer: b
Question: Trades on the NYSE are generally completed by having a brokerage firm acting as a “dealer” buy securities and adding them to its inventory or selling from its inventory. The NASDAQ, on the other hand, operates as an auction market, where buyers offer to buy, and sellers to sell, and the price is negotiated on the floor of the exchange. a. True b. False
Answer: False
Question: Which of the following statements is CORRECT? a. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument. b. Other things held constant, the higher a firm’s target dividend payout ratio, the higher its expected growth rate should be. c. Miller and Modigliani’s dividend irrelevance theory says that the percentage of its earnings that a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price. d. The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to a decrease in dividend payout ratios. e. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high dividend payout ratio.
Answer: d
Question: If the information content, or signaling, hypothesis is correct, then a change in a firm’s dividend policy can have an important effect on its stock price and cost of equity.
Answer Options:
a. True
b. False
Answer: True
Question: Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument.
Answer Options:
a. True
b. False
Answer: False
Question: Which of the following statements is CORRECT?
Answer Options:
a. Increasing its use of financial leverage is one way to increase a firm’s return on investors’ capital (ROIC).
b. If a firm lowered its fixed costs but increased its variable costs by just enough to hold total costs at the present level of sales constant, this would increase its operating leverage.
c. The debt ratio that maximizes expected EPS generally exceeds the debt ratio that maximizes share price.
d. If a company were to issue debt and use the money to repurchase common stock, this would reduce its return on investors’ capital (ROIC). (Assume that the repurchase has no impact on the company’s operating income.)
e. If a change in the bankruptcy code made bankruptcy less costly to corporations, this would tend to reduce corporations’ debt ratios.
Answer: c
Question: If you wanted to know what rate of return stocks have provided in the past, you could examine data on the Dow Jones Industrial Index, the S&P 500 Index, or the NASDAQ Index. a. True b. False
Answer: True
Question: Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is lowered. Their argument is based on the assumption that a. investors are indifferent between dividends and capital gains. b. investors require that the dividend yield plus the capital gains yield equal a constant. c. capital gains are taxed at a higher rate than dividends. d. investors view dividends as being less risky than potential future capital gains. e. investors prefer a dollar of expected capital gains to a dollar of expected dividends because of the lower tax rate on capital gains.
Answer: d
Question: Other things held constant, which of the following events would be most likely to encourage a firm to increase the amount of debt in its capital structure?
Answer Options:
a. Its sales are projected to become less stable in the future.
b. The bankruptcy laws are changed in a way that would make bankruptcy more costly to the firm and its stockholders.
c. Management believes that the firm’s stock is currently overvalued.
d. The firm decides to automate its factory with specialized equipment and thus increase its use of operating leverage.
e. The corporate tax rate is increased.
Answer: e
Question: According to Modigliani and Miller (MM), in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing. a. True b. False
Answer: b. False