Answer Options:
a. True
b. False
Answer: True
Question: If management wants to maximize its stock price, and if it believes that the dividend irrelevance theory is correct, then it must adhere to the residual dividend policy.
Answer Options:
a. True
b. False
Answer: False
Question: Miller and Modigliani’s dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price.
Answer Options:
a. True
b. False
Answer: False
Question: There are two types of dividend reinvestment plans. Under one type of plan, the firm uses the cash that would have been paid as dividends to buy stock on the open market. Under the other type, the company issues new stock, keeps the cash that would have been paid out, and in effect sells new stock to those investors who choose to reinvest their dividends.
Answer Options:
a. True
b. False
Answer: True
Question: Some investors prefer dividends to retained earnings (and the capital gains retained earnings bring), while others prefer retained earnings to dividends. Other things held constant, it makes sense for a company to establish its dividend policy and stick to it, and then it will attract a clientele of investors who like that policy.
Answer Options:
a. True
b. False
Answer: True
Question: The announcement of an increase in the cash dividend should, according to MM, lead to an increase in the price of the firm’s stock, other things held constant.
Answer Options:
a. True
b. False
Answer: False
Question: 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 an increase in dividend payout ratios.
Answer Options:
a. True
b. False
Answer: False
Question: If a firm uses the residual dividend model to set dividend policy, then dividends are determined as a residual after providing for the equity required to fund the capital budget. Under this model, the higher the firm’s debt ratio, the lower its payout ratio will be, other things held constant.
Answer Options:
a. True
b. False
Answer: False
Question: Which of the following statements is CORRECT?
Answer Options:
a. Historically, the tax code has encouraged companies to pay dividends rather than retain earnings.
b. If a company uses the residual dividend model to determine its dividend payments, dividend payout will tend to increase whenever its profitable investment opportunities increase relatively rapidly.
c. The more a firm’s management believes in the clientele effect, the more likely the firm is to adhere strictly to the residual dividend model.
d. Large stock repurchases financed by debt tend to increase expected earnings and thus boost expected dividends in the firm’s financial model.
e. A dollar paid out to repurchase stock has the same tax benefit as a dollar paid out in dividends. Thus, both companies and investors should be indifferent between distributing cash through dividends and stock repurchase programs.
Answer: A. Historically, the tax code has encouraged companies to pay dividends rather than retain earnings.
Question: Which of the following statements is CORRECT?
Answer Options:
a. If a firm follows the residual dividend model, then a sudden increase in the number of profitable projects would be likely to lead to a reduction of the firm’s dividend payout ratio.
b. The clientele effect explains why so many firms change their dividend policies so often.
c. One advantage of adopting the residual dividend model is that this policy makes it easier for a corporation to attract a specific and well-identified dividend clientele.
d. New-stock dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don’t change the firm’s total amount of book equity.
e. Investors who receive stock dividends must pay taxes on the value of the new shares in the year the stock dividends are received.
Answer: A. If a firm follows the residual dividend model, then a sudden increase in the number of profitable projects would be likely to lead to a reduction of the firm’s dividend payout ratio.
Question: Which of the following statements is CORRECT?
Answer Options:
a. One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive.
b. If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not adhere strictly to the residual dividend model.
c. If a firm adheres strictly to the residual dividend model, then, holding all else constant, its dividend payout ratio will tend to rise whenever its investment opportunities improve.
d. If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends unchanged, this would motivate companies to increase their dividend payout ratios.
e. Despite its drawbacks, following the residual dividend model will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees.
Answer: B. If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not adhere strictly to the residual dividend model.
Question: Which of the following statements is CORRECT?
Answer Options:
a. Under the tax laws as they existed in 2014, a dollar received by an individual taxpayer as interest income is taxed at the same rate as a dollar received as dividends.
b. One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends.
c. Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend. As a result, share prices fall when dividend increases are announced because investors interpret the increase as a signal that the firm expects fewer good investment opportunities in the future.
d. If a company needs to raise new equity capital, a new-stock dividend reinvestment plan would make sense. However, if the firm does not need new equity, then an open market purchase dividend reinvestment plan would probably make more sense.
e. It is accurate to say that if a company has a high payout ratio, it probably has high-growth investment opportunities.
Answer: D. If a company needs to raise new equity capital, a new-stock dividend reinvestment plan would make sense. However, if the firm does not need new equity, then an open market purchase dividend reinvestment plan would probably make more sense.
Question: If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of their dividends reinvested, the company should reconsider its dividend policy and possibly move to a lower dividend payout ratio.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following does NOT normally influence a firm’s dividend policy decision?
Answer Options:
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. The fact that much of the firm’s equipment is leased rather than bought and owned.
Question: In the real world, dividends
Answer Options:
a. are usually more stable than earnings.
b. fluctuate more widely than earnings.
c. tend to be a lower percentage of earnings for mature firms.
d. are usually changed every year to reflect earnings changes, and these changes are randomly higher to lower.
Answer: A. are usually more stable than earnings.
Question: Which of the following statements is CORRECT?
Answer Options:
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. Firm M probably has a higher target dividend payout ratio than Firm N.
Question: If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a low payout ratio.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following statements is NOT CORRECT?
Answer Options:
a. Stock repurchases can be used by a firm as part of a plan to change its capital structure.
b. After a 3-for-1 stock split, a company’s price per share should fall, but the number of shares outstanding will rise.
c. Investors may interpret a stock repurchase program as a signal that the firm’s managers believe the stock is undervalued, or alternatively, as a signal that the firm does not have many good investment opportunities.
d. A company can repurchase stock to distribute a large one-time cash inflow, say from the sale of a division, to stockholders without having to increase its regular dividend.
e. Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan.
Answer: E. Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan.