Question: Which of the following statements is CORRECT? a. If a firm repurchases some of its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes. b. An open-market dividend reinvestment plan will be most attractive to companies that need new equity and would otherwise have to issue additional shares of common stock through investment bankers. c. Stock repurchases tend to reduce financial leverage. d. If a company declares a 2-for-1 stock split, its stock price should roughly double. e. One advantage of adopting the residual dividend model is that this makes it easier for corporations to meet the requirements of Modigliani and Miller’s dividend clientele theory.

Answer: a

Question: The Miller model begins with the Modigliani and Miller (MM) model with corporate taxes and then adds personal taxes. a. True b. False

Answer: a. True

Question: The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm’s stock price.

Answer Options:
a. True
b. False

Answer: True

Question: A share of common stock is not a derivative, but an option to buy the stock is a derivative because the value of the option is derived from the value of the stock. a. True b. False

Answer: True

Question: The NYSE is defined as a “spot” market purely and simply because it has a physical location. The NASDAQ, on the other hand, is not a spot market because it has no one central location. 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: The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant. a. True b. False

Answer: b. False

Question: Modigliani and Miller’s first article led to the conclusion that capital structure is “irrelevant” because it has no effect on a firm’s value. However, that article was criticized because it assumed that no taxes existed. MM then revised their original article to include corporate taxes, and this model led to the conclusion that a firm’s value would be maximized if it used (almost) 100% debt. a. True b. False

Answer: a. True

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: Which of the following statements is CORRECT? a. When firms are deciding on the size of stock splits–say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used. b. Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and reverse splits are illegal today. c. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits. d. When a company declares a stock split, the price of the stock typically declines–for example, by about 50% after a 2-for-1 split–and this necessarily reduces the total market value of the firm’s equity. e. If a firm’s stock price is quite high relative to most stocks–say $500 per share–then it can declare a stock split of say 20-for-1 so as to bring the price down to something close to $25. Moreover, if the price is relatively low–say $2 per share–then it can declare a “reverse split” of say 1-for-10 so as to bring the price up to somewhere around $20 per share.

Answer: e