Question: Which of the following statements is CORRECT? 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.

Answer: b

Question: Which of the following statements is CORRECT? 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

Question: The annual rate of return on any given stock can be found as the stock’s dividend for the year plus the change in the stock’s price during the year, divided by its beginning-of-year price. If you obtain such data on a large portfolio of stocks, like those in the S&P 500, find the rate of return on each stock, and then average those returns, this would give you an index’s price change for the year. a. True b. False

Answer: False

Question: If you decide to buy 100 shares of Google, you would probably do so by calling your broker and asking him or her to execute the trade for you. This would be defined as a secondary market transaction, not a primary market transaction. a. True b. False

Answer: True

Question: A major contribution of the Miller model is that it demonstrates, other things held constant, that

Answer Options:
a. personal taxes increase the value of using corporate debt.
b. personal taxes lower the value of using corporate debt.
c. personal taxes have no effect on the value of using corporate debt.
d. financial distress and agency costs reduce the value of using corporate debt.
e. debt costs increase with financial leverage.

Answer: b

Question: A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. A bank that takes in demand deposits and then uses that money to make long-term mortgage loans is one example of a financial intermediary. a. True b. False

Answer: True

Question: Modigliani and Miller (MM), in their second article, took account of taxes, bankruptcy, and other factors that were assumed away in their original article. Once they took account of all these assumptions, they concluded that every firm has a unique optimal capital structure. Moreover, a manager can use the second MM model to determine his or her firm’s optimal debt ratio. a. True b. False

Answer: b. False

Question: Business risk is affected by a firm’s operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk? a. Demand variability. b. Sales price variability. c. The extent to which operating costs are fixed. d. The extent to which interest rates on the firm’s debt fluctuate. e. Input price variability.

Answer: d. The extent to which interest rates on the firm’s debt fluctuate.

Question: Hedge funds are somewhat similar to mutual funds. The primary differences are that hedge funds are less highly regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions. a. True b. False

Answer: True

Question: Companies HD and LD have the same total assets, total investor-supplied capital, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also, both companies’ returns on investors’ capital (ROIC) exceed their after-tax costs of debt, r_d(1 – T). Which of the following statements is CORRECT?

Answer Options:
a. HD should have a higher return on assets (ROA) than LD.
b. HD should have a higher times interest earned (TIE) ratio than LD.
c. HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD’s.
d. Given that ROIC > r_d(1 – T), HD’s stock price must exceed that of LD.
e. Given that ROIC > r_d(1 – T), LD’s stock price must exceed that of HD.

Answer: c

Question: If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be. a. True b. False

Answer: a. True

Question: The term IPO stands for “individual purchase order,” as when an individual (as opposed to an institution) places an order to buy a stock. a. True b. False

Answer: False