Answer: e (Incorrect, the correct answer is a)
Question: Some people—including the former chairman of the Federal Reserve Board of Governors (Ben Bernanke)—have argued that one advantage of corporate debt from the stockholders’ standpoint is that the existence of debt forces managers to focus on cash flow and to refrain from spending too much of the firm’s money on private plane and other “perks.” This is one of the factors that led to the rise of LBOs and private equity firms. a. True b. False
Answer: a. True
Question: Each stock’s rate of return in a given year consists of a dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). Such returns are calculated for all the stocks in the S&P 500. A weighted average of those returns, using each stock’s total market value, is then calculated, and that average return is often used as an indicator of the “return on the market.” a. True b. False
Answer: True
Question: According to the signaling theory of capital structure, firms first use common equity for their capital, then use debt if and only if they can raise no more equity on “reasonable” terms. This occurs because the use of debt financing signals to investors that the firm’s managers think that the future does not look good. a. True b. False
Answer: b. False
Question: Which of the following statements about dividend policies is CORRECT? a. Miller and Modigliani argued that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the “bird-in-the-hand” effect. b. One reason that companies tend to favor distributing excess cash as dividends rather than by repurchasing stock is that dividends are normally taxed at a lower rate than gains on repurchased stock. c. One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest. d. One key advantage of the residual dividend model is that it enables a company to follow a stable dividend policy.
Answer: c
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: When a corporation’s shares are owned by a few individuals who are associated with the firm’s management, we say that the stock is closely held. a. True b. False
Answer: True
Question: The NYSE is defined as a “primary” market because it is one of the largest and most important stock markets in the world. a. True b. False
Answer: False
Question: The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, if the tax rate on dividends is high relative to that on capital gains, then individuals with low taxable incomes should favor stocks with low payouts and high-income individuals should favor high-payout companies.
Answer Options:
a. True
b. False
Answer: True
Question: Provided a firm does not use an extreme amount of debt, operating leverage typically affects only EPS, while financial leverage affects both EPS and EBIT. a. True b. False
Answer: b. False
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: Which of the following statements is CORRECT? a. Since debt financing raises the firm’s financial risk, increasing the target debt ratio will always increase the WACC. b. Since debt financing is cheaper than equity financing, raising a company’s debt ratio will always reduce its WACC. c. Increasing a company’s debt ratio will typically reduce the marginal costs of both debt and equity financing. However, this action still may raise the company’s WACC. d. Increasing a company’s debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company’s WACC. e. Since a firm’s beta coefficient is not affected by its use of financial leverage, leverage does not affect the cost of equity.
Answer: d. Increasing a company’s debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company’s WACC.
Question: Each stock’s rate of return in a given year consists of a dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). Such returns are calculated for all the stocks in the S&P 500. A simple average of those returns (which gives equal weight to each company in the S&P 500) is then calculated. That average is called “the return on the S&P Index,” and it is often used as an indicator of the “return on the market.” 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 better the firm’s investment opportunities, the lower its payout ratio will be, other things held constant.
Answer Options:
a. True
b. False
Answer: True
Question: If on January 3, 2015, a company declares a dividend of $1.50 per share, payable on January 31, 2015, to holders of record on January 17, then the price of the stock should drop by approximately $1.50 on January 15, which is the ex-dividend date.
Answer Options:
a. True
b. False
Answer: True