Answer Options:
a. You will have 200 shares of stock, and the stock will trade at or near $120 a share.
b. You will have 200 shares of stock, and the stock will trade at or near $60 a share.
c. You will have 100 shares of stock, and the stock will trade at or near $60 a share.
d. You will have 50 shares of stock, and the stock will trade at or near $120 a share.
e. You will have 50 shares of stock, and the stock will trade at or near $600 a share.
Answer: B. You will have 200 shares of stock, and the stock will trade at or near $60 a share.
Question: Suppose you plotted a curve which showed a Firm U’s WACC on the vertical axis and its debt ratio on the horizontal axis. Then you plotted a similar curve for Firm V. The curve for Firm U resembled a shallow “U,” while that for Firm V resembled a sharp “V.” Both firms have debt ratios that cause their WACCs to be minimized. Other things held constant, it would be easier for Firm V than Firm U to maintain a steady dividend and let the debt ratio vary without causing much opportunities and earnings from year to year.
Answer Options:
a. True
b. False
Answer: False
Question: A “reverse split” reduces the number of shares outstanding.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following statements is CORRECT?
Answer Options:
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: E. Stock repurchases make the most sense at times when a company believes its stock is undervalued.
Question: It has been argued that investors prefer high-payout companies because dividends are more certain (less risky) than the capital gains that are supposed to come from retained earnings. However, Miller and Modigliani say that this argument is incorrect, and they call it the “bird-in-the-hand fallacy.” MM base their argument on the belief that most dividends are reinvested in stocks, hence are exposed to the same risks as reinvested earnings.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following statements about dividend policies is CORRECT?
Answer Options:
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. 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.
Question: A 100% stock dividend and a 2:1 stock split should, at least conceptually, have the same effect on the firm’s stock price.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following statements is CORRECT?
Answer Options:
a. If a company has a 2-for-1 stock split, its stock price should roughly double.
b. Capital gains earned on shares repurchased are taxed less favorably than dividends, which is why companies typically pay dividends and avoid share repurchases.
c. Very often, a company’s stock price will rise when it announces that it plans to commence a share repurchase program. Such an announcement could lead to a stock price decline, but this does not normally happen.
d. Stock repurchases increase the number of outstanding shares.
e. The clientele effect is the best explanation for why companies tend to vary their dividend payments from quarter to quarter.
Answer: B. Capital gains earned on shares repurchased are taxed less favorably than dividends, which is why companies typically pay dividends and avoid share repurchases.
Question: One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm’s required return constant, 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
Question: Which of the following statements is CORRECT?
Answer Options:
a. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their investment in the company.
b. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account.
c. Stock repurchases can be used by a firm that wants to increase its debt ratio.
d. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities.
e. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding.
Answer: C. Stock repurchases can be used by a firm that wants to increase its debt ratio.
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: 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 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: Your firm adheres strictly to the residual dividend model. All else equal, which of the following factors would be most likely to lead to an increase in the firm’s dividend per share?
Answer Options:
a. The firm’s net income increases.
b. The company increases the percentage of equity in its target capital structure.
c. The number of profitable potential projects increases.
d. Congress lowers the tax rate on capital gains, leaving the rest of the tax code unchanged.
e. Earnings are unchanged, but the firm issues new shares of common stock.
Answer: A. The firm’s net income increases.
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
Answer Options:
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. investors view dividends as being less risky than potential future capital gains.
Question: If a firm adheres strictly to the residual dividend policy, and if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/assets ratio), then the firm should pay
Answer Options:
a. the same dividend as it paid the prior year.
b. no dividends to common stockholders.
c. dividends only out of funds raised by the sale of new common stock.
d. dividends only out of funds raised by borrowing money (i.e., issuing debt).
e. dividends only out of funds raised by selling off fixed assets.
Answer: B. no dividends to common stockholders.