Answer Options:
a. True
b. False
Answer: False
Question: If a firm declares a 20:1 stock split, and the pre-split price was $500, then we might expect the post-split price to be $25. However, it often turns out that the post-split price will be higher than $25. This higher price could be due to signaling effects investors believe that management split the stock because they think the firm is going to do better in the future. The higher price could also be because investors like lower-priced shares.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following statements is CORRECT?
Answer Options:
a. 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.
b. Other things held constant, the higher a firm’s target dividend payout ratio, the higher its expected growth rate should be.
c. Miller and Modigliani’s dividend irrelevance theory says that the percentage of its earnings that a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price.
d. 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 a decrease in dividend payout ratios.
e. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high dividend payout ratio.
Answer: D. 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 a decrease in dividend payout ratios.
Question: Your firm uses the residual dividend model to set dividend policy. Market interest rates suddenly rise, and stock prices decline. Your firm’s earnings, investment opportunities, and capital structure do not change. If the firm follows the residual dividend model, then its dividend payout ratio would increase.
Answer Options:
a. True
b. False
Answer: True
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 would be most likely to lead to a decrease in a firm’s dividend payout ratio?
Answer Options:
a. Its earnings become more stable.
b. Its access to the capital markets increases.
c. Its research and development efforts pay off, and it now has more high-return investment opportunities.
d. Its accounts receivable decrease due to a change in its credit policy.
e. Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.
Answer: C. Its research and development efforts pay off, and it now has more high-return investment opportunities.
Question: Which of the following statements about dividend policies is CORRECT?
Answer Options:
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. One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest.
Question: If on January 3, 2015, a company declares a dividend of $1.50 per share, payable on January 31, 2015, then the price of the stock should drop by approximately $1.50 on January 31.
Answer Options:
a. True
b. False
Answer: False
Question: If a firm adheres strictly to the residual dividend model, the issuance of new common stock would suggest that
Answer Options:
a. the dividend payout ratio has remained constant.
b. the dividend payout ratio is increasing.
c. no dividends will be paid during the year.
d. the dividend payout ratio is decreasing.
e. the dollar amount of capital investments had decreased.
Answer: C. no dividends will be paid during the year.
Question: Which of the following statements is CORRECT?
Answer Options:
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. 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.
Question: If a retired individual lives on his or her investment income, then it would make sense for this person to prefer stocks with high payouts so he or she could receive cash without going to the trouble and expense of selling stocks. On the other hand, it would make sense for an individual who would just reinvest any dividends received to prefer a low-payout company because that would save him or her taxes and brokerage costs.
Answer Options:
a. True
b. False
Answer: True
Question: Which of the following actions will best enable a company to raise additional equity capital, other things held constant?
Answer Options:
a. Refund long-term debt with lower cost short-term debt.
b. Declare a stock split.
c. Begin an open-market purchase dividend reinvestment plan.
d. Initiate a stock repurchase program.
e. Begin a new-stock dividend reinvestment plan.
Answer: E. Begin a new-stock dividend reinvestment plan.