Q&A Hero

Q: Which of the following is (are) true? A) In general, the higher the number of positive NPV investment opportunities for a firm, the lower the dividend payout ratio. B) If the clientele effect is correct, firms should follow a constant dividend payout ratio policy. C) According to the informational content of dividends, an increase in dividends is always a positive signal. D) In industries with volatile earnings, the residual dividend policy results in the most consistent dividend stream.

Q: Assume that the tax on dividends and the tax on capital gains is the same. All else equal, what would a prudent investor prefer? A) The prudent investor would be indifferent between receiving dividends or capital gains. B) The prudent investor would prefer dividendsa dollar today is always worth more than a dollar to be received in the future. C) The prudent investor would prefer capital gainsthe capital gain tax liability can be deferred until gains are realized. D) More information is needed.

Q: Assume that a firm has a steady record of paying stable dividends for years. Market analysts had expected management to increase the dividend by 7.5% in the latest quarter. However, management announced a 15% increase in the current year's dividend. The market value of the stock rose 20% on the day of the announcement. Which of the following would best explain the stock market's reaction to the announcement? A) expectations theory B) dividend irrelevance theory C) residual dividend theory D) agency theory

Q: Assume that a firm has a steady record of paying high dividends for years. A new management team decided to cut the current year's dividend in half without disclosing why. The market value of the stock fell 35% on the day the dividend cut was announced. Which of the following would best explain the stock market's reaction to the announcement? A) empirical theory B) dividend irrelevance theory C) residual dividend theory D) information effect

Q: Which of the following statements would be consistent with the residual dividend theory? A) Wealthy investors prefer corporations to defer dividend payments because capital gains produce greater after-tax income. B) Dividends are more certain than capital gains. C) Dividends should only be paid if a firm has profits in excess of the amount needed to finance the current year's capital investments. D) Investors are indifferent whether stock returns come from dividend income or capital gains income.

Q: Which of the following statements would be consistent with the bird-in-the-hand dividend theory? A) Investors are indifferent whether stock returns come from dividend income or capital gains income. B) Dividends are more certain than capital gains income. C) Wealthy investors prefer corporations to defer dividend payments because capital gains produce greater after-tax income. D) Dividends are less certain than capital gains.

Q: Which of the following statements would be consistent with the dividend irrelevance theory? A) There is no relationship between a firm's dividend policy and the value of its common stock. B) Perfect capital markets are assumed to exist which allow investors to buy and sell stock without incurring any transaction costs. C) Investors are indifferent whether stock returns come from dividend income or capital gains income. D) All of the above

Q: A justification for no dividend payments that would be pleasing to shareholders could be A) insufficient cash available for dividend payments. B) positive NPV investment projects that require the firm to retain cash for investment purposes. C) an investor clientele that prefers current liquidity. D) cash will be used for a stock dividend.

Q: In perfect capital markets there A) is no informational content assigned to a particular dividend policy. B) are no income taxes. C) are no flotation costs. D) all of the above

Q: All of the following may influence a firm's dividend payment EXCEPT A) investment opportunities. B) investor transaction costs. C) common stock par value. D) flotation costs.

Q: According to the residual theory of dividends, A) dividends are a residual after investment financing needs have been met. B) earnings remaining after payment of preferred stock dividends should be paid to common stockholders. C) dividend payments are a constant percentage of earnings per share. D) a dividend is the residual above the payout ratio.

Q: According to the perfect markets approach to dividend policy, A) other things equal, the greater the payout ratio, the greater the share price of the firm. B) the price of a share of stock is unrelated to dividend policy. C) the firm should retain earnings so stockholders will receive a capital gain. D) the firm should pay a dividend only after current equity financing needs have been met.

Q: According to the clientele effect, A) companies should have dividend payout ratios of either 100% or 0%. B) companies should avoid making capricious changes in their dividend policies. C) companies should change their dividend policies to please their target group of investors. D) even if capital markets are perfect, dividend policy still matters.

Q: High dividends may increase stock values due to all of the following reasons EXCEPT A) dividends are more certain than capital gains. B) higher dividends are used to signal higher expected future earnings. C) dividends are used as a tool to minimize agency costs. D) higher dividends allow companies to increase their proportion of external equity financing.

Q: An increase in flotation costs will most likely result in which of the following? A) smaller dividend payments so that less external equity financing is needed B) larger dividend payments so shareholders are able to earn their required returns C) larger dividend payments to offset higher taxes paid by investors D) no change in dividend policies because flotation costs are paid by purchasers of common stock

Q: All of the following factors support the proposition that dividend policy matters EXCEPT A) investors desire to minimize and defer taxes, and capital gains get preferential tax treatment over dividend income. B) perfect capital markets. C) information asymmetry exists between shareholders and managers. D) flotation costs significantly increase the cost of new common stock compared to retained earnings.

Q: AFB, Inc. declared a dividend of $2 per share, which was an increase of 25% from the prior year, yet AFB, Inc. stock declined by 3% the day of the announcement. DAS, Inc. declared a dividend of $2 per share, which was the same as the prior year, and its stock increased in value by 2% on the day of the announcement. These events could be most readily explained by the A) information effect. B) clientele effect. C) expectations theory. D) residual dividend theory.

Q: The payment of dividends may indirectly result in closer monitoring of management's investment activities, thus increasing shareholder value by A) reducing agency costs. B) increasing information asymmetry. C) increasing a company's amount of free cash flow. D) reducing auditing fees.

Q: Dividend changes may be used by management as a credible communication tool to signal investors about future earnings under which of the following dividend policy theories? A) the clientele effect B) the residual dividend theory C) the information effect D) the expectations theory

Q: The residual dividend theory suggests that dividends will only be paid A) if the tax rate on capital gains is higher than the tax rate on dividends. B) if the corporation has more positive NPV projects than it can fund. C) if interest rates available to shareholders are higher than the required return on the company's stock. D) if current retained earnings exceed the equity portion of the firm's capital budget.

Q: Which of the following supports the "bird-in-the-hand" dividend theory? A) Investors prefer dividends to capital gains because of the time value of money. B) Increasing a firm's dividends transfers risk and ownership from the current shareholders to new owners. C) Investment decisions are not influenced by dividend policy. D) Capital mix decisions are not influenced by dividend policy.

Q: The "bird-in-the-hand" dividend theory suggests that A) high dividends increase stock value because shareholders believe they can earn a higher return than the company. B) high dividends increase stock value because shareholders are more certain of the dividend yield than of potential future capital gains. C) high dividends increase stock value because capital markets are inefficient and dividends are the only sure way to get money from an equity investment. D) high dividends decrease stock value because dividend payments take money out of the corporate "nest" and reduce the ability of the corporation to function effectively.

Q: Low dividends may increase stock value according to the A) bird-in-the-hand theory. B) information effect. C) impact of agency costs. D) tax bias in favor of capital gains.

Q: A corporation with very high growth prospects and many positive NPV projects to fund may want to increase its dividend based on A) the tax bias against capital gains. B) the residual dividend theory. C) the information effect. D) the very low agency costs of the corporation.

Q: Grainery Distillers, Inc. is experiencing high demand for its products and high growth rates. The company just reported earnings per share of $5 for the most recent year and has many positive NPV projects to fund. One vice president wants to pay a dividend of $5 per share, arguing that this will maximize shareholder value. You argue that a much smaller dividend will maximize value. Your argument may be based on A) the bird-in-the-hand theory. B) the residual dividend theory. C) the information effect. D) the very high agency costs of the corporation.

Q: The dividend irrelevance hypothesis is based on all of the following assumptions EXCEPT A) investment decisions will not be altered by the amount of dividend payments. B) investors do not need cash dividends to supplement their current income. C) perfect capital markets. D) borrowing decisions will not be altered by the amount of dividend payments.

Q: An investor who requires a 12% percent return for a stock that pays no dividends and requires a 9% return for a stock that pays its entire return from dividends is most likely a proponent of A) the bird-in-the-hand dividend theory. B) the residual dividend theory. C) the clientele effect. D) the information effect.

Q: A corporation announces a significant increase in its annual dividend and its stock price increases on the news. This could be explained most directly by A) residual dividend theory. B) bird-in-the-hand theory. C) perfect capital markets. D) MM"s indifference theorem.

Q: A corporation announces a large increase in its annual dividend, but its stock price declines. This could result from A) residual dividend theory. B) bird-in-the-hand theory. C) perfect capital markets. D) MM's indifference theorem.

Q: Dew Drop In, Inc. announces is quarterly dividend will increase from $3.80 to $4.00. After the announcement, the price of Dew Drop In, Inc.'s stock drops. The most likely explanation is that A) the stock market is a perfect market. B) investors are irrational. C) investors were expecting a larger increase. D) Dew Drop In, Inc.'s debt ratio decreased.

Q: Other things equal, individuals in high-income tax brackets should have a preference for firms that retain their earnings rather than pay dividends.

Q: The information effect hypothesis implies that increasing dividends provides a more credible signal of higher future earnings than does management's assertion that future earnings will be higher.

Q: In order to reduce agency costs, managers may decrease dividends, thus shifting the focus of investors to future capital gains that can only be attained by a well-run corporation.

Q: The clientele effect does not imply that either high or low dividends are optimal, rather that firms should not make significant and arbitrary changes in their existing dividend policy.

Q: If the tax rate on dividends and the tax rate on capital gains are the same, then investors are indifferent to dividend policy.

Q: The residual dividend theory implies that internally generated funds (i.e., retained earnings) should be used to fund all new investment projects before the company uses any additional debt.

Q: Federal tax law is irrelevant to corporate dividend policy because dividends are not tax deductible.

Q: An investor who requires an 18% percent return for a stock that pays no dividends and requires a 12% return for a stock that pays its entire return from dividends may be following the bird-in-the-hand dividend theory.

Q: According to the bird-in-the-hand dividend theory, investors value a dollar of expected capital gain more highly than a dollar of expected dividends because capital gains are more unpredictable than dividends.

Q: When considering taxes, most investors prefer capital gains over dividend income.

Q: In a perfect market, investors are only concerned with total returns and are not concerned whether it is in capital gains or dividend income.

Q: The residual dividend theory suggests that dividends should be paid to stockholders first, and then what is left can be reinvested by the firm.

Q: When an unexpected change in dividend policy develops, investors may attach informational content to the events.

Q: The existence of taxes can directly affect a common shareholder's preference for capital gains or dividend income.

Q: Security markets are considered to be perfect when firms can issue securities at no cost and the investor incurs no brokerage commissions.

Q: A firm's dividend policy provides information pertaining to the firm's payout ratio and its stability.

Q: If a company in a perfect capital market decreased its dividend per share, an investor would be forced to sell his common stock at a depressed price.

Q: If a firm were to unexpectedly omit payment of its quarterly dividend, that firm's stock price would probably drop.

Q: Under the ideal conditions of perfect capital markets, dividend policy has no effect upon share price.

Q: We typically expect to find rapidly growing firms to have high payout ratios.

Q: The residual theory of dividends connects a firm's dividend policy and its level of capital investments.

Q: Since stock dividends do not require payment in cash, their impact on a corporation's share price can be only positive (if there is an information effect) or neutral, but not negative.

Q: As a corporation's investment opportunities increase, the dividend payout ratio should decrease so that the corporation can avoid flotation costs.

Q: The residual dividend theory is based on the observation that flotation costs make the cost of new common stock significantly higher than the cost of retained earnings.

Q: Low dividends may increase stock value due to the advantage of tax deferral that comes with capital gains.

Q: According to the "bird-in-the-hand" dividend theory, the required return for a stock that pays its entire return from dividends is higher than the required return for a high-growth stock that pays no dividend.

Q: Because of the overriding importance of cash flows to valuation, one basic tenet of finance is that dividends increase the value of a company's common stock.

Q: A fast-growing company with many high net present value projects may maximize shareholder wealth by NOT paying a dividend.

Q: In order to maximize shareholder value, a corporation must earn a higher rate of return on a dollar that is retained in the corporation than the shareholders can earn by investing the dollar elsewhere.

Q: According to the expectations theory, the actual dividend must equal the expected dividend, or else the stock price will decrease after the dividend amount is announced.

Q: One potential rationale for paying dividends is that the payment of dividends indirectly results in a closer monitoring of management's investment activities, hence lowering agency costs.

Q: A closely-held company whose owners are trying to maintain control would be less likely to pay dividends so that all earnings may be retained to finance future growth.

Q: The information effect suggests dividend policy matters because dividends act as a persuasive communications tool, signaling investors about the financial condition of the firm.

Q: According to the clientele effect, dividend policy matters even if capital markets are perfect because investors self-select into dividend preference groups.

Q: An investor who pays no tax would be more likely to accept the view that high dividends increase stock values rather than the view that low dividends increase stock values.

Q: Memory, Inc. expects earnings per share this year to be $8. If earnings per share grow at an average annual rate of 6 percent and if Baker pays 60 percent of its earnings as dividends, what will the expected dividend per share be in 7 years?

Q: A firm's dividend payout ratio is A) the ratio of dividends to sales. B) the ratio of dividends to market equity. C) the ratio of dividends to earnings. D) the ratio of dividends to book equity.

Q: QRW, Inc. has a retained earnings balance of $2,000,000. The company reported net income of $600,000, sales of $4,000,000, and has 200,000 shares of common stock outstanding. The company announced a dividend of $2.00 per share. Therefore the company's dividend payout ratio is A) 66.7%. B) 50%. C) 20%. D) 10%.

Q: Analysis of dividend policy begins with the basic assumption that shareholder wealth maximization is the primary goal, and therefore dividends should be of primary concern even if their payment results in capital rationing.

Q: When Firm X makes the decision to pay dividends, they also make the decision not to reinvest the cash in the firm.

Q: A firm's dividend policy includes two basic components: the dividend payout ratio and the profit retention ratio.

Q: Identify several factors that influence the decision to issue debt.

Q: Premium Lodging, Inc., is financed entirely with 3 million shares of common stock selling for $50 a share. Capital of $10 million is needed for this year's capital budget. Additional funds can be raised with new stock (ignore dilution) or with 11 percent 12-year bonds. Premium Lodging's tax rate is 35 percent. Calculate the financing plan's EBIT indifference point.

Q: Sunshine Candy Company's capital structure for the past year of operation is shown below. First mortgage bonds at 12% $2,000,000 Debentures at 15% 1,500,000 Common stock (1,000,000 shares) 5,000,000 Retained earnings 500,000 TOTAL $9,000,000 The federal tax rate is 50 percent. Sunshine Candy Company, home-based in Orlando, wants to raise an additional $1,000,000 to open new facilities in Tampa and Miami. The firm can accomplish this via two alternatives: (1) It can sell a new issue of 20-year debentures with 16 percent interest; or (2) 20,000 new shares of common stock can be sold to the public to net the candy company $50 per share. A recent study, performed by an outside consulting organization, projected Sunshine Candy Company's long-term EBIT level at approximately $6,800,000. Find the indifference level of EBIT (with regard to earnings per share) between the suggested financing plans.

Q: The MAX Corporation is planning a $4,000,000 expansion this year. The expansion can be financed by issuing either common stock or bonds. The new common stock can be sold for $60 per share. The bonds can be issued with a 12 percent coupon rate. The firm's existing shares of preferred stock pay dividends of $2.00 per share. The company's corporate income tax rate is 46 percent. The company's balance sheet prior to expansion is as follows:MAX CorporationCurrent Assets$2,000,000Fixed Assets8,000,000Total Assets$10,000,000Current Liabilities$1,500,000Bonds:(8%, $1,000 par value)1,000,000(10%, $1,000 par value)4,000,000Preferred Stock:($100 par value)$500,000Common Stock:($2 par value)700,000Retained Earnings2,300,000Total Liabilities and Equity$10,000,000a. Calculate the indifference level of EBIT between the two plans.b. If EBIT is expected to be $3 million, which plan will result in higher EPS?

Q: Balon Plastics, Inc. is financed entirely with 3 million shares of common stock selling for $20 a share. Capital of $4 million is needed for this year's capital budget. Additional funds can be raised with new stock (ignore dilution) or with 13 percent 10-year bonds. The firm's tax rate is 40 percent. a. Calculate the financing plan's EBIT indifference point. b. The expected level of EBIT is $10,320,000 with a standard deviation of $2,000,000. What is the probability that EBIT will be above the indifference point? c. Does the "indifference point" calculated in question (a) above truly represent a point where stockholders are indifferent between stock and debt financing? Explain your answer.

Q: Balon Plastics, Inc. is trying to decide how best to finance a proposed $10,000,000 capital investment. Under Plan I, the project will be financed entirely with long-term 9 percent bonds. The firm currently has no debt or preferred stock. Under Plan II, common stock will be sold to net the firm $20 a share; presently, 1,000,000 shares are outstanding. The corporate tax rate for Balon is 40 percent. a. Calculate the indifference level of EBIT associated with the two financing plans. b. Prepare an EBIT-EPS analysis chart, showing the intersection of the two financing plan lines. c. Which financing plan would you expect to cause the greatest change in EPS relative to a change in EBIT? Why? d. If EBIT is expected to be $3.1 million, which plan will result in a higher EPS?

Q: The EBIT-EPS indifference point A) identifies the EBIT level at which the EPS will be the same regardless of the financing plan. B) identifies the point at which the analysis can use EBIT and EPS interchangeably. C) identifies the level of earnings at which the management is indifferent about the payments of dividends. D) identifies the sales level at which EBIT equals EPS.

Q: Basic tools of capital-structure management include A) EBIT-EPS analysis. B) comparative leverage ratios. C) capital budgeting techniques. D) both A and B.

Q: The primary weakness of EBIT-EPS analysis is that A) it ignores the implicit cost of debt financing. B) it double counts the cost of debt financing. C) it applies only to firms with large amounts of debt in their capital structure. D) it may only be used by firms that are profitable this year.