Question 1

Toombs Media Corp. recently completed a 3-for-1 stock split. Prior to the split, its stock sold for $90 per share. The firm's total market value was unchanged by the split. Other things held constant, what is the best estimate of the stock's post-split price?

Accepted Answer

A)  $30.00 
B)  $31.50 
C)  $33.08 
D)  $34.73 
E)  $36.47

Question 2

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?

Accepted Answer

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.

Question 3

Mortal Inc. expects to have a capital budget of $500,000 next year. The company wants to maintain a target capital structure with 30% debt and 70% equity, and its forecasted net income is $400,000. If the company follows the residual dividend model, how much in dividends, if any, will it pay?

Accepted Answer

A)  $45,125 
B)  $47,500 
C)  $50,000 
D)  $52,500 
E)  $55,125

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

Fauver Industries plans to have a capital budget of $650,000. It wants to maintain a target capital structure of 40% debt and 60% equity, and it also wants to pay a dividend of $225,000. If the company follows the residual dividend model, how much net income must it earn to meet its investment requirements, pay the dividend, and keep the capital structure in balance?

Accepted Answer

A)  $584,250 
B)  $615,000 
C)  $645,750 
D)  $678,038 
E)  $711,939

Question 6

Which of the following actions will best enable a company to raise additional equity capital, other things held constant?

Accepted Answer

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.

Question 7

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 for Firm U to maintain a steady dividend in the face of varying investment opportunities and earnings from year to year.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following statements is CORRECT?

Accepted 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. 
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.

Question 9

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

Accepted Answer

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.

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  Under the tax laws as they existed in 2011, 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. 
E)  Dividend reinvestment plans have not caught on in most industries, and today over 99% of all DRIPs are offered by utilities.

Question 11

If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of their dividends reinvested, the company should reconsider its dividend policy and possibly move to a lower dividend payout ratio.

Accepted Answer

A) True 
 B)False

Question 12

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.

Accepted Answer

A) True 
 B)False

Question 13

Sheehan Corp. is forecasting an EPS of $3.00 for the coming year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at $800,000, and it is committed to maintaining a $2.00 dividend per share. It finances with debt and common equity, but it wants to avoid issuing any new common stock during the coming year. Given these constraints, what percentage of the capital budget must be financed with debt?

Accepted Answer

A)  30.54% 
B)  32.15% 
C)  33.84% 
D)  35.63% 
E)  37.50%

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following statements is CORRECT?

Accepted Answer

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.

Question 16

Portland Plastics Inc. has the following data. If it follows the residual dividend model, what is its forecasted dividend payout ratio?
Capital budget $12,500
% Debt 40%
Net income (NI) $11,500

Accepted Answer

A)  25.36% 
B)  28.17% 
C)  31.30% 
D)  34.78% 
E)  38.26%

Question 17

Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on either its cost of capital or its stock price.

Accepted Answer

A) True 
 B)False

Question 18

If on January 3, 2012, a company declares a dividend of $1.50 per share, payable on January 31, 2012, to holders of record on January 19, then the price of the stock should drop by approximately $1.50 on January 17, which is the ex-dividend date.

Accepted Answer

A) True 
 B)False

Question 19

You own 100 shares of Troll Brothers' stock, which currently sells for $120 a share. The company is about to declare a 2-for-1 stock split. Which of the following best describes your likely position after the split?

Accepted Answer

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.

Question 20

The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price.

Accepted Answer

A) True 
 B)False

Exam 15: Dividends

Toombs Media Corp. recently completed a 3-for-1 stock split. Prior to the split, its stock sold for $90 per share. The firm's total market value was unchanged by the split. Other things held constant, what is the best estimate of the stock's post-split price?

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?

Mortal Inc. expects to have a capital budget of $500,000 next year. The company wants to maintain a target capital structure with 30% debt and 70% equity, and its forecasted net income is $400,000. If the company follows the residual dividend model, how much in dividends, if any, will it pay?

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.

Which of the following actions will best enable a company to raise additional equity capital, other things held constant?

Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of their dividends reinvested, the company should reconsider its dividend policy and possibly move to a lower dividend payout ratio.

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.

Which of the following statements is CORRECT?

Portland Plastics Inc. has the following data. If it follows the residual dividend model, what is its forecasted dividend payout ratio? Capital budget $12,500 % Debt 40% Net income (NI) $11,500

Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on either its cost of capital or its stock price.

If on January 3, 2012, a company declares a dividend of $1.50 per share, payable on January 31, 2012, to holders of record on January 19, then the price of the stock should drop by approximately $1.50 on January 17, which is the ex-dividend date.

You own 100 shares of Troll Brothers' stock, which currently sells for $120 a share. The company is about to declare a 2-for-1 stock split. Which of the following best describes your likely position after the split?

The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price.