uestion 1 Which of the following statements is correct?Answer One advantage of dividend reinvestmentplans is that they enable investors to avoid paying taxes on thedividends they receive. If a company has an established clientele of investorswho prefer a high dividend payout, and if management wants to keepstockholders happy, it should notfollow the strict residual dividend policy. If a firm follows a strict residual dividend policy,then, holding all else constant, its dividend payout ratio willtend to rise whenever the firms investment opportunitiesimprove. If Congress eliminates taxes on capital gains butleaves the personal tax rate on dividends unchanged, this wouldmotivate companies to increase their dividend payout ratios. Despite its drawbacks, following the residual dividendpolicy will tend to stabilize actual cash dividends, and this willmake it easier for firms to attract a clientele that prefers highdividends, such as retirees. .2 points Question 2 If a firm adheres strictly to the residual dividend policy, theissuance of new common stock would suggest thatAnswer the dividend payout ratio has remainedconstant. the dividend payout ratio is increasing. no dividends were paid during the year. the dividend payout ratio is decreasing. the dollar amount of investments has decreased. .2 points Question 3 Which of the following statements is correct?Answer Firms with a lot of good investmentopportunities and a relatively small amount of cash tend to haveabove average payout ratios. One advantage of the residual dividend policy is thatit leads to a stable dividend payout, which investors like. An increase in the stock price when a companydecreases its dividend is consistent with signaling theory aspostulated by MM. If the clientele effect is correct, then for acompany whose earnings fluctuate, a policy of paying a constantpercentage of net income will probably maximize the stockprice. Stock repurchases make the most sense at times when acompany believes its stock is undervalued. .2 points Question 4 If a firm adheres strictly to the residual dividend policy, then ifits optimal capital budget requires the use of all earnings for agiven year (along with new debt according to the optimal debt/totalassets ratio), then the firm should payAnswer no dividends except out of past retainedearnings. no dividends to common stockholders. dividends only out of funds raised by the sale of newcommon stock. dividends only out of funds raised by borrowing money(i.e., issue debt). dividends only out of funds raised by selling offfixed assets. .2 points Question 5 Which of the following statements is NOT correct?Answer Stock repurchases can be used by a firm aspart of a plan to change its capital structure. After a 3-for-1 stock split, a companys price pershare should fall, but the number of shares outstanding willrise. Investors can interpret a stock repurchase program asa signal that the firms managers believe the stock isundervalued. Companies can repurchase shares to distribute largeinflows of cash, say from the sale of a division, to stockholderswithout paying cash dividends. Stockholders pay no income tax on dividends if thedividends are used to purchase stock through a dividendreinvestment plan. .2 points Question 6 Which of the following would be most likely to lead to a decreasein a firms dividend payout ratio?Answer Its earnings become more stable. Its access to the capital markets increases. Its R&D efforts pay off, and it now has morehigh-return investment opportunities. Its accounts receivable decrease due to a change inits credit policy. Its stock price has increased over the last year by agreater percentage than the increase in the broad stock marketaverages. .2 points Question 7 Which of the following statements is correct?Answer If a company has a 2-for-1 stock split,its stock price should roughly double. Capital gains earned in a share repurchase are taxedless favorably than dividends; this explains why companiestypically pay dividends and avoid share repurchases. Very often, a companys stock price will rise when itannounces that it plans to commence a share repurchaseprogram. Such an announcement could lead to a stock pricedecline, but this does not normally happen. Stock repurchases increase the number of outstandingshares. The clientele effect is the best explanation for whycompanies tend to vary their dividend payments from quarter toquarter. .2 points Question 8 You own 100 shares of Troll Brothers stock, which currently sellsfor $120 a share. The company is contemplating a 2-for-1stock split. Which of the following best describes what yourposition will be after such a split takes place?Answer You will have 200 shares of stock, and thestock will trade at or near $120 a share. You will have 200 shares of stock, and the stock willtrade at or near $60 a share. You will have 100 shares of stock, and the stock willtrade at or near $60 a share. You will have 50 shares of stock, and the stock willtrade at or near $120 a share. You will have 50 shares of stock, and the stock willtrade at or near $60 a share. .2 points Question 9 Which of the following statements is correct?Answer If a firm repurchases some of its stock inthe open market, then shareholders who sell their stock for morethan they paid for it will be subject to capital gains taxes. An open-market dividend reinvestment plan will be mostattractive to companies that need new equity and would otherwisehave to issue additional shares of common stock through investmentbankers. Stock repurchases tend to reduce financialleverage. If a company declares a 2-for-1 stock split, its stockprice should roughly double. One advantage of adopting the residual dividend policyis that this makes it easier for corporations to meet therequirements of Modigliani and Millers dividend clienteletheory. .2 points Question 10 Myron Gordon and John Lintner believe that the required return onequity increases as the dividend payout ratio is decreased. Their argument is based on the assumption thatAnswer investors are indifferent betweendividends and capital gains. investors require that the dividend yield and capitalgains yield equal a constant. capital gains are taxed at a higher rate thandividends. investors view dividends as being less risky thanpotential future capital gains. investors value a dollar of expected capital gainsmore highly than a dollar of expected dividends because of thelower tax rate on capital gains. .2 points Question 11 Which of the following statements is correct?Answer The tax code encourages companies to paydividends rather than retain earnings. If a company uses the residual dividend model todetermine its dividend payments, dividends payout will tend toincrease whenever its profitable investment opportunitiesincrease. The stronger management thinks the clientele effectis, the more likely the firm is to adopt a strict version of theresidual dividend model. Large stock repurchases financed by debt tend toincrease earnings per share, but they also increase the firmsfinancial risk. A dollar paid out to repurchase stock is taxed at thesame rate as a dollar paid out in dividends. Thus, bothcompanies and investors are indifferent between distributing cashthrough dividends and stock repurchase programs. .2 points Question 12 Firm M is a mature firm in a mature industry. Its annual netincome and net cash flows are both consistently high andstable. However, Ms growth prospects are quite limited, soits capital budget is small relative to its net income. FirmN is a relatively new firm in a new and growing industry. Itsmarkets and products have not stabilized, so its annual operatingincome fluctuates considerably. However, N has substantialgrowth opportunities, and its capital budget is expected to belarge relative to its net income for the foreseeable future. Whichof the following statements is correct?Answer Firm M probably has a lower debt ratiothan Firm N. Firm M probably has a higher dividend payout ratiothan Firm N. If the corporate tax rate increases, the debt ratio ofboth firms is likely to decline. The two firms are equally likely to pay highdividends. Firm N is likely to have a clientele of shareholderswho want to receive consistent, stable dividend income. .2 points Question 13 Which of the following statements about dividend policies iscorrect?Answer Modigliani and Miller argue that investorsprefer dividends to capital gains because dividends are morecertain than capital gains. They call this the bird-in-thehand effect. One reason that companies tend to avoid stockrepurchases is that dividend payments are taxed at a lower ratethan gains on stock repurchases. One advantage of dividend reinvestment plans is thatthey allow shareholders to avoid paying taxes on the dividends thatthey choose to reinvest. One key advantage of a residual dividend policy isthat it enables a company to follow a stable dividend policy. The clientele effect suggests that companies shouldfollow a stable dividend policy. .2 points Question 14 Which of the following statements is CORRECT?Answer When firms are deciding on the size ofstock splits?say whether to declare a 2-for-1 split or a 3-for-1split, it is best to declare the smaller one, in this case the2-for-1 split, because then the after-split price will be higherthan if the 3-for-1 split had been used. Back before the SEC was created in the 1930s,companies would declare reverse splits in order to boost theirstock prices. However, this was determined to be a deceptivepractice, and it is illegal today. Stock splits create more administrative problems forinvestors than stock dividends, especially determining the taxbasis of their shares when they decide to sell them, so today stockdividends are used far more often than stock splits. When a company declares a stock split, the price ofthe stock typically declines?by about 50% after a 2-for-1 split?andthis necessarily reduces the total market value of the equity. If a firms stock price is quite high relative to moststocks?say $500 per share?then it can declare a stock split of say10-for-1 so as to bring the price down to something close to$50. Moreover, if the price is relatively low?say $2 pershare?then it can declare a reverse split of say 1-for-25 so asto bring the price up to somewhere around $50 per share. .2 points Question 15 Which of the following statements is correct?Answer One disadvantage of dividend reinvestmentplans is that they increase transactions costs for investors whowant to increase their ownership in the company. One advantage of dividend reinvestment plans is thatthey enable investors to postpone paying taxes on the dividendscredited to their account. Stock repurchases can be used by a firm that wants toincrease its debt ratio. Stock repurchases make sense if a company expects tohave a lot of profitable new projects to fund over the next fewyears, provided investors are aware of these investmentopportunities. One advantage of an open market dividend reinvestmentplan is that it provides new equity capital and increases theshares outstanding.
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