Chapter 16

35) Two corporations A and B have exactly the same risk, and both have a current stock price of $100. Corporation A pays no dividend and will have a price of $120 one year from now. Corporation B pays dividends and will have a price of $113 one year from now after paying the dividend. The corporations pay no taxes and investors pay no taxes on capital gains, but pay a 30 percent income tax on dividends. What is the value of the dividend that investors expect corporation B to pay one year from today? A) $7 B) $13 C) $10 D) $20

C) $10 The after-tax returns must be the same. The return on stock A is 20 percent, or $20. The after-tax return on stock B must also be 20 percent, or $20. Stock B will deliver $13 of capital gains and must therefore deliver an after-tax dividend of $7. The pre-tax dividend is = (120 − 113)/0.7 = $10.

37) If the corporate tax rate is 21 percent, what is the maximum effective tax rate on dividends received by another corporation? A) 30 percent B) 21 percent C) 6.3 percent D) 63 percent

C) 6.3 percent Seventy percent of dividends received by another corporation is tax-exempt. Tax rate = (0.3) × (0.21) = 0.063 = 6.3%.

40) A firm in Australia earns a pretax profit of $A10 per share. Suppose that it pays a corporate tax of $3 per share (30 percent tax rate) in taxes. The firm pays the remaining $A7 in dividends to a shareholder in the 40 percent marginal tax bracket. What is the amount of additional tax paid by the shareholder under an imputation tax system? A) $A1.00 B) $0.00 C) $A4.00 D) $A5.80

A) $A1.00

3) Which of these dates, when arranged in chronological order, occurs last? A) Dividend payment date B) Ex-dividend date C) Record date D) Dividend declaration date

A) Dividend payment date

16) Generally, firms engage in stock repurchases during I) boom times as firms accumulate excess cash; II) recessions due to low stock prices; III) times when competitors' stock prices are dropping A) I only B) II only C) III only D) II and III only

A) I only

12) What is the likely impact on a typical individual investor if a firm undertakes a stock repurchase in lieu of a cash dividend? A) Lower income taxes, if capital gains tax rates are less than dividend tax rates B) Higher income taxes, if capital gains tax rates are less than dividend tax rates C) Lower share price D) A tax-free transaction

A) Lower income taxes, if capital gains tax rates are less than dividend tax rates

17) According to financial executives' views on dividend policy, which of the following statements is most frequently cited? A) We try to avoid reducing the dividend. B) We try to maintain a smooth dividend stream. C) We look at the current dividend level. D) We are reluctant to make a change that may have to be reversed.

A) We try to avoid reducing the dividend.

19) Generally, investors interpret the announcement of a decrease in dividends as A) bad news, and the stock price drops. B) good news, and the stock price increases. C) a nonevent that does not affect the stock prices. D) very good news, and the stock price jumps up.

A) bad news, and the stock price drops.

29) The rightist position is that the market will reward firms for having A) high dividend yield. B) a low dividend yield C) good management, regardless of dividend yield. D) a zero payout policy.

A) high dividend yield.

30) According to behavioral finance, investors prefer dividends because A) investors prefer the discipline that comes from spending only the dividends. B) dividends generate lower taxes. C) the stock market is efficient. D) dividends provide a tax deduction.

A) investors prefer the discipline that comes from spending only the dividends.

33) If dividends are taxed more heavily than capital gains, then investors A) should be willing to pay more for stocks with low dividend yields. B) should be willing to pay more for stocks with high dividend yields. C) should be willing to pay the same for stocks regardless of their dividend yields. D) should be willing to pay more for stocks having infrequent share repurchases.

A) should be willing to pay more for stocks with low dividend yields.

25) Company X has 100 shares outstanding. It earns $1,000 per year and expects to pay all of it as dividends. If the firm expects to maintain this dividend forever, calculate the stock price today. (The required rate of return is 10 percent.) A) $110 B) $100 C) $90 D) $10

B) $100 Dividends = 1,000/100 = $10. P = 10/0.1 = $100.

26) Company X has 100 shares outstanding. It earns $1,000 per year and expects to pay all of it as dividends. If the firm expects to maintain this dividend forever, calculate the stock price after the dividend payment. (The required rate of return is 10 percent.) A) $110 B) $100 C) $90 D) $10

B) $100 Dividends = 1,000/100 = $10; P = 10/0.1 = $100.

39) A firm in Australia earns a pretax profit of $A10 per share. Suppose that it pays a corporate tax of $3 per share (30 percent tax rate) in taxes. The firm pays the remaining $A7 in dividends to a shareholder in the 30 percent marginal tax bracket. What is the amount of additional tax paid by the shareholder under an imputation tax system? A) $A2.10 B) $A0.00 C) $A3.00 D) $A5.10

B) $A0.00

11) Consider the procedure whereby the firm states a series of prices at which it is prepared to repurchase stock. Shareholders then submit offers indicating how many shares they wish to sell and at which price. The firm then calculates the lowest price at which it is able to buy the desired number of shares. This procedure is known as a(n) A) open market repurchase. B) Dutch auction. C) green mail. D) tender offer.

B) Dutch auction.

5) On January 2, Michigan Mining declared a $2-per-share quarterly dividend payable on March 9th to stockholders of record on Friday, February 9. What is the latest date by which you could purchase the stock and still get the recently declared dividend? A) February 5 B) February 6 C) February 7 D) February 8

B) February 6

22) Miller and Modigliani's indifference proposition regarding dividend policy A) assumes that tax rates increase at the same rate as inflation. B) assumes that investors can sell their stock at a fair price. C) states that investors are indifferent between stock dividends and cash dividends. D) states that investors are indifferent between stock repurchases and cash dividends.

B) assumes that investors can sell their stock at a fair price.

32) Even if both dividends and capital gains are taxed at the same ordinary income tax rate, the effect of each type of tax is different because A) capital gains are actually taxed, while dividends are taxed on paper only. B) dividends are taxed when distributed, while capital gains are deferred until the stock is sold. C) both dividends and capital gains are taxed every year. D) capital gains are actually taxed, while dividends are taxed on paper; and both dividends and capital gains are taxed every year.

B) dividends are taxed when distributed, while capital gains are deferred until the stock is sold.

18) Generally, investors interpret the announcement of an increase in dividends as A) bad news, and the stock price drops. B) good news, and the stock price increases. C) a nonevent that does not affect the stock price. D) very bad news, and the stock price plunges.

B) good news, and the stock price increases.

20) Generally, investors view the announcement of an open-market repurchase program as A) bad news, and the stock price drops. B) good news, and the stock price increases. C) a nonevent that does not affect the stock price. D) very bad news, and the stock price plunges.

B) good news, and the stock price increases.

10) The par value of the outstanding shares is known as A) retained earnings. B) legal capital. C) book value of equity. D) additional paid-in capital.

B) legal capital.

9) A Dutch auction is the same as a(n) A) discriminatory price auction. B) uniform price auction. C) English auction. D) share repurchase.

B) uniform price auction.

27) Company X has 100 shares outstanding. It earns $1,000 per year and announces that it will use all $1,000 to repurchase its shares in the open market instead of paying dividends. Calculate the number of shares outstanding at the end of year 1, after the first share repurchase, if the required rate of return is 10 percent. A) 110 B) 100 C) 90.91 D) 89

C) 90.91 Share price at beginning of year = [$1000/0.1]/100 = $100 per share. Share price at end of year, before repurchase, equals $100 × 1.10 = $110. Number of shares purchased = $1,000/$110 = 9.09. 100 − 9.09 = 90.91 shares remain.

4) Which of the following lists events in chronological order from earliest to latest? A) Record date, declaration date, ex-dividend date B) Declaration date, record date, ex-dividend date C) Declaration date, ex-dividend date, record date D) Record date, ex-dividend date, declaration date

C) Declaration date, ex-dividend date, record date

31) If investors do not like dividends because of the additional taxes that they have to pay, how would you expect stock prices to behave on the ex-dividend date? A) Fall by more than the amount of the dividend B) Fall exactly by the amount of the dividend C) Fall by less than the amount of the dividend D) Cannot be predicted.

C) Fall by less than the amount of the dividend Relative demand for the stock will increase on the ex-dividend date since the stock no longer trades with the dividend attached. So the stock price will fall due to the dividend, but will increase to some extent due to its ex-dividend status. On net, it will fall less than the amount of the dividend.

1) Firms can pay out cash to their shareholders in the following way(s): I) dividends; II) share repurchases; III) interest payments A) I only B) II only C) I and II only D) III only

C) I and II only

38) Dividend policy may affect firm value because I) there is an unsatisfied clientele that prefer dividends to capital gains; II) there are sufficient loopholes in the tax system that wealthy shareholders can avoid taxes on dividends; III) well-managed companies prefer to signal their worth by paying high dividends A) I only B) I and II only C) I and III only D) II and III only

C) I and III only

7) The following statements are true of dividend reinvestment plans (DRIPs): I) They are offered by the companies to their shareholders. II) Generally, new shares are issued at a discount. III) The dividends are taxable as ordinary income. A) I only B) I and III only C) I, II, and III D) III only

C) I, II, and III

2) Dividend policy changes are decided and announced by I) the managers of a firm; II) the government; III) the board of directors A) I only B) II only C) III only D) I and II only

C) III only

6) Which of the following dividends are never in the form of cash? I) regular dividend; II) special dividend; III) stock dividend; IV) liquidating dividend A) I only B) II only C) III only D) I, II, and IV only

C) III only

24) The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy: A) Changes in investment policy will alter dividend policy. B) Changes in dividend policy will alter investment policy. C) Investment policy is independent of dividend policy. D) Dividends are tax-deductible and investments are depreciable.

C) Investment policy is independent of dividend policy.

28) One possible reason that shareholders often insist on higher dividends is A) they agree with Miller and Modigliani. B) the capital gains tax disadvantage. C) the stock market is efficient. D) they do not trust managers to spend retained earnings wisely.

D) they do not trust managers to spend retained earnings wisely.

42) Firms can pay out cash to their shareholders in two ways: cash dividends and stock dividends. (T/F)

False

48) An equivalent alternative to paying cash dividends is to pay stock dividends. (T/F)

False

49) Dividend payments are used to change the firm's capital structure by replacing equity with debt. (T/F)

False

41) Companies using a tender offer to repurchase shares typically offer a stock price greater than the current stock price. (T/F)

True

43) In 2009, JPMorgan Chase cut its dividend down to $0.05 per share and the bank's share price increased in response. (T/F)

True

44) Adoption of Rule 10b-18 by the SEC has protected firms from being prosecuted for manipulating their share price through share repurchases. (T/F)

True

45) A high-dividend policy is more difficult for a weak firm than a strong firm because it likely will not have the cash to support it. (T/F)

True

46) Healy and Palepu found that the stock price of firms that stopped paying a dividend declined by 9.5 percent on average upon announcement. (T/F)

True

47) Many companies have automatic dividend reinvestment plans (DRIPs). (T/F)

True

50) Most firms have long-run target dividend payout ratios. (T/F)

True

51) Stock repurchases are like bumper dividends, but they do not typically substitute for regular cash dividends. (T/F)

True

52) Managers are reluctant to make dividend changes that they may have to reverse. (T/F)

True

53) Managers try to avoid reducing their stock's dividend. (T/F)

True

54) Miller and Modigliani's argument for dividend irrelevance assumes an efficient market. (T/F)

True

55) Australia follows an imputation tax system for the payment of taxes on dividends. (T/F)

True

56) The Miller and Modigliani dividend irrelevance argument assumes that the firm's investment policy and debt policy are both settled (fixed). (T/F)

True

57) The Miller and Modigliani dividend irrelevance argument assumes that the firm can issue new shares at a fair price. (T/F)

True

36) Which of the following investors has the strongest tax reason to prefer dividends over capital gains? A) Pension funds B) Financial institutions C) Individuals D) Corporations

D) Corporations

13) Suppose that there are no taxes, transactions costs, or other market imperfections. Which of the following actions is most likely to make shareholders better off? A) Increase dividends. B) Reduce share repurchases. C) Announce that dividends will not change for at least three years. D) Eliminate negative-NPV projects.

D) Eliminate negative-NPV projects.

34) Consider the payout policies of U.S. nonfinancial firms from 2011-2017. Which category had the highest percentage of firms? A) Firms that paid dividends and repurchased shares B) Firms that paid dividends but did not repurchase shares C) Firms that paid no dividends but did repurchase shares D) Firms that paid no dividends and did not repurchase shares

D) Firms that paid no dividends and did not repurchase shares

15) According to survey data, which is the least-often cited dividend policy consideration? A) Firms want to avoid dividend reductions. B) Firms desire a smooth dividend policy. C) Firms avoid dividend policy reversals. D) Firms would prefer to raise new funds rather than reduce dividends.

D) Firms would prefer to raise new funds rather than reduce dividends.

8) Firms can repurchase shares in the following ways: I) open market repurchase; II) tender offer; III) Dutch auction; IV) direct negotiation with a major shareholder A) I only B) II only C) III only D) I, II, III, and IV

D) I, II, III, and IV

14) Which of the following are true? I) Firms have long-run target dividend payout ratios. II) Dividend changes follow shifts in long-term, sustainable earnings. III) Managers are reluctant to make dividend changes that might have to be reversed. A) I only B) II only C) III only D) I, II, and III

D) I, II, and III

23) The following are indicators that the firm has a cash surplus:. I) Free cash flow is reliably positive. II) The firm has a low debt ratio compared to similar firms. III) The firm has sufficient debt capacity to cover unexpected opportunities or setbacks. A) I only B) II only C) III only D) I, II, and III

D) I, II, and III

21) A key assumption of the Miller and Modigliani (MM) dividend irrelevance argument is that A) future stock prices are certain. B) firms have an adequate supply of Treasury shares. C) there exists a risk-free asset. D) new shares are sold at a fair price.

D) new shares are sold at a fair price.