Unit 4 (Ch 16 MC)

If the corporate tax rate is 35%, what is the maximum effective tax rate on dividends received by another corporation? Select one: a. 35% b. 30% c. 10.5% d. 65%

70% of dividends received by another corporation is tax-exempt. Tax rate = (0.3) x (0.35) = 0.105 = 10.5%. The correct answer is: 10.5%

Managers are reluctant to make dividend changes that they may have to reverse. Select one: True False

The correct answer is 'True'.

According to financial executives' views on dividend policy, which of the following statements is most frequently cited? Select one: 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.

The correct answer is: We try to avoid reducing the dividend.

Generally, investors interpret the announcement of a decrease in dividends as: Select one: a. bad news and the stock price drops. b. good news and the stock price increases. c. a nonevent and does not affect the stock prices. d. very good news and the stock price jumps up.

The correct answer is: bad news and the stock price drops.

Which of the following investors has the strongest tax reason to prefer dividends over capital gains? Select one: a. pension funds b. financial institutions c. individuals d. corporations

The correct answer is: corporations

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: Select one: 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. both a and c.

The correct answer is: dividends are taxed when distributed, while capital gains are deferred until the stock is sold.

Generally, investors interpret the announcement of an increase in dividends as: Select one: a. bad news and the stock price drops. b. good news and the stock price increases. c. a nonevent and does not affect the stock price. d. very bad news and the stock price plunges.

The correct answer is: good news and the stock price increases.

Companies using a tender offer to repurchase shares typically offer a stock price greater than the current stock price. Select one: True False

True

cum dividend

When a stock trades before the ex-dividend date, entitling anyone who buys the stock to the dividend

Ex-Dividend Date

the date two business days before the date of record, establishing those individuals entitled to a dividend

Share Price Equation

(Profits) / (Number of Shares)

Record Date

A specific date on which the company will determine the registered owners of stock and, therefore, who will receive the dividend

Which of these dates, when arranged in chronological order, occurs last? Select one: a. dividend payment date b. ex-dividend date c. record date d. dividend declaration date

Dividend payment date

dividend payment date

The date on which a corporation pays dividends to its stockholders

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. Select one: True False

True

Miller and Modigliani's argument for dividend irrelevance assumes an efficient market. Select one: True False

True

Most firms have long-run target dividend payout ratios. Select one: True False

True

The Miller and Modigliani dividend irrelevance argument assumes that the firm's investment policy and debt policy are both settled. Select one: True False

True

tender offer

an offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt stockholders to sell their shares

declaration date

the date on which the board of directors officially approves a dividend

Dividend payments are used to change the firm's capital structure by replacing equity with debt. Select one: True False

False

Dividend Irrelevance Theory

The theory that a firm's dividend policy has no effect on either its value or its cost of capital

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%. Select one: a. 110.0 b. 100.0 c. 90.91 d. 89.0

Share price at beginning of year = [$1000/0.1]/100 = $100 per share. Share price at end of year, before repurchase, equals $100 x 1.10 = $110 (i.e., 10% is the equilibrium expected return on the stock and all of that return is in the form of an expected capital gain if there are no dividends expected to be paid). Number of shares purchased = $1,000/$110 = 9.09. 100 - 9.09 = 90.91 shares remain. The correct answer is: 90.91

Firms can pay out cash to their shareholders in the following ways:I) dividends; II) share repurchases; III) interest payments Select one: a. I only b. II only c. I and II only d. III only

The correct answer is: I and II only

Which of the following lists events in chronological order from earliest to latest? Select one: 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

The correct answer is: Declaration date, ex-dividend date, record date

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? Select one: a. Increase dividends. b. Reduce share repurchases. c. Announce that dividends will not change for at least three years. d. Eliminate negative-NPV projects.

The correct answer is: Eliminate negative-NPV projects.

Consider the payout policies of U.S. firms from 2001-2010. Which category had the highest percentage of firms? Select one: 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

The correct answer is: Firms that paid no dividends and did not repurchase shares

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. Select one: a. I only b. II only c. III only d. I, II, and III

The correct answer is: I, II, and III

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. Select one: a. I only b. II only c. III only d. I, II, and III

The correct answer is: I, II, and III

Dividend policy changes are decided by:I) the managers of a firm; II) the government; III) the board of directors Select one: a. I only b. II only c. III only d. I and II only

The correct answer is: III only

Which of the following dividends is never in the form of cash?I) regular dividend;II) special dividend;III) stock dividend;IV) liquidating dividend Select one: a. I only b. II only c. III only d. I, II, and IV onl

The correct answer is: III only

The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy: Select one: 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.

The correct answer is: Investment policy is independent of dividend policy.

Generally, investors view the announcement of an open-market repurchase program as: Select one: a. bad news and the stock price drops. b. good news and the stock price increases. c. a nonevent and does not affect the stock price. d. very bad news and the stock price plunges.

The correct answer is: good news and the stock price increases.

According to behavioral finance, investors prefer dividends because: Select one: 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.

The correct answer is: investors prefer the discipline that comes from spending only the dividends.

A key assumption of the Miller and Modigliani (MM) dividend irrelevance argument is that: Select one: 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.

The correct answer is: new shares are sold at a fair price.

If dividends are taxed more heavily than capital gains, then investors: Select one: 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.

The correct answer is: should be willing to pay more for stocks with low dividend yields.

One possible reason that shareholders often insist on higher dividends is: Select one: 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.

The correct answer is: they do not trust managers to spend retained earnings wisely.

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% income on dividends. What is the value of the dividend that investors expect corporation B to pay one year from today? Select one: a. $7 b. $13 c. $10 d. $20

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

What is the likely impact on a typical individual investor if a firm undertakes a stock repurchase in lieu of a cash dividend? Select one: 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

b. Higher income taxes, if capital gains tax rates are less than dividend tax rates