Corporate Finance Ch 16 (Just Short Answers

68. Briefly describe the middle-of-the-roaders' position.

Middle-of-the-roaders hold that a firm's value is not affected by its dividend policy.

72. Briefly explain how the imputation tax system works in Australia using an example.

Operating Income: 100 Corporate Tax: 30 After-Tax Income (paid out as dividends): 70 Grossed-Up Dividend: 100 Income Tax Paid by the Investor at 15%: 15 Tax credit for corporate payment: -30 Tax due from shareholder: -15 Income to Shareholders: 85

71. Briefly explain how the shareholders are taxed twice in the U.S.A. using an example.

Operating Income: 100 Corporate Tax: 30 After-Tax Income (paid out as dividends): 70 Income Tax Paid by the Investor at 15%: 10.5 Income to Shareholders: 59.5

64. State Miller and Modigliani's proposition on dividend irrelevance.

Miller and Modigliani state that in a world without taxes, transaction costs or other market imperfections, dividend policy followed is irrelevant to the value of the firm.

67. Briefly explain how current tax laws favor capital gains?

Tax rate on capital gains tax rate is 20%, while for taxable income it is much higher. Tax laws favor capital gains in another way. Taxes on dividends have to be paid immediately. But, taxes on capital gains can be deferred until the shares are sold and capital gains realized. The longer the shareholders wait, less the present value of capital gains liability.

60. Briefly explain the chronology of dividend payment.

The board of directors set the dividend for a firm. The date on which the board of directors announce the dividend is called the declaration date. Dividend will be paid to shareholders as of record date. Two business days prior to record date is the ex-dividend date. Shares bought on the ex-dividend date or later does not come with the dividend. The date checks are mailed to the shareholders is the payment date.

73. A retiree believes that investing in a non-dividend paying growth firm, that requires the periodic sale of stock for income, will eventually lead to a loss of all shares. Explain the flaw in this logic.

A growth firm, by definition, we have an increasing share price. Over time the firm will either have stock splits to maintain a stock price within a certain trading range or the price will go up substantially over time. In the case of stock splits, the retiree will get an ever increasing number of shares. In the case of an increasing share price, the retiree will need to liquidate an ver decreasing quantity of shares. In either case, the share will not disappear any faster than they would through dividend payments.

62. Briefly discuss different ways in which a firm can pay dividends to its shareholders.

Firms pay a regular cash dividend each quarter. Occasionally, firms pay extra or special dividends. Frequently firms also declare stock dividends. That is, shareholders receive additional shares of stock instead of cash. Many times firms might repurchase their own stock. This is in lieu of paying dividends. "Greenmail" is another form of share repurchase.

66. Briefly describe the leftists' point of view on dividends and taxes.

If the dividends are taxed at a higher rate than capital gains, firms should pay the lowest cash dividends. By shifting their distribution policy, corporations can transform dividends into capital gains. Leftists generally favor low dividend payout.

70. Briefly describe the "imputation tax system."

In the imputation tax system, shareholders are taxed on dividends, but they receive a tax deduction, which is equal to their share of the corporate tax that the company has paid. This is followed in Australia.

65. Rightists argue that increasing a firm's dividend will increase its value. State some key points in their assertion.

Investors prefer cash to capital gains as cash dividends are certain and capital gains are uncertain; many investors prefer cash, as they need it for living expenses; investors see the information converged by dividend payments as indicative of a firm's good performance.

61. What is SEC Rule 10b-18? Briefly explain.

SEC Rule 10b-18 was adopted in 1982. Prior to adoption of this rule, firms that repurchased the shares of their own firm were liable for prosecution for manipulating their share price. SEC Rule 10b-18 has provisions that protect firms against such a prosecution.

63. Briefly explain the information content of share repurchase.

Share repurchases are generally a rare event. When a firm announces a repurchase program it is not making a long-term commitment. Firms repurchase shares when they accumulated cash that they are not able to invest profitably. Share repurchase may indicate under priced stock. Share repurchase may also be used to signal management's confidence in the future of the firm.

69. Briefly explain how shareholders' returns are taxed twice in the United States?

Shareholders' returns are taxed at the corporate level as corporate tax, and at the shareholders level as either income tax or capital gains tax.