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1. Which of the following
statements about dividend policies is CORRECT?
a. Modigliani and Miller argue
that investors prefer dividends to capital gains because dividends are more
certain than capital gains. They call this the ―bird-in-the hand‖ effect.
b. One reason that companies tend
to avoid stock repurchases is that dividend payments are taxed at a lower rate
than gains on stock repurchases.
c. One advantage of dividend
reinvestment plans is that they allow shareholders to avoid paying taxes on the
dividends that they choose to reinvest.
d. One key advantage of a residual
dividend policy is that it enables a company to follow a stable dividend
policy.
e. The clientele effect suggests
that companies should follow a stable dividend policy.
2. Which of the following
statements is CORRECT?
a. One disadvantage of dividend
reinvestment plans is that they increase transactions costs for investors who
want to increase their ownership in the company.
b. One advantage of dividend
reinvestment plans is that they enable investors to postpone paying taxes on
the dividends credited to their account.
c. Stock repurchases can be used
by a firm that wants to increase its debt ratio.
d. Stock repurchases make sense
if a company expects to have a lot of profitable new projects to fund over the
next few years, provided investors are aware of these investment opportunities.
e. One advantage of an open
market dividend reinvestment plan is that it provides new equity capital and
increases the shares outstanding.
3. Which of the following
statements is CORRECT?
a. When firms are deciding on the
size of stock splits—say whether to declare a 2-for-1 split or a 3-for-1 split,
it is best to declare the smaller one, in this case the 2-for-1 split, because
then the after-split price will be higher than if the 3-for-1 split had been
used.
b. Back before the SEC was
created in the 1930s, companies would declare reverse splits in order to boost
their stock prices. However, this was determined to be a deceptive practice,
and it is illegal today.
c. Stock splits create more
administrative problems for investors than stock dividends, especially
determining the tax basis of their shares when they decide to sell them, so
today stock dividends are used far more often than stock splits.
d. When a company declares a
stock split, the price of the stock typically declines—by about 50% after a
2-for-1 split—and this necessarily reduces the total market value of the
equity.
e. If a firm’s stock price is
quite high relative to most stocks—say $500 per share—then it can declare a
stock split of say 10-for-1 so as to bring the price down to something close to
$50.
4. Which of the following
statements is CORRECT?
a. If a firm follows the
residual dividend policy, then a sudden increase in the number of profitable
projects is likely to reduce the firm’s dividend payout.
b. The clientele effect can
explain why so many firms change their dividend policies so often.
c. One advantage of adopting the
residual dividend policy is that this policy makes it easier for corporations
to develop 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.
5. DeAngelo Corp.'s projected net
income is $150.0 million, its target capital structure is 25% debt and 75%
equity, and its target payout ratio is 65%. DeAngelo has more positive NPV
projects than it can finance without issuing new stock, but its board of
directors had decreed that it cannot issue any new shares in the foreseeable
future. The CFO now wants to determine how the maximum capital budget would be
affected by changes in capital structure policy and/or the target dividend
payout policy. Versus the current policy, how much larger could the capital
budget be if (1) the target debt ratio were raised to 75%, other things held
constant, (2) the target payout ratio were lowered to 20%, other things held
constant, and (3) the debt ratio and payout were both changed by the indicated
amounts.
Increase in Capital Budget
Increase Debt Lower Payout Do
Both to 75% to 20%___________________
a. $114.0 $73.3 $333.9
b. $120.0 $77.2 $351.5
c. $126.4 $81.2 $370.0
d. $133.0 $85.5 $389.5
e. $140.0 $90.0 $410.0
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