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Exam 14: Distribution to Shareholders: Dividends and Share Repurchases

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Question 1

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Which of the following statements is CORRECT?

A) Under the tax laws as they existed in 2015,a dollar received by an individual taxpayer as interest income is taxed at the same rate as a dollar received as dividends.
B) One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends.
C) Empirical research indicates that,in general,companies send a negative signal to the marketplace when they announce an increase in the dividend.As a result,share prices fall when dividend increases are announced because investors interpret the increase as a signal that the firm expects fewer good investment opportunities in the future.
D) If a company needs to raise new equity capital,a new-stock dividend reinvestment plan would make sense.However,if the firm does not need new equity,then an open market purchase dividend reinvestment plan would probably make more sense.
E) Dividend reinvestment plans have not caught on in most industries,and today over 99% of all DRIPs are offered by utilities.

F) A) and D)
G) B) and E)

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Question 2

True/False

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The federal government sometimes taxes dividends and capital gains at different rates.Other things held constant,if the tax rate on dividends is high relative to that on capital gains,then individuals with low taxable incomes should favor stocks with low payouts and high-income individuals should favor high-payout companies.

A) True
B) False

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Question 3

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There are two types of dividend reinvestment plans.Under one type of plan,the firm uses the cash that would have been paid as dividends to buy stock on the open market.Under the other type,the company issues new stock,keeps the cash that would have been paid out,and in effect sells new stock to those investors who choose to reinvest their dividends.

If on January 3 a company declares a dividend of $1.50 per share,payable on January 31 to holders of record on January 17,then the price of the stock should drop by approximately $1.50 on January 15,which is the ex-dividend date.

Mortal Inc.expects to have a capital budget of $450,000 next year.The company wants to maintain a target capital structure with 35% debt and 65% equity,and its forecasted net income is $400,000.If the company follows the residual dividend model,how much in dividends,if any,will it pay?

If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of their dividends reinvested,the company should reconsider its dividend policy and possibly move to a lower dividend payout ratio.

Your firm adheres strictly to the residual dividend model.All else equal,which of the following factors would be most likely to lead to an increase in the firm's dividend per share?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Ring Technology has a capital budget of $875,000,it wants to maintain a target capital structure of 35% debt and 65% equity,and it also wants to pay a dividend of $575,000.If the company follows the residual dividend model,how much net income must it earn to meet its capital budgeting requirements and pay the dividend,all while keeping its capital structure in balance?

A 100% stock dividend and a 2:1 stock split should,at least conceptually,have the same effect on the firm's stock price.

Ross-Jordan Financial has suffered losses in recent years,and its stock currently sells for only $0.60 per share.Management wants to use a reverse split to get the price up to a more "reasonable" level,which it thinks is $12 per share.How many of the old shares must be given up for one new share to achieve the $12 price,assuming this transaction has no effect on total market value?

Suppose you plotted a curve which showed a Firm U's WACC on the vertical axis and its debt ratio on the horizontal axis.Then you plotted a similar curve for Firm V.The curve for firm U resembled a shallow "U," while that for Firm V resembled a sharp "V." Both firms have debt ratios that cause their WACCs to be minimized.Other things held constant,it would be easier for Firm V than for Firm U to maintain a steady dividend in the face of varying investment opportunities and earnings from year to year.

Which of the following does NOT normally influence a firm's dividend policy decision?

If management wants to maximize its stock price,and if it believes that the dividend irrelevance theory is correct,then it must adhere to the residual dividend policy.

One advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest.

Sheehan Corp.is forecasting an EPS of $5.00 for the coming year on its 500,000 outstanding shares of stock.Its capital budget is forecasted at $700,000,and it is committed to maintaining a $4.00 dividend per share.It finances with debt and common equity,but it wants to avoid issuing any new common stock during the coming year.Given these constraints,what percentage of the capital budget must be financed with debt?

If a firm adheres strictly to the residual dividend policy,and if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/assets ratio) ,then the firm should pay

If investors prefer firms that retain most of their earnings,then a firm that wants to maximize its stock price should set a low payout ratio.

It has been argued that investors prefer high-payout companies because dividends are more certain (less risky)than the capital gains that are supposed to come from retained earnings.However,Miller and Modigliani say that this argument is incorrect,and they call it the "bird-in-the-hand fallacy." MM base their argument on the belief that most dividends are reinvested in stocks,hence are exposed to the same risks as reinvested earnings.