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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.

A) True
B) False

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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 investment 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.

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

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Which of the following statements is CORRECT?


A) If a firm repurchases some of its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes.
B) An open-market dividend reinvestment plan will be most attractive to companies that need new equity and would otherwise have to issue additional shares of common stock through investment bankers.
C) Stock repurchases tend to reduce financial leverage.
D) If a company declares a 2-for-1 stock split, its stock price should roughly double.
E) One advantage of adopting the residual dividend model is that this makes it easier for corporations to meet the requirements of Modigliani and Miller's dividend clientele theory.

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

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Ellinger Inc. is a mature company in a mature industry. It plans to distribute all of its income at year-end, and its earnings are not expected to grow. The CFO is now considering whether the firm should distribute income to stockholders as dividends or use the funds to repurchase common stock. She believes the P/E ratio would not be affected by a repurchase. Moreover, she believes that the stock can be repurchased at the end of the year at the then-current price, which is expected to be the now-current price plus the dividend that would otherwise be received at year-end. Based on the data shown below, and disregarding any possible tax effects, how much would a stockholder who owns 100 shares gain if the firm used its net income to repurchase stock rather than for dividends?


A) $564.06
B) $593.75
C) $625.00
D) $656.25
E) $689.06

F) B) and C)
G) All of the above

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Which of the following statements is CORRECT?


A) Historically, the tax code has encouraged companies to pay dividends rather than retain earnings.
B) If a company uses the residual dividend model to determine its dividend payments, dividend payout will tend to increase whenever its profitable investment opportunities increase relatively rapidly.
C) The more a firm's management believes in the clientele effect, the more likely the firm is to adhere strictly to the residual dividend model.
D) Large stock repurchases financed by debt tend to increase expected earnings per share, but they also tend to increase the firm's financial risk.
E) A dollar paid out to repurchase stock has the same tax benefit as a dollar paid out in dividends. Thus, both companies and investors should be indifferent between distributing cash through dividends and stock repurchase programs.

F) All of the above
G) B) and E)

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Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and she also wants to pay a dividend of $500,000. If the company follows the residual dividend model, how much income must it earn, and what will its dividend payout ratio be?


A) $ 898,750; 55.63%
B) $ 943,688; 58.41%
C) $ 990,872; 61.34%
D) $1,040,415; 64.40%
E) $1,092,436; 67.62%

F) A) and B)
G) A) and C)

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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?


A) The firm's net income increases.
B) The company increases the percentage of equity in its target capital structure.
C) The number of profitable potential projects increases.
D) Congress lowers the tax rate on capital gains, leaving the rest of the tax code unchanged.
E) Earnings are unchanged, but the firm issues new shares of common stock.

F) B) and C)
G) C) and E)

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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.

A) True
B) False

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NY Fashions has the following data. If it follows the residual dividend model, how much total dividends, if any, will it pay out?


A) $20,363
B) $21,434
C) $22,563
D) $23,750
E) $25,000

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

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Chicago Brewing has the following data, dollars in thousands. If it follows the residual dividend model, what will its dividend payout ratio be?


A) 48.11%
B) 50.52%
C) 55.57%
D) 61.13%
E) 67.24%

F) A) and B)
G) None of the above

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A

Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price.

A) True
B) False

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Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument.

A) True
B) False

Correct Answer

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

A) True
B) False

Correct Answer

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If a firm adheres strictly to the residual dividend model, the issuance of new common stock would suggest that


A) the dividend payout ratio has remained constant.
B) the dividend payout ratio is increasing.
C) no dividends will be paid during the year.
D) the dividend payout ratio is decreasing.
E) the dollar amount of capital investments had decreased.

F) A) and B)
G) A) and C)

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Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on either its cost of capital or its stock price.

A) True
B) False

Correct Answer

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Which of the following statements is NOT CORRECT?


A) Stock repurchases can be used by a firm as part of a plan to change its capital structure.
B) After a 3-for-1 stock split, a company's price per share should fall, but the number of shares outstanding will rise.
C) Investors may interpret a stock repurchase program as a signal that the firm's managers believe the stock is undervalued, or, alternatively, as a signal that the firm does not have many good investment opportunities.
D) A company can repurchase stock to distribute a large one-time cash inflow, say from the sale of a division, to stockholders without having to increase its regular dividend.
E) Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan.

F) A) and B)
G) None of the above

Correct Answer

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Some investors prefer dividends to retained earnings (and the capital gains retained earnings bring), while others prefer retained earnings to dividends. Other things held constant, it makes sense for a company to establish its dividend policy and stick to it, and then it will attract a clientele of investors who like that policy.

A) True
B) False

Correct Answer

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The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to an increase in dividend payout ratios.

A) True
B) False

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False

Ring Technology has a capital budget of $850,000, it wants to maintain a target capital structure of 35% debt and 65% equity, and it also wants to pay a dividend of $400,000. 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) $ 904,875
B) $ 952,500
C) $1,000,125
D) $1,050,131
E) $1,102,638

F) All of the above
G) C) and E)

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B

New Orleans Builders Inc. has the following data. If it follows the residual dividend model, what is its forecasted dividend payout ratio?


A) 18.23%
B) 20.25%
C) 22.50%
D) 25.00%
E) 27.50%

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

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