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Exam 15: Distributions to Shareholders: Dividends and Share Repurchases

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Question 41

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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.

A) True
B) False

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Question 42

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Which of the following actions will best enable a company to raise additional equity capital,other things held constant?

A) Refund long-term debt with lower cost short-term debt.
B) Declare a stock split.
C) Begin an open-market purchase dividend reinvestment plan.
D) Initiate a stock repurchase program.
E) Begin a new-stock dividend reinvestment plan.

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

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Question 43

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If a firm uses the residual dividend model to set dividend policy,then dividends are determined as a residual after providing for the equity required to fund the capital budget.Under this model,the higher the firm's debt ratio,the lower its payout ratio will be,other things held constant.

One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm's required return constant,other things held constant.

If the information content,or signaling,hypothesis is correct,then a change in a firm's dividend policy can have an important effect on its stock price and cost of equity.

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

Whitman Antique Cars Inc.has the following data,and it follows the residual dividend model.Some Whitman family members would like more dividends,and they also think that the firm's capital budget includes too many projects whose NPVs are close to zero.If Whitman reduced its capital budget to the indicated level,by how much could dividends be increased,holding other things constant? ? $\begin{array} { l r } \text { Original capital budget } & \$ 3,000,000 \\\text { New capital budget } & \$ 1,900,000 \\\text { Net income } & \$ 3,500,000 \\\% \text { Debt } & 30 \%\end{array}$ ?

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.

D.Paul Inc.forecasts a capital budget of $700,000.The CFO wants to maintain a target capital structure of 45% debt and 55% equity,and she also wants to pay a dividend of $350,000.If the company follows the residual dividend model,how much income must it earn,and what will its dividend payout ratio be?

Toombs Media Corp.recently completed a 3-for-1 stock split.Prior to the split,its stock sold for $170 per share.The firm's total market value was unchanged by the split.Other things held constant,what is the best estimate of the stock's post-split price?

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?

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.

Portland Plastics Inc.has the following data.If it follows the residual dividend model,what is its forecasted dividend payout ratio? $\begin{array} { l r } \text { Capital budget } & \$ 12,000 \\\% \text { Debt } & 40 \% \\\text { Net income (NI) } & \$ 13,600\end{array}$ ?

The announcement of an increase in the cash dividend should,according to MM,lead to an increase in the price of the firm's stock,other things held constant.

If on January 3 a company declares a dividend of $1.50 per share,payable on January 31 then the price of the stock should drop by approximately $1.50 on January 31.