CHAPTER 14

        1.     A firm that follows a strict residual dividend policy is likely to maintain a stable pattern of dividends over time.

        A)    True

        B)    False

        2.     A cash payment to shareholders that results from the sale of some of the firm's assets is called __________.

        A)    a regular dividend

        B)    an extra dividend

        C)    a residual dividend

        D)    a liquidating dividend

        E)     a homemade dividend

        3.     All else equal, an investor is likely to prefer a firm with a low dividend payout rate

                I. if the firm has many positive NPV projects in which it could invest

                II. if marginal corporate tax rates exceed marginal personal tax rates

                III. if stock issuance costs are significant

                IV. if the firm's dividend payout is not restricted by a bond indenture

        A)    II only

        B)    I and III only

        C)    II and III only

        D)    II, III and IV only

        E)     I, II, III and IV

        4.        Suppose the personal tax rate on dividend income increases. All else equal, one would expect the cost of equity for high-dividend firms to decrease.

        A)    True

        B)    False

        5.     Rank the following goals in increasing order of importance in a compromise dividend policy.

                I. Avoid dividend cuts

                II. Maintain a target debt/equity ratio

                III. Avoid the need to sell equity

                IV. Avoid cutting back on positive NPV projects

        A)   IV, II, I, III

        B)    II, III, IV, I

        C)    IV, I, II, III

        D)    I, II, IV, III

        E)     IV, I, III, II

        6.     Of the following, only _____________ will likely affect the three equity accounts of common stock, retained earnings, and additional paid in capital.

        A)    the payment of a regular cash dividend

        B)    the payment of a stock dividend

        C)    the payment of a cash liquidating dividend

        D)    the payment of a special cash dividend

        E)     a stock split

        7.        Lucky Mike's, Inc. has a target debt/equity ratio of 0.75. After-tax earnings for 1996 were $850,000 and the firm needs $1,150,000 for new investments. If the company follows a residual dividend policy, what dividend will be paid?

        A)    $0

        B)        $67,240

        C)        $192,857

        D)        $213,164

        E)        $862,500

        8.        Which of the following is/are correct?

                I. Based on real-world factors, dividends are irrelevant

                II. Because of tax effects for individual investors and new issue costs, a low-dividend policy is best

                III. Because of the desire for current income and related factors, a high-dividend policy is best

        A)    I only

        B)    II and III only

        C)    I and III only

        D)    III only

        E)     I, II, and III

        9.     One of the goals of a compromise dividend policy is to avoid the need to sell equity.

        A)    True

        B)    False

        10.   A firm that follows a strict residual dividend payout will have a stable dividend.

        A)    True

        B)    False

        11.   A ________ is a payment made to shareholders from sources other than current or accumulated retained earnings.

        A)        distribution

        B)        stock dividend

        C)    extra dividend

        D)        liquidating dividend

        E)        regular cash dividend

Use the following to answer questions 12-15:

Consider a firm called Alex, Inc. which is financed 100% with equity. The firm has 100,000 shares of stock outstanding, with a market price of $5 per share. Total earnings for the most recent year are $50,000. The firm has cash of $25,000 in excess of what is necessary to fund its positive NPV projects. The firm is considering using the cash to pay an extra dividend of $25,000 or to repurchase stock in the amount of $25,000. The firm has other assets worth $475,000 (market value). For each of the questions that follow, assume there are no transaction costs, taxes or other market imperfections.

        12.        Which of the following is NOT correct in comparing a $25,000 share repurchase to a $25,000 cash dividend in a world with no taxes, transaction costs, or other market imperfections?

        A)    The price per share of the firm's stock will be the same after either the share repurchase or the cash dividend

        B)    The firm's earnings per share will be higher after the repurchase than it would be after the dividend

        C)    The firm's price/earnings ratio will be the same after either the share repurchase or the cash dividend

        D)    The firm will have fewer shares of stock outstanding after the repurchase than it would after the dividend

        E)     The total wealth of an individual shareholder will not be affected by either the share repurchase or the cash dividend

        13.        Assume the firm uses the $25,000 excess cash to buy back stock at $5 per share. Also assume you owned 1,000 shares before the repurchase and that this was your total wealth. If you sold none of your shares back to the firm, what is your total wealth after the repurchase is completed?

        A)        $4,500

        B)        $4,750

        C)        $5,000

        D)        $5,250

        E)        $5,500

        14.        Assume the firm pays the $25,000 excess cash out in the form of a cash dividend. What will the firm's price/earnings ratio be after the dividend?

        A)    9.00

        B)    9.25

        C)    9.50

        D)    9.75

        E)        10.00

        15.        Assume the firm pays the $25,000 excess cash out in the form of a cash dividend. Also assume you owned 1,000 shares before the dividend was paid and that this was your total wealth. Immediately after the dividend is paid, what is your total wealth?

        A)        $4,500

        B)        $4,750

        C)        $5,000

        D)        $5,250

        E)        $5,500

        16.   A cash payment to shareholders that will not be repeated in the future is called ____________.

        A)    a regular dividend

        B)    an extra dividend

        C)    a liquidating dividend

        D)    a residual dividend

        E)     a special dividend

        17.        Which of the following is an accurate statement?

        A)        Once declared, a dividend is no longer a liability of the firm

        B)    The value of a firm's stock is ultimately determined by its dividend policy

        C)    On average, stock dividends are the most common form of dividend issued

        D)    In the absence of a more favorable tax rate on cash dividends, investors will prefer stocks with relatively high dividend payout rates

        E)        Dividend stability is usually viewed as a desirable objective

        18.        Rocky Ground Camping Supply Inc. has 200,000 shares of stock outstanding, each with a par value of $5 and a market value of $15. In addition, on the balance sheet there is additional paid in capital of $950,000 and retained earnings of $1,450,000. If the firm declares a 4-for-1 stock split, what is the stock's market value after the split? Assume there are no taxes or transaction costs.

        A)        $3.75

        B)        $5.00

        C)        $7.50

        D)        $10.00

        E)        $12.50

        19.   In a world with significant transactions costs, investors will generally prefer low-dividend stocks to high-dividend stocks, all else equal.

        A)    True

        B)    False

        20.   Even once it is declared, a common stock dividend does not become a legal financial obligation of the firm.

        A)    True

        B)    False

Answer Key

        1.     B     

        2.     B     

        3.     B     

        4.     B     

        5.     E     

        6.     B     

        7.     C    

        8.     B     

        9.     A    

        10.   B     

        11.   A    

        12.   A    

        13.   C    

        14.   C    

        15.   C    

        16.   E     

        17.   E     

        18.   A    

        19.   A