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CHAPTER 17
DISTRIBUTIONS TO SHAREHOLDERS:
DIVIDENDS AND REPURCHASES
Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject lines.
True/False
Easy:
(17.3) Optimal distribution policy
1.
FR
Answer: a
EASY
The optimal distribution policy strikes that balance between current
dividends and capital gains that maximizes the firm’s stock price.
a. True
b. False
(17.3) Dividend irrelevance
2.
FR
Answer: b
EASY
The dividend irrelevance theory, proposed by Miller and Modigliani,
says that provided a firm pays at least some dividends, how much it
pays does not affect either its cost of capital or its stock price.
a. True
b. False
(17.3) Dividend irrelevance
3.
FR
Answer: b
EASY
MM's dividend irrelevance theory says that while dividend policy does
not affect a firm's value, it can affect the cost of capital.
a. True
b. False
(17.3) Investors’ dividend preferences
4.
FR
Answer: a
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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EASY
(17.3) Dividends and stock prices
5.
FR
Answer: b
EASY
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.
a. True
b. False
(17.7) Residual distribution policy
6.
FR
Answer: a
EASY
If a firm adopts a residual distribution policy, distributions are
determined as a residual after funding the capital budget. Therefore,
the better the firm's investment opportunities, the lower its payout
ratio should be.
a. True
b. False
(17.13) Stock dividends and splits
7.
FR
Answer: a
EASY
Stock dividends and stock splits should, at least conceptually, have
the same effect on shareholders’ wealth.
a. True
b. False
(17.33) Reverse split
8.
FR
Answer: a
EASY
A reverse split reduces the number of shares outstanding.
a. True
b. False
Medium:
(17.3) Dividend irrelevance
9.
FR
Answer: a
MEDIUM
Underlying the dividend irrelevance theory proposed by Miller and
Modigliani is their argument that the value of the firm is determined
only by its basic earning power and its business risk.
a. True
b. False
(17.3) Dividend-growth tradeoff
10.
FR
Answer: a
MEDIUM
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.
a. True
b. False
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(17.5) Signaling hypothesis
11.
FR
Answer: a
MEDIUM
If the information content, or signaling, hypothesis is correct, then
changes in dividend policy can have an important effect on the firm’s
value and capital costs.
a. True
b. False
(17.7) Residual distribution policy
12.
FR
Answer: b
MEDIUM
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 distribution policy.
a. True
b. False
(17.7) WACC and dividend policy
13.
FR
If the shape of the curve depicting a firm's WACC
is more like a sharp "V", as opposed to a shallow
easier for the firm to maintain a steady dividend
varying investment opportunities or earnings from
Answer: b
MEDIUM
versus its debt ratio
"U", it will be
in the face of
year to year.
a. True
b. False
(17.13) Stock splits
14.
FR
Answer: a
MEDIUM
Even if a stock split has no information content, and even if the
dividend per share adjusted for the split is not increased, there can
still be a real benefit (i.e., a higher value for shareholders) from
such a split, but any such benefit is probably small.
a. True
b. False
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Multiple Choice: Conceptual
Easy:
(17.6) Dividend payout
15.
CR
Answer: a
EASY
In the real world, dividends
a.
b.
c.
d.
are usually more stable than earnings.
fluctuate more widely than earnings.
tend to be a lower percentage of earnings for mature firms.
are usually changed every year to reflect earnings changes, and
these changes are randomly higher or lower, depending on whether
earnings increased or decreased.
e. are usually set as a fixed percentage of earnings, e.g., at 40% of
earnings, so if EPS = $2.00, then DPS will equal $0.80. Once the
percentage is set, then dividend policy is on “automatic pilot” and
the actual dividend depends strictly on earnings.
(17.13) Stock splits
16.
CR
Answer: a
EASY
Poff Industries’ stock currently sells for $120 a share. You own 100
shares of the stock. The company is contemplating a 2-for-1 stock
split. Which of the following best describes what your position will
be after such a split takes place?
a. You will have 200 shares of stock, and the stock will trade at or
near $60 a share.
b. You will have 100 shares of stock, and the stock will trade at or
near $60 a share.
c. You will have 50 shares of stock, and the stock will trade at or
near $120 a share.
d. You will have 50 shares of stock, and the stock will trade at or
near $60 a share.
e. You will have 200 shares of stock, and the stock will trade at or
near $120 a share.
Medium:
(17.3) Dividends versus capital gains
17.
CR
Answer: c
MEDIUM
Myron Gordon and John Lintner believe that the required return on
equity increases as the dividend payout ratio is decreased. Their
argument is based on the assumption that
a. investors require that the dividend yield and capital gains yield
equal a constant.
b. capital gains are taxed at a higher rate than dividends.
c. investors view dividends as being less risky than potential future
capital gains.
d. investors value a dollar of expected capital gains more highly than
a dollar of expected dividends because of the lower tax rate on
capital gains.
e. a. investors are indifferent between dividends and capital gains.
(17.3) Optimal dividend policy
CR
Answer: c
MEDIUM
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18.
Which of the following should NOT influence a firm’s dividend policy
decision?
a. A strong preference by most shareholders for current cash income
versus capital gains.
b. Constraints imposed by the firm’s bond indenture.
c. The fact that much of the firm’s equipment has been leased rather
than bought and owned.
d. The fact that Congress is considering changes in the tax law
regarding the taxation of dividends versus capital gains.
e. The firm’s ability to accelerate or delay investment projects.
(17.5) Dividend theories
19.
CR
Answer: d
MEDIUM
Which of the following statements about dividend policies is CORRECT?
a. One reason that companies tend to avoid stock repurchases is that
dividend payments are taxed at a lower rate than gains on stock
repurchases.
b. One advantage of dividend reinvestment plans is that they allow
shareholders to avoid paying taxes on the dividends that they choose
to reinvest.
c. One key advantage of a residual dividend policy is that it enables a
company to follow a stable dividend policy.
d. The clientele effect suggests that companies should follow a stable
dividend policy.
e. 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.
(17.7) Dividend payout
20.
CR
Answer: b
MEDIUM
Which of the following would be most likely to lead to a decrease in a
firm’s dividend payout ratio?
a. Its access to the capital markets increases.
b. Its R&D efforts pay off, and it now has more high-return investment
opportunities.
c. Its accounts receivable decrease due to a change in its credit
policy.
c. Its stock price has increased over the last year by a greater
percentage than the increase in the broad stock market averages.
e. Its earnings become more stable.
(17.7) Residual dividend policy
21.
CR
Answer: e
MEDIUM
Reynolds Paper Products Corporation follows a strict residual dividend
policy. 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 company increases the percentage of equity in its target capital
structure.
b. The number of profitable potential projects increases.
c. Congress lowers the tax rate on capital gains. The remainder of the
tax code is not changed.
d. Earnings are unchanged, but the firm issues new shares of common
stock.
e. The firm’s net income increases.
(17.8) Residual dividend policy
22.
CR
Answer: a
MEDIUM
If a firm adheres strictly to the residual dividend policy, then if its
optimal capital budget requires the use of all earnings for a given
year (along with new debt according to the optimal debt/total assets
ratio), then the firm should pay
a. no dividends to common stockholders.
b. dividends only out of funds raised by the sale of new common stock.
c. dividends only out of funds raised by borrowing money (i.e., issue
debt).
d. dividends only out of funds raised by selling off fixed assets.
e. no dividends except out of past retained earnings.
(17.8) Residual dividend policy
23.
Answer: b
MEDIUM
If a firm adheres strictly to the residual dividend policy, the
issuance of new common stock would suggest that
a.
b.
c.
d.
e.
the dividend payout ratio is increasing.
no dividends were paid during the year.
the dividend payout ratio is decreasing.
the dollar amount of investments has decreased.
the dividend payout ratio has remained constant.
(17.10) Stock repurchases and DRIPs
24.
CR
CR
Answer: b
MEDIUM
Which of the following statements is CORRECT?
a. One advantage of dividend reinvestment plans is that they enable
investors to postpone paying taxes on the dividends credited to
their account.
b. Stock repurchases can be used by a firm that wants to increase its
debt ratio.
c. 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.
d. One advantage of an open market dividend reinvestment plan is that
it provides new equity capital and increases the shares outstanding.
e. One disadvantage of dividend reinvestment plans is that they
increase transactions costs for investors who want to increase their
ownership in the company.
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(17.10) Dividends, DRIPs, and repurchases
25.
CR
Answer: c
MEDIUM
Which of the following statements is CORRECT?
a. One nice feature of dividend reinvestment plans (DRIPs) is that they
reduce the taxes investors would have to pay if they received cash
dividends.
b. Empirical research indicates that, in general, companies send a
negative signal to the marketplace when they announce an increase in
the dividend, and as a result share prices fall when dividend
increases are announced. The reason is that investors interpret the
increase as a signal that the firm has relatively few good
investment opportunities.
c. If a company wants to raise new equity capital rather steadily over
time, a new stock dividend reinvestment plan would make sense.
However, if the firm does not want or need new equity, then an open
market purchase dividend reinvestment plan would probably make more
sense.
d. Dividend reinvestment plans have not caught on in most industries,
and today about 99% of all companies with DRIPs are utilities.
e. Under the tax laws as they existed in 2008, a dollar received for
repurchased stock must be taxed at the same rate as a dollar
received as dividends.
(17.10) Dividend policy and stock repurchases
26.
CR
Answer: c
MEDIUM
Which of the following statements is CORRECT?
a. If a company uses the residual dividend model to determine its
dividend payments, dividends payout will tend to increase whenever
its profitable investment opportunities increase.
b. The stronger management thinks the clientele effect is, the more likely
the firm is to adopt a strict version of the residual dividend model.
c. Large stock repurchases financed by debt tend to increase earnings
per share, but they also increase the firm’s financial risk.
d. A dollar paid out to repurchase stock is taxed at the same rate as a
dollar paid out in dividends. Thus, both companies and investors
are indifferent between distributing cash through dividends and
stock repurchase programs.
e. The tax code encourages companies to pay dividends rather than
retain earnings.
(17.10) Miscellaneous dividend concepts
27.
CR
Answer: b
MEDIUM
Which of the following statements is CORRECT?
a. Capital gains earned in a share repurchase are taxed less favorably
than dividends; this explains why companies typically pay dividends
and avoid share repurchases.
b. Very often, a company’s stock price will rise when it announces that
it plans to commence a share repurchase program. Such an
announcement could lead to a stock price decline, but this does not
normally happen.
c. Stock repurchases increase the number of outstanding shares.
d. The clientele effect is the best explanation for why companies tend
to vary their dividend payments from quarter to quarter.
e. If a company has a 2-for-1 stock split, its stock price should
roughly double.
(17.12) Dividend theory
28.
CR
Answer: d
MEDIUM
Which of the following statements is CORRECT?
a. One advantage of the residual dividend policy is that it leads to a
stable dividend payout, which investors like.
b. An increase in the stock price when a company decreases its dividend
is consistent with signaling theory as postulated by MM.
c. If the “clientele effect” is correct, then for a company whose
earnings fluctuate, a policy of paying a constant percentage of net
income will probably maximize the stock price.
d. Stock repurchases make the most sense at times when a company
believes its stock is undervalued.
e. Firms with a lot of good investment opportunities and a relatively
small amount of cash tend to have above average payout ratios.
(17.12) Dividend policy
29.
CR
Answer: a
MEDIUM
Which of the following statements is CORRECT?
a. If a company has an established clientele of investors who prefer a
high dividend payout, and if management wants to keep stockholders
happy, it should not follow the strict residual dividend policy.
b. If a firm follows a strict residual dividend policy, then, holding
all else constant, its dividend payout ratio will tend to rise
whenever the firm’s investment opportunities improve.
c. If Congress eliminates taxes on capital gains but leaves the
personal tax rate on dividends unchanged, this would motivate
companies to increase their dividend payout ratios.
d. Despite its drawbacks, following the residual dividend policy will
tend to stabilize actual cash dividends, and this will make it
easier for firms to attract a clientele that prefers high dividends,
such as retirees.
e. One advantage of dividend reinvestment plans is that they enable
investors to avoid paying taxes on the dividends they receive.
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(17.12) Miscellaneous dividend concepts
30.
CR
Answer: a
MEDIUM
Consider two very different firms, M and N. Firm M is a mature firm in
a mature industry. Its annual net income and net cash flows are both
consistently high and stable. However, M’s growth prospects are quite
limited, so its capital budget is small relative to its net income.
Firm N is a relatively new firm in a new and growing industry. Its
markets and products have not stabilized, so its annual operating
income fluctuates considerably. However, N has substantial growth
opportunities, and its capital budget is expected to be large relative
to its net income for the foreseeable future. Which of the following
statements is CORRECT?
a. Firm M probably has a higher dividend payout ratio than Firm N.
b. If the corporate tax rate increases, the debt ratio of both firms is
likely to decline.
c. The two firms are equally likely to pay high dividends.
d. Firm N is likely to have a clientele of shareholders who want to
receive consistent, stable dividend income.
e. Firm M probably has a lower debt ratio than Firm N.
(17.13) Stock dividends and stock splits
31.
CR
Answer: d
MEDIUM
Which of the following statements is CORRECT?
a. 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.
b. 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.
c. 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.
d. 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. Moreover, if
the price is relatively low—say $2 per share—then it can declare a
“reverse split” of say 1-for-25 so as to bring the price up to
somewhere around $50 per share.
e. 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.
(Comp: 17.9-17.13) Miscellaneous dividend concepts CR
32.
Answer: e
MEDIUM
Which of the following statements is CORRECT?
a. 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.
b. Stock repurchases tend to reduce financial leverage.
c. If a company declares a 2-for-1 stock split, its stock price should
roughly double.
d. One advantage of adopting the residual dividend policy is that this
makes it easier for corporations to meet the requirements of
Modigliani and Miller’s dividend clientele theory.
e. 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.
(Comp: 17.9-17.14) Miscellaneous dividend concepts CR
33.
Answer: d
Which of the following actions will best enable a company to raise
additional equity capital?
a.
b.
c.
d.
e.
Declare a stock split.
Begin an open-market purchase dividend reinvestment plan.
Initiate a stock repurchase program.
Begin a new-stock dividend reinvestment plan.
Refund long-term debt with lower cost short-term debt.
(Comp: 17.13,17.14) Stock repurchases and stock splits CRAnswer: d
34.
MEDIUM
MEDIUM
Which of the following statements is NOT CORRECT?
a. After a 3-for-1 stock split, a company’s price per share should
fall, but the number of shares outstanding will rise.
b. Investors can interpret a stock repurchase program as a signal that
the firm’s managers believe the stock is undervalued.
c. Companies can repurchase shares to distribute large inflows of cash,
say from the sale of a division, to stockholders without paying cash
dividends.
d. Stockholders pay no income tax on dividends if the dividends are
used to purchase stock through a dividend reinvestment plan.
e. Stock repurchases can be used by a firm as part of a plan to change
its capital structure.
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Medium/Hard:
(17.12) Dividend policy
35.
CR
Answer: e MEDIUM/HARD
Which of the following statements is CORRECT?
a. The clientele effect can explain why so many firms change their
dividend policies so often.
b. 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.
c. 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.
d. Investors who receive stock dividends must pay taxes on the value of
the new shares in the year the stock dividends are received.
e. 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.
Multiple Choice: Problems
Note to Professors: Most of these problems may be changed algorithmically.
Those that cannot are labeled nonalgorithmic. With some combinations of
variables, the residual policy may result in zero dividends and a zero payout
ratio. When this possibility exists, we so indicate. With other similar
problems, we set the algorithmic constraints so that there will always be a
positive dividend.
Easy:
36.
(17.7) Residual model-divs paid, divs always positive
Answer: e EASY
CR
The projected capital budget of Kandell Corporation is $1,000,000, its
target capital structure is 60% debt and 40% equity, and its forecasted
net income is $550,000. If the company follows a residual dividend
policy, what total dividends, if any, will it pay out?
a.
b.
c.
d.
e.
$122,176
$128,606
$135,375
$142,500
$150,000
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to a publicly accessible website, in whole or in part.
Chapter 17: Dividends
Problems
Page 505
37.
(17.7) Residual dividend model--dividend payout ratio
Answer: d EASY
CR
Grandin Inc. is evaluating its dividend policy. It has a capital budget
of $625,000, and it wants to maintain a target capital structure of 60%
debt and 40% equity. The company forecasts a net income of $475,000.
If it follows the residual dividend policy, what is its forecasted
dividend payout ratio?
a.
b.
c.
d.
e.
40.61%
42.75%
45.00%
47.37%
49.74%
(17.7) Residual dividend policy—nonalgorithmic
38.
Answer: a
EASY
The capital budget of Creative Ventures Inc. is $1,000,000. The
company wants to maintain a target capital structure that is 30% debt
and 70% equity. The company forecasts that its net income this year
will be $800,000. If the company follows a residual dividend policy,
what will be its total dividend payment?
a.
b.
c.
d.
e.
$100,000
$200,000
$300,000
$400,000
$500,000
(17.7) Residual dividend policy—nonalgorithmic
39.
CR
CR
Answer: c
EASY
Rohter Galeano Inc. is considering how to set its dividend policy. It
has a capital budget of $3,000,000. The company wants to maintain a
target capital structure that is 15% debt and 85% equity. The company
forecasts that its net income this year will be $3,500,000. If the
company follows a residual dividend policy, what will be its total
dividend payment?
a.
b.
c.
d.
e.
$205,000
$500,000
$950,000
$2,550,000
$3,050,000
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to a publicly accessible website, in whole or in part.
Page 506
Problems
Chapter 17: Dividends
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(17.7) Residual dividend policy—nonalgorithmic
40.
EASY
$100,000
$200,000
$300,000
$400,000
$500,000
(17.13) Stock splits--fractional splits
CR
Answer: c
EASY
Yesterday, Berryman Investments was selling for $90 per share. Today,
the company completed a 7-for-2 stock split. If the total market value
was unchanged by the split, what is the price of the stock today?
a.
b.
c.
d.
e.
$23.21
$24.43
$25.71
$27.00
$28.35
(17.13) Stock splits--simple splits
42.
Answer: e
Sanchez Company has planned capital expenditures that total $2,000,000.
The company wants to maintain a target capital structure that is 35%
debt and 65% equity. The company forecasts that its net income this
year will be $1,800,000. If the company follows a residual dividend
policy, what will be its total dividend payment?
a.
b.
c.
d.
e.
41.
CR
CR
Answer: a
EASY
Last week, Weschler Paint Corp. completed a 3-for-1 stock split.
Immediately prior to the split, its stock sold for $150 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?
a.
b.
c.
d.
e.
$50.00
$52.50
$55.13
$57.88
$60.78
Easy/Medium:
43.
(17.7) Residual dividend model--find net income
Answer: b EASY/MEDIUM
CR
McCann Publishing has a target capital structure of 35% debt and 65%
equity. This year’s capital budget is $850,000 and it wants to pay a
dividend of $400,000. If the company follows a residual dividend
policy, 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?
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to a publicly accessible website, in whole or in part.
Chapter 17: Dividends
Problems
Page 507
a.
b.
c.
d.
e.
$904,875
$952,500
$1,000,125
$1,050,131
$1,102,638
(17.7) Residual div. model--find net income CR
44.
Answer: b
EASY/MEDIUM
Harvey’s Industrial Plumbing Supply’s target capital structure consists
of 40% debt and 60% equity. Its capital budget this year is forecast to
be $650,000. It also wants to pay a dividend of $225,000. If the
company follows the residual dividend policy, how much net income must
it earn to meet its capital requirements, pay the dividend, and keep the
capital structure in balance?
a.
b.
c.
d.
e.
$584,250
$615,000
$645,750
$678,038
$711,939
Medium:
(17.7) Residual model--divs paid, divs are zero
45.
Answer: e
MEDIUM
Victor Rumsfeld Inc.’s dividend policy is under review by its board. Its
projected capital budget is $2,000,000, its target capital structure is
60% debt and 40% equity, and its forecasted net income is $600,000. If
the company follows a residual dividend policy, what total dividends, if
any, will it pay out?
a.
b.
c.
d.
e.
$240,000
$228,000
$216,600
$205,770
$0
(17.7) Resid. model--find NI, divs and payout CR
46.
CR
Answer: a
MEDIUM
The capital budget forecast for the Santano Company is $725,000. The
CFO wants to maintain a target capital structure of 45% debt and 55%
equity, and it also wants to pay dividends of $500,000. If the company
follows the residual dividend policy, how much income must it earn, and
what will its dividend payout ratio be?
a.
b.
c.
d.
e.
Net Income
$898,750
$943,688
$990,872
$1,040,415
$1,092,436
Payout
55.63%
58.41%
61.34%
64.40%
67.62%
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to a publicly accessible website, in whole or in part.
Page 508
Problems
Chapter 17: Dividends
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(17.7) Residual dividend policy
47.
Answer: d
$673,652
$709,107
$746,429
$785,714
$825,000
(17.7) Residual dividend policy
CR
Answer: d
MEDIUM
Silvana Inc. projects the following data for the coming year. If the
firm follows the residual dividend policy and also maintains its target
capital structure, what will its payout ratio be?
EBIT
Interest rate
Debt outstanding
Shares outstanding
a.
b.
c.
d.
e.
$2,000,000
10%
$5,000,000
$5,000,000
Capital budget
% Debt
% Equity
Tax rate
$850,000
40%
60%
40%
37.2%
39.1%
41.2%
43.3%
45.5%
(17.7) Residual div. policy; dividend may be zero CR
49.
MEDIUM
United Builders wants to maintain a target capital structure with 30%
debt and 70% equity. Its forecasted net income is $550,000, and because
of market conditions, the company will not issue any new stock during
the coming year. If the firm follows the residual dividend policy, what
is the maximum capital budget that is consistent with maintaining the
target capital structure?
a.
b.
c.
d.
e.
48.
CR
Answer: d
MEDIUM
David Rose Inc. forecasts a capital budget of $500,000 next year with
forecasted net income of $400,000. The company wants to maintain a
target capital structure of 30% debt and 70% equity. If the company
follows the residual dividend policy, how much in dividends, if any,
will it pay?
a.
b.
c.
d.
e.
$42,869
$45,125
$47,500
$50,000
$52,500
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to a publicly accessible website, in whole or in part.
Chapter 17: Dividends
Problems
Page 509
(17.13) Stock splits--reverse split
50.
CR
47.50
49.88
50.00
52.50
55.13
(17.13) Stock splits--optimal stock split
CR
Answer: c
MEDIUM
Brinkley Resources stock has has increased significantly over the last
five years, selling now for $175 per share. Management feels this price
is too high for the average investor and wants to get the price down to
a more typical level, which it thinks is $25 per share. What stock
split would be required to get to this price, assuming the transaction
has no effect on the total market value? Put another way, how many new
shares should be given per one old share?
a.
b.
c.
d.
e.
6.65
6.98
7.00
7.35
7.72
(17.13) Stock splits--positive market reaction
52.
MEDIUM
In recent years Constable Inc. has suffered losses, and its stock
currently sells for only $0.50 per share. Management wants to use a
reverse split to get the price up to a more "reasonable" level, which it
thinks is $25 per share. How many of the old shares must be given up
for one new share to achieve the $25 price, assuming this transaction
has no effect on total market value?
a.
b.
c.
d.
e.
51.
Answer: c
CR
Answer: c
MEDIUM
Downie Foods recently completed a 4-for-1 stock split. Prior to the
split, its stock sold for $120 per share. If the firm's total market
value increased by 5% as a result of increased liquidity caused by the
split, what was the stock price following the split?
a.
b.
c.
d.
e.
$28.43
$29.93
$31.50
$33.08
$34.73
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Page 510
Problems
Chapter 17: Dividends
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Medium/Hard:
53.
(17.7) Residual dividend model--req'd debt ratio
Answer: e
MEDIUM/HARD
CR
Warren Supply Inc. is evaluating its capital budget. The company
finances with debt and common equity, but because of market conditions,
wants to avoid issuing any new common stock during the coming year. It
is forecasting an EPS of $3.00 for the coming year on its 500,000
outstanding shares of stock. Its capital budget is forecasted at
$800,000, and it is committed to maintaining a $2.00 dividend per share.
Given these constraints, what percentage of the capital budget must be
financed with debt?
a.
b.
c.
d.
e.
30.54%
32.15%
33.84%
35.63%
37.50%
(17.13) Stock splits--positive market reaction
54.
Answer: b
MEDIUM/HARD
The Meltzer Corporation is contemplating a 7-for-3 stock split. The
current stock price is $75.00 per share, and the firm believes that its
total market value would increase by 5% as a result of the improved
liquidity that it thinks would follow the split. What is the stock's
expected price following the split?
a.
b.
c.
d.
e.
55.
CR
$32.06
$33.75
$35.44
$37.21
$39.07
(17.7) Residual model--divs paid or stock issued
Answer: e
MEDIUM/HARD
CR
Getler Inc.’s projected capital budget is $2,000,000, its target capital
structure is 40% debt and 60% equity, and its forecasted net income is
$1,000,000. If the company follows a residual dividend policy, how much
dividends will it pay or, alternatively, how much new stock must it
issue?
a.
b.
c.
d.
e.
Dividends
$514,425
$541,500
$570,000
$600,000
$0
Stock Issued
$162,901
$171,475
$180,500
$190,000
$200,000
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Chapter 17: Dividends
Problems
Page 511
Hard:
(17.7) Residual model--divs paid or stock issued
56.
Answer: e
HARD
Norton Electrical has quite a few positive NPV projects from which to
choose. The problem is that it has more of these projects than it can
finance without issuing new stock and the board of directors refuses to
issue any new shares in the foreseeable future. Norton’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%. 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.
a.
b.
c.
d.
e.
57.
CR
Increase
Increase Debt
to 75%
$114.0
$120.0
$126.4
$133.0
$140.0
in Capital Budget
Lower Payout
to 20%
Do Both
$73.3
$333.9
$77.2
$351.5
$81.2
$370.0
$85.5
$389.5
$90.0
$410.0
(17.10) Dividends and intrinsic stock price
CR
Answer: c
The following data apply to Garber Industries, Inc. (GII):
Value of operations
Short-term investments
Debt
Number of shares
HARD
$1,000
$100
$300
100
The company plans on distributing $50 million as dividend payments. What
will the intrinsic per share stock price be immediately after the
distribution?
a.
b.
c.
d.
e.
$6.32
$6.65
$7.00
$7.35
$7.72
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Problems
Chapter 17: Dividends
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58.
(17.10) Repurchases and intrinsic stock price
CR
Answer: b
The following data apply to Elizabeth’s Electrical Equipment:
Value of operations
Short-term investments
Debt
Number of shares
HARD
$20,000
$1,000
$6,000
300
The company plans on distributing $50 million by repurchasing stock.
What will the intrinsic per share stock price be immediately after the
repurchase?
a.
b.
c.
d.
e.
$47.50
$50.00
$52.50
$55.13
$57.88
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Chapter 17: Dividends
Problems
Page 513
CHAPTER 17
ANSWERS AND SOLUTIONS
1.
(17.3) Optimal distribution policy
FR
Answer: a
EASY
2.
(17.3) Dividend irrelevance
FR
Answer: b
EASY
3.
(17.3) Dividend irrelevance
FR
Answer: b
EASY
4.
(17.3) Investors’ dividend preferences
FR
Answer: a
EASY
5.
(17.3) Dividends and stock prices
FR
Answer: b
EASY
6.
(17.7) Residual distribution policy
FR
Answer: a
EASY
7.
(17.13) Stock dividends and splits
FR
Answer: a
EASY
8.
(17.13) Reverse split
FR
Answer: a
EASY
9.
(17.3) Dividend irrelevance
FR
Answer: a
MEDIUM
10.
(17.3) Dividend-growth tradeoff
FR
Answer: a
MEDIUM
11.
(17.5) Signaling hypothesis
FR
Answer: a
MEDIUM
12.
(17.7) Residual distribution policy
FR
Answer: b
MEDIUM
13.
(17.7) WACC and dividend policy
FR
Answer: b
MEDIUM
14.
(17.13) Stock splits
FR
Answer: a
MEDIUM
15.
(17.6) Dividend payout
CR
Answer: a
EASY
16.
(17.13) Stock splits
CR
Answer: a
EASY
17.
(17.3) Dividends versus capital gains
CR
Answer: c
MEDIUM
18.
(17.3) Optimal dividend policy
CR
Answer: c
MEDIUM
19.
(17.5) Dividend theories
CR
Answer: d
MEDIUM
20.
(17.7) Dividend payout
CR
Answer: b
MEDIUM
21.
(17.7) Residual dividend policy
CR
Answer: e
MEDIUM
22.
(17.8) Residual dividend policy
CR
Answer: a
MEDIUM
23.
(17.8) Residual dividend policy
CR
Answer: b
MEDIUM
24.
(17.10) Stock repurchases and DRIPs
CR
Answer: b
MEDIUM
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25.
(17.10) Dividends, DRIPs, and repurchases
CR
Answer: c
26.
(17.10) Dividend policy and stock repurchases
27.
(17.10) Miscellaneous dividend concepts
CR
Answer: b
MEDIUM
28.
(17.12) Dividend theory
CR
Answer: d
MEDIUM
29.
(17.12) Dividend policy
CR
Answer: a
MEDIUM
30.
(17.12) Miscellaneous dividend concepts
CR
Answer: a
MEDIUM
31.
(17.13) Stock dividends and stock splits
CR
Answer: d
MEDIUM
32.
(Comp: 17.9-17.13) Miscellaneous dividend concepts CR
Answer: e
MEDIUM
33.
(Comp: 17.9-17.14) Miscellaneous dividend concepts
CR Answer: d
MEDIUM
34.
(Comp: 17.13,17.14) Stock repurchases and stock splits CRAnswer: d
MEDIUM
35.
(17.12) Dividend policy
36.
(17.7) Residual model-divs paid, divs always positive CR Answer: e
CR
CR
MEDIUM
Answer: c MEDIUM
Answer: e
MEDIUM/HARD
EASY
Capital budget
$1,000,000
% Equity
40%
Net income (NI)
$550,000
Dividends paid = NI – [% Equity(Capital budget)] $150,000
37.
(17.7) Residual dividend model--dividend payout ratio CR Answer: d
Capital budget
Equity ratio
Net income (NI)
Dividends paid = NI – (Equity ratio)(Capital budget)
Dividend payout ratio = Dividends paid/NI
38.
EASY
$625,000
40%
$475,000
$225,000
47.37%
(17.7) Residual dividend policy—nonalgorithmic
CR
Answer: a
EASY
Answer: c
EASY
The amount of new investment which must be financed with equity is:
$1,000,000  70% = $700,000.
Since the firm has $800,000 of net income only $100,000 will be left for dividends.
39.
(17.7) Residual dividend policy—nonalgorithmic
CR
The amount of new investment which must be financed with equity is:
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Chapter 17: Dividends
Answers
Page 515
$3,000,000  85% = $2,550,000.
Since the firm has $3,500,000 of net income, $950,000 = $3,500,000 – $2,550,000 will be left for dividends.
40.
(17.7) Residual dividend policy—nonalgorithmic
CR
Answer: e
EASY
The amount of new investment which must be financed with equity is:
$2,000,000  65% = $1,300,000.
Since the firm has $1,800,000 of net income only $500,000 = $1,800,000 – $1,300,000 will be left for dividends.
41.
(17.13) Stock splits--fractional splits
CR
Answer: c
EASY
CR
Answer: a
EASY
Number of new shares
7
Number of old shares
2
Old (pre-split) price
$90
New price = Old price × (Old shrs/New shrs) $25.71
42.
(17.13) Stock splits--simple splits
Number of new shares
Number of old shares
Pre-split stock price
Post-split stock price: P0/New per old =
43.
3
1
$150
$50.00
(17.7) Residual dividend model-find net income CR Answer: b
Capital budget
Equity ratio
Dividends to be paid
Required net income = Dividends + (Capital budget  % Equity)
44.
$850,000
65%
$400,000
$952,500
(17.7) Residual dividend model-find net income CR Answer: b
Capital budget
% Equity
Dividends to be paid
Required net income = Dividends + (Capital budget  % Equity)
45.
EASY/MEDIUM
$650,000
60%
$225,000
$615,000
(17.7) Residual model--divs paid, divs are zero
Answer: e
MEDIUM
(17.7) Residual model-find NI, then divs and payout CR Answer: a
MEDIUM
Capital budget
% Equity
Net income (NI)
Dividends paid = NI – [% Equity(Capital Budget)]
46.
EASY/MEDIUM
Capital budget
Equity ratio
CR
$2,000,000
40%
$600,000
$0
$725,000
55%
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Dividends paid
NI=Divs + (Eq % × Cap Bud)
Payout = Dividends/NI
47.
$500,000
$898,750
55.63%
(17.7) Residual dividend policy
CR
% Debt
% Equity
Net income
Max capital budget = NI/% Equity
Check: Is calculated max cap bud  %Equity = NI?
48.
30%
70%
$550,000
$785,714
$550,000
(17.7) Residual dividend policy
EBIT
Interest rate
Debt outstanding
Shares outstanding
$2,000,000
10%
$5,000,000
$5,000,000
Answer: d
Answer: d
Capital budget
% Debt
% Equity
Tax rate
$850,000
40%
60%
40%
$2,000,000
500,000
$1,500,000
600,000
$900,000
510,000
$390,000
43.33%
MEDIUM
30%
70%
$500,000
$400,000
$350,000
$50,000
(17.13) Stock splits--reverse split
CR
Current price
Target price
Old shares surrendered per 1 new share = Target price/Old price
51.
MEDIUM
(17.7) Residual dividend policy; dividend may be zero CRAnswer: d
% Debt
% Debt
Capital budget
Net income
Equity requirement = Cap Bud x % Equity =
Dividends = NI − Equity requirement =
50.
= net income
CR
EBIT
− Interest expense = interest rate × debt
Taxable income
− Taxes = Tax rate × income
Net income (NI)
− Equity needed for capital budget = % Equity(capital budget) =
Dividends = NI − Equity needed
Payout ratio = Dividends/NI
49.
MEDIUM
(17.13) Stock splits--optimal stock split
Current price
Target price
Answer: c
MEDIUM
Answer: c
MEDIUM
$0.50
$25.00
50.00
CR
$175.00
$25.00
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Chapter 17: Dividends
Answers
Page 517
No. of new shares per 1 old share = Current price/Target price
7.00
52.
(17.13) Stock splits--positive market reaction
CR
Answer: c
53.
New shares per 1 old share
4
Pre-split stock price
$120
% value increase
5%
Post-split stock price = (P0/New per old)(% Value increase)
$31.50
(17.7) Residual dividend model-req'd debt ratio CR Answer: e
MEDIUM
MEDIUM/HARD
EPS
$3.00
Shares outstanding
500,000
DPS
$2.00
Capital budget
$800,000
Net income = EPS × Shares outstanding =
$1,500,000
Dividends paid = DPS × Shares outstanding =
$1,000,000
Retained earnings available
$500,000
Capital budget − Retained earnings = Debt needed $300,000
Debt needed/Capital budget = % Debt financing
37.5%
54.
(17.13) Stock splits--positive market reaction
CR
Number of new shares
Number of old shares
Old (pre-split) price
% Increase in value
New price before value increase = Old price/(Old shares/New shares)
New price after value increase = Prior  (1 + % Value increase)
55.
Answer: b
MEDIUM/HARD
7
3
$75.00
5%
$32.14
$33.75
(17.7) Residual model-divs paid or stock issued CR Answer: e
$2,000,000
60%
$1,000,000
Dividends:
Dividends paid = NI − [% Equity(Cap. Bud)], stock issued if dividends zero or neg
$0
MEDIUM/HARD
Capital budget
% Equity
Net income (NI)
56.
(17.7) Residual model--divs paid or stock issued
Current
maximum
NI
$150.0
%Debt
25.0%
%Equity
75.0%
% Payout
65.0%
Dividends
$97.5
Retained earnings
$52.5
Max. capital budget = RE/%Equity
$70.0
Increase over current: Changed amt − Current max. NA
CR
or new stock:
$200,000
Answer: e
New Maximums:
If increase
If lower
debt
payout
$150.0
$150.0
75.0%
25.0%
25.0%
75.0%
65.0%
20.0%
$97.5
$30.0
$52.5
$120.0
$210.0
$160.0
$140.0
$90.0
HARD
If do
both
$150.0
75.0%
25.0%
20.0%
$30.0
$120.0
$480.0
$410.0
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57.
(17.10) Dividends and intrinsic stock price
Value of operations
Prior to
Distribution
$1,000.00
After
Distribution
$1,000.00
+ Value of nonoperating assets
Total intrinsic value of firm
100.00
$1,100.00
0.00
$1,000.00
− Debt
Intrinsic value of equity
300.00
$800.00
300.00
$700.00
÷ Number of shares
100.00
$8.00
100.00
$7.00
Intrinsic price per share
58.
CR
(17.10) Repurchases and intrinsic stock price
CR
Value of operations
Prior to
Distribution
$20,000
After
Distribution
$20,000
+ Value of nonoperating assets
Total intrinsic value of firm
$1,000
$21,000
$0
$20,000
− Debt
Intrinsic value of equity
$6,000
$15,000
$6,000
$14,000
÷ Number of shares
300
$50.00
280
$50.00
Intrinsic price per share
# shares repurchased =
Value of nonoperating assets /
Price prior to distribution
Answer: c
HARD
Answer: b
HARD
$20.00
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Chapter 17: Dividends
Answers
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