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Exam 15: Distributions to Shareholders: Dividends and

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Question 31

True/False

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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

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Question 32

Multiple Choice

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Ross-Jordan Financial has suffered losses in recent years, 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) 47.50
B) 49.88
C) 50.00
D) 52.50
E) 55.13

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

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Question 33

Multiple Choice

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Mortal Inc. expects to have a capital budget of $500,000 next year. The company wants to maintain a target capital structure with 30% debt and 70% equity, and its forecasted net income is $400,000. If the company follows the residual dividend policy, how much in dividends, if any, will it pay?

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.

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.

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.

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.

Which of the following statements about dividend policies is CORRECT?

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.

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.

If a retired individual lives on his or her investment income, then it would make sense for this person to prefer stocks with high payouts so he or she could receive cash without going to the trouble and expense of selling stocks. On the other hand, it would make sense for an individual who would just reinvest any dividends received to prefer a low-payout company because that would save him or her taxes and brokerage costs.

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.

Which of the following statements is CORRECT?

Dentaltech 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?

If on January 2, 2008, a company declares a dividend of $1.50 per share, payable on January 31, 2008, 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.

Toombs Media Corp. recently completed a 3-for-1 stock split. Prior to the split, its stock sold for $90 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?

Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% 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.

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.

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 better the firm's investment opportunities, the lower its payout ratio will be, other things held constant.

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 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?