Ch. 16: Payout Policy Flashcards
Following the MM proposition, in a theoretical world with perfect capital markets, the payout policy (to pay dividends or repurchasing stocks) is important
True/False
False:
Following the MM proposition, in a theoretical world with perfect capital markets, the payout policy does not matter - i.e., it makes no difference whether surplus cash is paid out as dividend or spent on repurchase
In the real world (imperfect markets) whether to payout surplus cash as dividends or spend them on stock repurchase can be important due to (select all correct)
A) The information content of dividends and repurchases being different
B) Cash dividends and share repurchases are typically taxed differently
C) The type of payout is unimportant as long as they do not affect cashflows
A) The information content of dividends and repurchases being different
B) Cash dividends and share repurchases are typically taxed differently
When deciding whether cash is indeed surplus, the financial manager must be able to answer affirmative to three questions. Which?
1) Investment decision: are all real investments with positive NPVs accepted? If not, the cash is not surplus
2) Capital structure: is the firm’s debt ratio prudent and manageable? If not, FCF is better used to pay down debt
3) Rainy day money: are the company’s holdings of cash a sufficient cushion for unexpected setbacks and sufficient war chest for unexpected opportunities
Paying out surplus cash may send a positive signal to market because?
Is assures shareholders that cash is not wasted on unnecessary overinvestment, excessive perks, and excessive compensation
There are three types of dividends - which?
1) regular periodic (e.g., quarterly cash dividend
2) extra/ special/ unexpected dividend
3) stock dividend: not cash, but stock
Which of the following are types of stock repurchases?
A) Tender offer
B) Dutch Auction
C) Direct negotiation with major shareholders
D) Open market transaction
D) A + B + C
E) C + B + D
F) A+B+C+D
F) A+B+C+D
A firm states a series of prices at which it is prepared to repurchase stock. Shareholders then submit offers declaring how many shares they wish to sell at each price, and the company calculates the lowest price at which it can buy the desired number of shares.
This is a form of stock repurchase termed ______
Dutch auction
When the firm offers to buy back a stated number of shares at a fixed price, which is typically set to be 20% above the current market level, this is a form of stock repurchase termed _____
Tender offer
Generally, the announcement of an increase in dividends signals managers’ confidence in future profits (the information content of dividends) and is interpreted by investors as good news and the stock price increases. Thus, as a dividend is decrease, it sends an adverse signal to the market.
True/ False
True
Stock repurchases typically happen after special events that are not expected to be recurring
True/ False
True
Generally, a company announcing a share repurchase is not (necessarily) making a long-term commitment to repurchase in later years
True/ False
True
Generally, the information content of a share repurchase announcement is more strongly positive than the announcement of a dividend increase
True/ False
False:
Generally, the information content of a share repurchase announcement is less strongly positive than the announcement of a dividend increase
In perfect capital markets the choice between dividends and share repurchases has no effect on the market value of the firm
True/ False
True
In perfect capital markets increased dividend payments financed by issuing stocks has no effect on the market value of the firm (holding the firm’s assets, investments, and borrowing policy fixed)
True/ False
True
If you believe that pay-out policy matters, you simultaneously assume that the market deviates from perfection
True/ False
True
One of the assumptions of Modigliani and Miller is perfect capital markets. What does this entail?
1) No taxes
2) No transaction costs
3) No issuance costs
4) In general no market imperfections
Modigliani and Miller assumes that the capital budgeting decision is given - i.e., that the lhs (asset) side of the B/S is fixed
True/ False
True
Modigliani and Miller assumes that the financing decision is given - i.e., that the rhs (liability) side of the B/S is fixed - often we assume that firms are fully equity financed
True/ False
True
MM argues that dividend policy is value-irrelevant in perfect markets
True/ False
True
According to rightists, dividends are value-destroying
True/ False
False:
According to rightists, dividends are good and result in higher value
According to Rightists, investors prefer a large fraction of earnings to be paid out to shareholders as dividends: i.e., they prefer high dividend payout ratios. I.e., increased dividend payout ratios increases market value of stock
True/ False
True
Rightists have two arguments for advocating high pay-out ratios. Which?
1) Market imperfection: deviating from MM’s proposition 1 assumptions
2) Pay-out policy have impact on management incentives
Rightists argue for the existence of a natural clientele for high dividend pay-out stocks - i.e., some investors have a clear preference for dividend payments, incl. which?
A) financial institutions legally restricted from holding stocks lacking established dividend records
B) Trusts and endowment funds, because dividends are regarded as spendable income, giving rise to preference
C) Shareholders who are able to save on transaction costs and save considerable inconvenience in trading to meet liquidity needs
D) Pension funds
A) financial institutions legally restricted from holding stocks lacking established dividend records
B) Trusts and endowment funds, because dividends are regarded as spendable income, giving rise to preference
C) Shareholders who are able to save on transaction costs and save considerable inconvenience in trading to meet liquidity needs
The rightists challenges MM’s assumption of the asset side (capital budgeting) of the balance sheet being fixed/ given
True/ False
True
According to rightists, increase in dividend payout or share repurchase may lead to rise in stock price. Why?
Not because dividends are necessarily valuable in themselves, but because they signal a more careful, value-oriented investment policy with no money wasted on unwise spending/ investment
Which of the following statements is/ are not in coherence with the radical left school of thought?
A) If dividends are taxed more heavily than capital gains, firms should pay the lowest cash dividend they can get away with
B) Available cash should rather be spent on stock repurchase than dividend payments for tax-saving reasons
C) Increased dividend payments reduce market value of stock
D) In the US, the most obvious and serious market imperfection has been the different tax treatment of dividends and capital gains
E) taxes alone can explain the payout policy adopted by firms
False:
E) taxes alone can explain the payout policy adopted by firms
Assuming that the radical left are correct in their view, stocks with high dividend yields will have higher/lower market value of equity than stocks with low dividend yield
Assuming that the radical left are correct in their view, stocks with high dividend yields will have lower market value of equity than stocks with low dividend yield
Bc. shareholders prefer capital gains rather than dividends due to tax reasons
Assuming that the radical left are correct in their view, stocks with high dividend yields will have higher/lower pre-tax risk-adjusted rate of return
Assuming that the radical left are correct in their view, stocks with high dividend yields will have higher pre-tax risk-adjusted rate of return
Bc. shareholders will demand a higher premium from holding high dividend stocks, wherefore required rate of return for such stocks is higher
Assuming that the radical left are correct in their view, stocks with high dividend yields will have higher/lower pre-tax risk-adjusted rate of return
Assuming that the radical left are correct in their view, stocks with high dividend yields will have higher pre-tax risk-adjusted rate of return
Bc. shareholders will demand a higher premium from holding high dividend stocks, wherefore required rate of return for such stocks is higher
Assuming that the radical left are correct in their view, stocks with high dividend yields will have higher/lower/equal after-tax risk-adjusted rate of return
Assuming that the radical left are correct in their view, stocks with high dividend yields will have EQUAL after-tax risk-adjusted rate of return
After adjusting for tax, all else equal, the two stocks should be equivalent since it is assumed that taxes gives rise to preferences for one over the other
In young firms’ payout decisions, following statements are true (select all correct)
A) Young firms with plenty of profitable capital budgeting proposals and growth opportunities should retain and reinvest all operating cash flows
B) there is no point in paying out cash to investors if the firm has to replace the cash by borrowing or issuing new shares
C) retaining cash helps avoid costs of issuing securities and minimizes shareholders’ taxes
D) Investors are less worried about unnecessary overinvestment because growth opportunities are plenty
E) investments are financed as much as possible with internally generated CFs
All are true
The older and more mature the firm becomes, the more/less of cash is paid out as dividends or spent on repurchase rather than retained
The older and more mature the firm becomes, the MORE of cash is paid out as dividends or spent on repurchase rather than retained
Share repurchase is more/less flexible than dividends
MORE
Once a firm announces a regular cash dividend, investors expect the cash dividend to continue unless the firm encounters serious financial trouble. The same strong assumption is not the case for repurchases
Generally, the announcement of an increase in dividends leads to stock increase/ decrease in practice
Generally, the announcement of an increase in dividends leads to stock increase in practice
Note that this is opposite to the argument by radical left
Increased dividend pay-out ratios increase market value of stock. This is argued by:
A) Modigliani and Miller
B) Rightists
C) Radical left
B) Rightists
Increased dividend payments reduce market value of stock.
This is argued by:
A) Modigliani and Miller
B) Rightists
C) Radical left
C) Radical left
