CH14 TB PAYOUT POLICY Flashcards
Payout policy refers to the decisions that firms make about whether to distribute cash to shareholders, how much cash to distribute, and by what means the cash should be distributed.
T or F?
TRUE
Rapidly growing firms pay high dividends to shareholders.
T or F?
FALSE
Dividends are the only means by which firms can distribute cash to shareholders.
T or F?
FALSE
Share repurchases
Companies can distribute cash to shareholders through dividends or share repurchases, but they rarely do both.
T or F?
FALSE
Because retained earnings are a form of internal financing, the dividend decision can significantly affect a firm’s external financing requirements.
T or F?
TRUE
In the aggregate, firms distribute far more cash to shareholders by paying dividends than they do by repurchasing shares.
T or F?
FALSE
In the U.S. over the last 40 years or so, in the aggregate ________.
A) the dollar volume of share repurchases has been growing faster than the volume of dividend payments
B) the dollar volume of dividend payments has been growing faster than the volume of share repurchases
C) the dollar volume of dividend payments and share repurchases have been growing at about the same pace
D) firms have been cutting back on share repurchase activities
A
In the aggregate, over time dividend payments tend to fluctuate more than share repurchases.
T or F?
FALSE
In the aggregate and over a long period of time ________.
A) earnings grow faster than dividends
B) earnings and dividends grow at a similar pace
C) earnings grow more slowly than dividends
D) dividend payments exceed earnings
B
When firms’ earnings fluctuate, they tend to adjust their payout policy by ________.
A) allowing dividends to fluctuate while holding share repurchases relatively steady
B) allowing share repurchases to fluctuate while holding dividends relatively steady
C) adjusted both dividends and share repurchases so the total payout as a percentage of earnings remains relatively steady
D) stop paying dividends and repurchasing shares
B
Over many years, share repurchases have accounted for an increasing percentage of the total cash paid out by firms to shareholders.
T or F?
TRUE
After a recession when the economy starts to expand again, firms tend to ________.
A) increase share repurchases faster than they increase dividends
B) increase dividends faster than they increase share repurchases
C) increase share repurchases and dividends at a similar rate
D) increase dividends and hold share repurchases constant until they are confident that the recovery will last for a few years
A
Holders of record are stockholders whose names are recorded on the date of record receive the declared dividend.
T or F?
TRUE
Purchasers of a stock selling ex dividend receive the current dividend.
T or F?
FALSE
The date of record (dividends) is the actual date on which a company will mail the dividend payment to the holders of record.
T or F?
FALSE
Date of payment
The dividend payment date is set by a firm’s board of directors and represents the actual date on which the firm mails the dividend payment to the holders of record.
T or F?
TRUE
The payment date is five days after the date of record, on which the company will mail the dividend payment to the holders of record.
T or F?
FALSE
The ex dividend period begins four business days prior to the payment date.
T or F?
FALSE
Two business days
The payment of cash dividends to corporate stockholders is decided based on the recommendation of the auditors.
T or F?
FALSE
The repurchase of common stock results in a type of reverse dilution, since the earnings per share increases as the number of shares outstanding falls.
T or F?
TRUE
The repurchase of shares reduces the number of outstanding shares.
T or F?
TRUE
In a tender offer share repurchase, a firm announces the price it is willing to pay to buy back shares and the quantity of shares it wishes to repurchase.
T or F?
TRUE
With the passage of the Tax Cuts and Jobs Act of 2017, dividends paid by corporations are not taxable at the shareholder level.
T or F?
FALSE
The Jobs and Growth Tax Relief Reconciliation Act of 2003 significantly reduced the double taxation of dividends.
T or F?
TRUE
By purchasing shares through a firm’s dividend reinvestment plan (or DRIP), shareholders typically can acquire shares at a value that is below the prevailing market price.
T or F?
TRUE
By purchasing shares through a firm’s dividend reinvestment plan (or DRIP), shareholders typically can acquire shares at a value that is above the prevailing market price.
T or F?
FALSE
lower
Dividend reinvestment plans (DRIPs) enable stockholders to use dividends received on a firm’s stock to acquire additional shares—even fractional shares—at little or no transaction (brokerage) cost.
T or F?
TRUE
In theory, when a stock begins to trade ex dividend, the price of the stock should drop by roughly the amount of the dividend.
T or F?
TRUE
When common stock is repurchased and retired, the underlying motive is to ________.
A) delay taxes
B) boost the stock’s dividends
C) distribute cash to the owners
D) reduce the retained earnings balance
C
Which of the following type of firms are most likely to pay cash dividends?
A) rapidly growing firms
B) firms encouraging innovation
C) large mature firms
D) firms expanding their operations
C
At a firm’s quarterly dividend meeting held April 9, the directors declared a $0.50 per share cash dividend for the holders of record on Monday, May 19. The firm’s stock will sell ex dividend on about ________.
A) April 11
B) April 9
C) May 19
D) May 17
D
The term ex dividend refers to ________.
A) a period beginning 2 business days prior to the date of record, during which a stock is sold without the right to receive the current dividend
B) the date on which all investors whose names are recorded as stockholders receive a declared dividend at a specified future time
C) a period beginning 7 business days prior to the date of record, during which a stock is sold without the right to receive the current dividend
D) the actual date on which a firm mails the dividend payment to the holders of record
A
The payment of cash dividends to corporate stockholders is decided by the ________.
A) creditors
B) stockholders
C) SEC
D) board of directors
D
In a(n) ________, a firm specifies a range of prices that it is willing to repurchase shares and the quantity of shares that it desires.
A) Dutch auction
B) tender offer
C) American option
D) self-tender offer
A
In a(n) ________, a firm announces the price it is willing to pay to buy back shares and the quantity of shares it wishes to repurchase.
A) Dutch auction
B) tender offer
C) American option
D) European auction
B
A tender offer repurchase is a repurchase program in which a firm ________.
A) offers to repurchase a fixed number of shares, usually at a discount relative to the market value
B) offers to repurchase a fixed number of shares, usually at a premium relative to the market value
C) offers to repurchase a fixed number of shares, usually at par relative to the market value
D) has a right to repurchase a fixed number of shares at a premium relative to the market value
B
Which of the following is a reason for a firm for repurchasing its shares?
A) to diminish the shareholder value by increasing the number of shares outstanding and thereby raising earnings per share
B) to help encourage a friendly takeover by increasing the number of publicly traded shares
C) to distribute cash to stockholders
D) to make shares available for cash dividends
C
The net effect of a stock repurchase is ________.
A) similar to an interest payment
B) similar to a cash dividend
C) similar to a stock split
D) similar to a reverse stock split
B
Which of the following is true of a dividend payout?
A) When a firm announces that it will increase its dividend, the share price usually decreases on that news.
B) Dividend payments send a positive signal to investors in the marketplace that management believes that the stock is overvalued.
C) When a stock begins to trade ex dividend the share price will fall.
D) When a stock begins to trade ex dividend there is no impact on the share price if the market. is efficient
C
Which of the following methods can be utilized by a firm when it wants to purchase outstanding shares of common stock?
A) a purchase of stock through private placement
B) a tender offer at varying prices
C) a tender offer at a specified price
D) an European auction plan
C
Repurchase of stock ________ the earnings per share and ________ the market price of stock.
A) increases; increases
B) decreases; decreases
C) increases; decreases
D) decreases; increases
A
In a Dutch auction, ________.
A) a firm offers to repurchase a fixed number of shares, at a discount
B) a firm offers to repurchase a fixed number of shares, at a premium
C) a firm specifies a range of prices at which it is willing to repurchase shares and the quantity of shares that it desires
D) a firm enables stockholders to use dividends received on the firm’s stock to acquire additional shares
C
Under the Jobs and Growth Tax Relief Reconciliation Act of 2003, the maximum rate of taxation on dividends received by shareholders was set at ________.
A) 18%
B) 20%
C) 25%
D) 15%
D
A dividend reinvestment plan enables stockholders to ________.
A) reinvest the dividends in money market instruments which are risk free
B) reinvest all dividends in the firm with no accompanying increase in equity
C) acquire additional dividends through redemption of stock
D) acquire shares at little or no transaction costs
D
The stock repurchase can be viewed as a cash dividend.
T or F?
TRUE
The residual theory of dividends suggests that the dividend paid by a firm should be viewed as a residual, the amount left over after all acceptable investment opportunities have been undertaken.
T or F?
TRUE
The residual theory of dividends implies that if a firm’s available retained earnings are in excess of its financing needs, it should distribute the earnings by paying dividends to stockholders.
T or F?
TRUE
The residual theory of dividends, as espoused by Modigliani and Miller, suggests that dividends represent an earnings residual rather than an active decision variable that affects firm value; this means that a firm’s decision to pay dividends or not will not have any impact on a firm’s share price.
T or F?
TRUE
The representative theory of dividends, as espoused by Modigliani and Miller, suggests that dividends represent a significant active decision variable that affects firm value.
T or F?
FALSE
The clientele effect is the argument that a firm attracts shareholders whose preferences with respect to the payment and stability of dividends corresponds to the payment pattern and stability of the firm itself.
T or F?
TRUE
According to Modigliani and Miller, a firm’s value is determined solely by the earning power and risk of its assets and that the manner in which it splits its earnings stream between dividends and internally retained funds does not affect this value.
T or F?
TRUE
Due to a clientele effect, Modigliani and Miller argue that shareholders with different dividend preferences align with firms with different dividend policies in such a way that the value of a firm’s stock is unaffected by dividend policy.
T or F?
TRUE
According to the bird-in-the-hand argument, current dividend payments reduce investor uncertainty and result in a higher value for a firm’s stock.
T or F?
TRUE
As per dividend relevance theory, current dividend payments are believed to reduce investor’s uncertainty, thereby—all else being equal—placing a lower value on a firm’s stock after its payment.
T or F?
FALSE
Dividend irrelevance theory—unaffected
The bird-in-the-hand argument espousing the importance of dividends or dividend relevance suggests that investors view current dividends as less risky than future dividends or capital gains.
T or F?
TRUE
The informational content of dividends refers to a link between dividend and future earnings. In other words, investors view a change in dividends, up or down, as a signal that management expects future earnings to change in the same direction.
T or F?
TRUE
Dividend payment policy is a form of ________.
A) capital budgeting policy
B) financing policy
C) working capital policy
D) dividend reinvestment policy
B
The residual theory of dividends suggests that ________.
A) different payout policies attract different types of investors but still do not change the value of a firm
B) dividends are irrelevant in determining the value of a firm
C) as long as a firm’s equity need exceeds the amount of retained earnings, no cash dividend is paid
D) the payout policies of different firms have no impact on the taxes that investors have to pay
C
According to the residual theory of dividends, if a firm’s equity need is less than the amount of retained earnings, the firm would ________.
A) borrow to pay the cash dividend
B) declare a dividend equal to the remaining balance
C) pay no cash dividends
D) pay dividends higher than the remaining balance to gain credibility
B
According to the residual theory of dividends, if a firm’s equity need exceeds the amount of retained earnings, the firm would ________.
A) borrow to pay the cash dividend
B) sell additional stock to pay the cash dividend
C) pay no cash dividends
D) pay less dividends
C
The clientele effect refers to ________.
A) the relevance of dividend policy on a firm’s share value
B) a firm’s ability to attract stockholders whose dividend preferences are similar to the firm’s dividend policy
C) the informational content of dividends that helps in predicting the future earnings and growth of a firm
D) the “bird-in-the-hand” argument
B
Modigliani and Miller suggest that the value of a firm is not affected by the firm’s dividend policy, due to ________.
A) the relevance of dividends
B) the clientele effect
C) the informational content
D) the optimal capital structure
B
Gordon and Lintner, recognizing that dividends affect stock prices, suggest that positive effects of dividend increases are attributable ________.
A) directly to the dividend policy
B) directly to the optimal capital structure
C) not to the informational content but to the consistency in the payment of dividends
D) to the informational content of the dividends with respect to future earnings
D
Gordon’s “bird-in-the-hand” argument suggests that ________.
A) dividends are irrelevant
B) firms should have a 100 percent payout policy
C) shareholders are risk averse and attach less risk to current dividends
D) the market value of a firm is unaffected by dividend policy
C
The information content of dividends refers to ________.
A) the nonpayment of dividends by corporations
B) dividend changes as indicators of a firm’s future
C) a stable and continuous dividend
D) a study of firm’s history of dividend payments
B
Which of the following is true of arguments for dividend relevance?
A) A firm’s value is determined solely by the earning power and risk of its assets.
B) Investors are generally risk averse and attach less risk to current dividends than future dividends or capital gains.
C) The value of a firm is unaffected as it functions in a perfect market.
D) A clientele effect exists which causes a firm’s shareholders to receive the dividends that they expect.
B
While an earnings requirement limiting the amount of dividends paid is sometimes imposed, a firm is not prohibited from paying more in dividends than its current earnings.
T or F?
TRUE
Since lenders are generally reluctant to grant loans to a firm to pay dividends, the firm’s ability to pay cash dividends is generally constrained by the amount of excess cash available.
T or F?
TRUE
In most states, legal capital is measured not only by the par value and paid-in capital in excess of par, but also by any accumulated retained earnings.
T or F?
FALSE
In most states, legal capital is measured either by the par value of common stock; other states, however, define legal capital to include not only the par value of the stock, but also any paid-in capital in excess of par.
T or F?
TRUE
If a firm has overdue liabilities or is legally insolvent or bankrupt, most states prohibit its payment of cash dividends.
T or F?
TRUE
Legal constraints prohibit the payment of cash dividends until a certain level of earnings has been achieved or limit the amount of dividends paid to a certain dollar amount or percentage of earnings.
T or F?
FALSE
The level of dividends a firm expects to pay is often directly related to how rapidly it expects to grow and expand its operations.
T or F?
TRUE
The level of dividends a firm expects to pay is generally unrelated to how rapidly it expects to grow as well as the level of asset investments required.
T or F?
FALSE
Because dividends are taxed at the same rate as capital gains under the 2003 Tax Act, a firm’s strategy of paying low or no dividends primarily offers tax advantages to wealthy stockholders through tax deferral.
T or F?
TRUE
In establishing a dividend policy, a firm should retain funds for investment in projects yielding higher returns than the owners could obtain from external investments of equal risk.
T or F?
TRUE
If a firm pays out a higher percentage of earnings, new equity capital will have to be raised with common stock, which will result in higher control and earnings for the existing owners.
T or F?
FALSE
Firms are usually prohibited by state law from distributing ________. A) retained earnings as dividends
B) paid-in capital in excess of par as dividends
C) dividends in a year the firm has a net loss
D) preferred dividends
T or F?
B
Legal capital refers to ________.
A) a legal constraint imposed by lenders of a firm to maintain a certain level of debt to equity ratio and capital
B) capital impairment restrictions are generally established to provide a sufficient equity base to protect creditors’ claims
C) the capital which is typically measured by the retained earnings
D) the capital which is typically measured by net income
B
An excess earnings accumulation tax is levied when ________.
A) shareholders receive dividends which exceed a firm’s earnings
B) firms do not pay dividends in order to delay the owners’ tax liability
C) firms do not pay dividends to reinvest in the firm
D) earnings exceed accumulated dividends over the years
B
The capital impairment restrictions are established to ________.
A) reduce dividends equal to or below the current earnings level
B) constrain the firm to paying dividends which do not require additional borrowing
C) provide sufficient safety to equity holders
D) provide a sufficient equity base to protect creditors’ claims
D
With regard to dividend payments, which of the following is included in the contractual constraints imposed by loan agreements?
A) limiting the payment to suppliers
B) limiting the percentage of earnings that can be paid out in dividends
C) sustaining a constant dividend payout ratio
D) making fixed payment to equityholders
B
Which of the following is considered in designing a dividend policy that is favorable to wealthy owners?
A) the tax status of the firm’s owners
B) the political risk of the firm
C) the liability of the firm’s owners
D) the reinvestment risk of the firm
A
A firm that has a large percentage of ________ investors may pay out a lower percentage of its earnings as dividends.
A) wealthy
B) domestic
C) middle-income
D) international
A
According to ________, investors’ demands for dividends fluctuate over time.
A) the catering theory
B) Modigliani and Miller theory
C) the residual theory of dividends
D) CAPM theory
A
According to the catering theory, firms cater to the preferences of ________.
A) investors
B) creditors
C) managers
D) government
A
A constant-payout-ratio dividend policy is based on the payment of a certain percentage of earnings to owners in each dividend period.
T or F?
TRUE
Regular dividend policy is a dividend policy based on the payment of a certain fixed percentage of earnings to owners in each dividend period.
T or F?
FALSE
Fixed dollar dividend
Regularly paying a fixed or increasing dividend reduces uncertainty about the frequency and magnitude of dividends.
T or F?
TRUE
By calling the additional dividend an extra dividend, a firm avoids setting expectations that the dividend increase will be permanent.
T or F?
TRUE
The dividend policy must be formulated considering two basic objectives, namely ________.
A) delaying the tax liability of the stockholder and information content
B) maximizing shareholder wealth and maintaining liquidity
C) maximizing shareholder wealth and providing for sufficient financing
D) maintaining liquidity and minimizing the weighted average cost of capital
C
A firm’s dividend payout ratio is calculated by ________.
A) dividing cash dividend per share by its earnings per share
B) dividing earnings per share by its cash dividend per share
C) dividing cash dividend per share by its net income
D) dividing net income by its cash dividend per share
A
Which type of dividend payment policy has the disadvantage that if a firm’s earnings drop or if a loss occurs in a given period, dividends may be low or nonexistent?
A) constant-payout-ratio policy
B) regular dividend policy
C) low-regular-and-extra dividend policy
D) stock dividend policy
A
The problem with a constant-payout-ratio dividend policy from the shareholders’ perspective is that ________.
A) it pays constant dividend irrespective of the earnings of a firm
B) if the firm’s earnings drop, the dividends tend to be lower
C) even when earnings are low, the company must pay a fixed dividend
D) there is no uniformity in this type of dividend policy
B
The problem with the regular dividend policy from a firm’s perspective is that ________.
A) it regularly pays dividends which fluctuate with earnings
B) if the firm’s earnings drop, the dividends may be low
C) even when earnings are low, the company must pay a fixed dividend
D) it increases the shareholders’ uncertainty
C
When a firm pays a stated dollar dividend and adjusts the payment as earnings increase, its dividend policy can be called ________.
A) a low-regular-and-extra dividend policy
B) a regular dividend policy
C) a target dividend-payout ratio policy
D) a constant-payout-ratio dividend policy
C
Which type of dividend payment policy has the advantage that if a firm’s earnings drop, dividends will still be maintained at a relatively constant level?
A) constant-payout-ratio policy
B) regular dividend policy
C) low-regular-and-extra dividend policy
D) target dividend policy
B
The advantage of using the extra dividend policy is that ________.
A) a firm can avoid giving false hopes to shareholders
B) if a firm’s earnings drop, so does the dividend payment
C) the extra dividend may become a regular event
D) cyclical shifts in earnings may be avoided
A
An advantage of a ________ is that it avoids giving shareholders false hopes.
A) constant-payout-ratio policy
B) regular dividend policy
C) low-regular-and-extra dividend policy
D) target dividend policy
C
A stock split commonly increases the stock’s per share par value.
T or F?
FALSE
decreases
The payment of a stock dividend is a shifting of funds between stockholders’ equity accounts rather than an outflow of funds.
T or F?
TRUE
When a firm pays a stock dividend, the shareholder’s proportion of ownership in a firm remains the same, and as long as the firm’s earnings remain unchanged, so does his or her share of total earnings.
T or F?
TRUE
If a firm’s earnings remain constant and total cash dividends do not increase, a stock dividend results in a lower per-share market value for the firm’s stock.
T or F?
TRUE
The shareholder receiving a stock dividend receives a share of common stock of equal value to their existing shares of common stock.
T or F?
FALSE
After the stock dividend is paid, the per share value of a stockholder’s stock will remain the same as the value before the stock dividend and, thus, the market value of his or her total holdings in the firm will remain unchanged.
T or F?
FALSE
A shareholder receiving a stock dividend typically receives nothing of value.
T or F?
TRUE
The shareholder receiving a stock dividend receives ________.
A) a share of common stock of equal value to their existing shares of common stock
B) cash
C) additional shares of common stock and cash
D) nothing of value
D
Stock dividends are ________.
A) taxable at a higher level than dividend taxes
B) taxable at a lower level than dividend taxes
C) non taxable
D) are taxable only to the shareholders
C
Paying a stock dividend ________.
A) decreases the retained earnings account
B) has no effect on the retained earnings account
C) increases the retained earnings account
D) reorganizes the income
B
In a 2-for-1 stock split, the number of shares outstanding decreases by fifty percent and the stock’s per share par value will double.
T or F?
FALSE
Reverse stock splits are usually initiated when a stock is selling at a very low price.
T or F?
TRUE
A stock split is usually taxable to a firm as it restructures the capital.
T or F?
FALSE
A ________ has an effect on a firm’s share price similar to that of a ________.
A) stock repurchase; stock split
B) stock dividend; stock split
C) cash dividend; stock dividend
D) cash dividend; stock split
B
The purpose of a stock split is to ________.
A) change a firm’s capital structure
B) decrease the dividend
C) enhance the trading activity of the stock by lowering the market price
D) increase the market price of a stock
C
A stock split has ________.
A) little effect on a firm’s capital structure
B) no effect on a firm’s capital structure
C) a measurable effect on a firm’s capital structure
D) a detrimental effect on a firm’s capital structure
B
The purpose of a reverse stock split is to ________.
A) issue additional shares
B) increase the dividend
C) increase the price of a stock
D) decrease trading activity
C
The primary purpose of a stock split is to ________.
A) issue additional shares
B) increase the dividend
C) reduce the price of a stock
D) reduce trading activity
C
