chapter 15

Question 1

What is FCF

Answer 1

all cash flows available for distribution

Question 2

how should a company use its FCF

Answer 2

pay interest
pay debt principal
pay dividends
repurchase stock
buy non operating assets

Question 3

what is the declaration date for dividend payments

Answer 3

the which a firms directors issues a statement declaring dividends

Question 4

what is the holder-of-record date in terms of dividend payment

Answer 4

at the close of business on holder-of-record date the company closes up stock transfer books and makes up a list of shareholders as of that date

Question 5

what is the ex-dividend date

Answer 5

the date when the right to the dividend leaves the stock

usually, a day before the holder-of-record date

Question 6

what is the payment date

Answer 6

date which firm actually sends dividend checks

Question 7

what are stock repurchases

Answer 7

when a company buys back some of its own outstanding stock

Question 8

what are the three ways in which stock repurchases are made?

Answer 8

1. firm can buy back through open market
2. firm can make an offer to current holders of stock
3. targeted stock repurchase: firm can buy a block of shares from one large holder

Question 9

target distribution ratio

Answer 9

the % of NI distributed to shareholders through cash dividends or stock repurchases

Question 10

target payout ratio

Answer 10

% of NI paid as a cash dividend

Question 11

what does it mean if a firm has a high distribution ration and high payout ratio

Answer 11

the dividend yield is relatively high and the expected capital gain is low

Question 12

what does it mean if a firm has a large distribution ratio and a low payout ratio

Answer 12

a low dividend yield but a relatively high expected capital gain yield

Question 13

what does it mean if a firm has a low distribution and payout ratio

Answer 13

low dividend yield and it is hoped that they have a high capital gain

Question 14

what is the dividend irrelevence theory

Answer 14

the value of a firm depends only on income produced by its assets not on how this income is split between dividends and R.E

Question 15

what is an important assumption to the dividend irrelevance theory

Answer 15

no taxes or costs exist (makes the two ways more equal if you ignore costs)

Question 16

Dividend Preference (Bird-in-the-Hand) Theory

Answer 16

Myron Gordon and John Litner:

a stock risk declines as dividends increase

stockholders prefer dividends and are willing to accept a lower return on stock

Question 17

What is Capital Gain Preference

Answer 17

stock price appreciation is still taxed more favorably than dividend income

• increase in a stocks price isn’t taxable until the stock is sold, whereas dividend is taxed immediately

investors should be willing to pay more for a low payout company

Question 18

Myron Gordon and John Litner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that….

Answer 18

investors view dividends as less risky than potential future capital gains

Question 19

What is the clientele Effect? and give examples

Answer 19

different groups of investors have different payout policies

retired, low income, or need cash now: dividend preference
stockholders in peak years: prefer capital gains

Question 20

why should managers be hesitant to change their dividend policy

Answer 20

clientele effect

Question 21

What should be in a company’s mind when deciding how much cash to distribute to stockholders

Answer 21

• ## how they can maximize shareholders value

Question 22

when firm’s product a lot of cash but distribute a lot to shareholders what clientele does this attract?

Answer 22

clientele that prefer high dividends

Question 23

when firms generate little or no excess cash because they have so many good investment opportunities meaning they don’t distribute cash but do enjoy rising earnings and stock prices, who does this attract?

Answer 23

investors who prefer capital gains

Question 24

what are the four steps to determining a target distribution ratio?

Answer 24

1. determine optimal capital budget
2. determine amount of equity needed to finance budget
3. use reinvested earning to meet equity requirements
4. pay dividends or repurchase stock only if more earnings are available than needed to support the optimal capital budget

Question 25

what does rigidly following the residual policy lead to?

Answer 25

fluctuating and unstable dividends

Question 26

how should firms use the residual policy

Answer 26

as a guide to set up their long-run target distribution ratios NOT as a guide to the distributions in a singular year

Question 27

what is the low-regular-dividend-plus-extras policy

Answer 27

when a company announces a low regular dividend that it is sure can be maintained and then if extra funds are available the company pays a extra dividend or repurchases stock

Question 28

What are the advantages of repurchases

Answer 28

1. viewed as a positive signal to investors
2. stock holders have a choice when the firm distributes cash by repurchasing stock
3. dividends are “sticky” in the short run and repurchases are a good short-term
4. residual model: target cash distribution levels
5. large scale changes in capital structures
6. companies can grant stock options

Question 29

what are disadvantages of repurchases

Answer 29

1. cash dividends are dependable
2. the selling stockholders may not be fully aware of all the implications of a repurchase
3. corp may pay too much for repurchased stock

Question 30

what are other factors that influence distributions

Answer 30

• the cost of selling new stock
• ability to substitute debt for equity
• control (manager may not want to lose control)

Question 31

what is a stock split

Answer 31

when you double the number of shares outstanding and cut the price

Question 32

when are stock splits normally used?

Answer 32

when there is a sharp price run up

Question 33

what are stock dividend

Answer 33

current share holders receive additional shares

• usually on a regular annual basis

Question 34

what is a dividend reinvestment plan

Answer 34

a plan that allows stockholders to automatically purchase shares of common stock with their cash dividends

Question 35

what are the two types of dividend investment plans

Answer 35

• one with stock that is already outstanding
• one involves newly issued stock