Chapter 17 - Finance Flashcards
What are dividends and share repurchases? How do they differ as a firm’s means to distribute cash to its shareholders?
A dividend is a share of profits and retained earnings a firm pays out to its shareholders.
Share repurchases are a transaction in which the firm uses cash to buy back shares of its own outstanding stock, which are held in the company’streasury and can be resold if the company needs to raise money in the future. Three possible transaction types of sales repurchases are
What are the key dates in the dividend payment process?
Declaration Date: the date on which the board authorizes the dividend.
Ex-Dividend Date : Everyone who purchases the stock on or after the ex-dividend date will not receive the dividend(because registering takes 2 or 3 business days).
Record Date: dividend is paid to the shareholders recorded on the record day.
Payable / Distribution Date : dividend checks are sent to the shareholders.
What is a special dividend, a stock split, a reverse stock split, and stock dividend?
Special Dividend: a one-time dividend that is much larger than a regular dividend.
Stock Split: when stocks are split (overall value remains the same)
Reverse Stock Split: when 1 stock doubles in value and number of shares is reduced
Stock Dividend: when dividend is not paid out in cash but in stocks (see accounting part)
There are three possible transaction types for a share repurchase:
Open Market Repurchase: firm announces its intention to buy its own shares in the open market an then proceeds to do so over time like any other investors. This is the most common way to repurchase shares.
Tender Offer: a firm offers to buy shares at a prespecified price during a short time period. The price is usually set at a substantial premium to the current market price.
Targeted Repurchase: when a firm wants to purchase share form a major shareholder. In this case the purchase price is negotiated directly with the seller.
Whats the effect of taxes on dividends, share repurchases and capital gains?
Shareholders typically must pay taxes on the dividends they receive, however they must also pay capital gains taxes when they sell their shares. Do taxes affect investors preferences for dividends versus share repurchases? If dividends are taxed at a higher rate than capital gains, shareholders will prefer share repurchases to dividends. A higher tax rate on dividends also makes it undesirable for a firm to raise funds to pay a dividend.
What are Clientele Effects?
When the dividend policy of a firm reflects the tax preference of its investor clientele. Individuals in the highest tax brackets have a preference for stocks that pay no or low dividends, whereas tax-free investors and corporations have a preference for stocks with high dividends.
What is dividend smoothing?
The practice of maintaining relatively constant dividends. Firms also increase dividends much more frequently than they cut them.
A firm can repurchase shares through a(n) ________ in which it offers to buy shares at a prespecified price during a short time period—generally within 20 days.
A) tender offer
B) open market share repurchases
C) targeted repurchase
D) Dutch auction share repurchase
A
The JRN Corporation will pay a constant dividend of $3 per share, per year, in perpetuity. Assume that all investors pay a 20% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 12%.
6) The price of a share of JRN’s stock is closest to: A) $20.00
B) $24.00
C) $25.00
D) $18.00
A)
Which of the following statements is FALSE?
A) Individuals in the highest tax brackets have a preference for stocks that pay high dividends, whereas tax-free investors and corporations have a preference for stocks with no or low dividends.
B) To compare investor preferences, we must quantify the combined effects of dividend and capital gains taxes to determine an effective dividend tax rate for an investor.
C) The dividend-capture theory states that absent transaction costs, investors can trade shares at the time of the dividend so that non-taxed investors receive the dividend.
D) Differences in tax preferences create clientele effects, in which the dividend policy of a firm is optimized for the tax preference of its investor clientele.
A
Which of the following statements is FALSE?
A) In perfect capital markets, buying and selling securities is a zero-NPV transaction, so it should not affect firm value.
B) Making positive-NPV investments will create value for the firm’s investors, whereas saving the cash or paying it out will not.
C) In perfect capital markets, if a firm invests excess cash flows in financial securities, the firm’s choice of payout versus retention is irrelevant and does not affect the initial share price.
D) After adjusting for investor taxes, there remains a substantial tax advantage for the firm to retain excess cash.
D
Which of the following statements is FALSE?
A) A firm must balance the tax costs of holding cash with the potential benefits of having to raise external funds in the future.
B) Paying out excess cash through dividends or share repurchases can boost the stock price by reducing managers’ ability and temptation to waste resources.
C) If there is a reasonable likelihood that future earnings will be insufficient to fund future positive-NPV investment opportunities, a firm may start accumulating cash to make up the difference.
D) According to the managerial entrenchment theory of payout policy, managers pay out cash only when pressured to do so by the firm’s investors.
A
Which of the following statements is FALSE?
A) Stocks generally trade in lots of 1000 shares, and in any case do not trade in units less than one share.
B) Non-cash special dividends are commonly used to spin off assets or a subsidiary as a separate company.
C) The typical motivation for a stock split is to keep the share price in a range thought to be attractive to small investors.
D) If a company declares a 10% stock dividend, each shareholder will receive one new share of stock for every 10 shares already owned.
A
