lecture chapter 17 (2)

Question 1

Clientele effects

Answer 1

Different in tax preferences across investor groups create clientele effects, in which the dividend policy of a firm is optimized for the tax preference of its investor clientele. Individuals in the highest tax brackets have a preferecne for stocks that pay no or low dividends, whereas tax-free investors and corporations have a preference for stocks with high dividends

Question 2

dividend capture theory

Answer 2

This theory states that absent transaction costs, investors can trade shares at the time of the dividend so that non-taxed investors receive the dividend. That is, non taxed investors need not hold the high-dividend paying stocks all the time; it is necessary only that they hold them when the dividend is actually paid

Question 3

MM payout irrelevance

Answer 3

In perfect capital markets a firm invests excess cash flows in financial securities, the firms choice of payout versus retention is irrelevant and does not affect the initial value of the firm

Question 4

Retaining cash

Answer 4

have to pay tax on additional income instead of paying it out

Question 5

T*retain

Answer 5

Measures the effective tax disadvantage of retaining cash

Tretain = (1-(1-Tc)(1-Tg)/(1-Ti))

Question 6

The advantage of holding cash to cover future potential cash needs is that this strategy allows a firm to avoid

Answer 6

The transaction costs of raising new capital (through new debt or equity issues) the direct costs of issuance range from 1% to 3% for debt issues and from 3.5% to 7% for equity issues.

Question 7

announcing a share repurchase today does not necessarily represent a long term commitment to repurchase shares why

Answer 7

Because unlike with dividend smoothing, firms do not smooth their repurchase activity

Question 8

another key difference between dividends and share repurchase

Answer 8

is that the cost of a share repurchase depends on the market price of the stock If managers believe the stock is currently overvalued, a share repurchase will be costly to the shareholders who choose to hold on to their shares because buying the stock at its current overvalued priec is a negative npv investment. By contrast, repurchasing shares when managers perceive the stock the beundervalued is a positive npv investment for these shareholders. Thus if managers are acting in the interst of long term shareholders and attempting to maximize the firms future share price, they will be more likely to repurchase shares if they believe the stock to be undervalued

Question 9

stock dividend; if a company declares a 10% stock dividend, each shareholder will receive

Answer 9

one new share of stock for every 10 shares already owned

Question 10

Stock dividends of 50% or higher are

Answer 10

generally referred to as stock splits

Question 11

Spin off

Answer 11

Rather than pay a dividend using cash or shares of its own stock, a firm can also distribute shares of a subsidiary in a transaction referred to as a spin off