Chapter 14
Distributions to Shareholders: Dividends and Repurchases
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1. If you were to argue that the firm's cost of equity, rs, does not change as the dividend payout decreases, you would be making an argument ___________ with MM's dividend irrelevance theory, and ___________ with Gordon and Lintner's "bird-in-the-hand" theory.
a. consistent; inconsistent
b. inconsistent; consistent
c. consistent; consistent
d. inconsistent; inconsistent
e. The argument above does not make sense; neither theory involves the cost of equity capital.

2. Which of the following statement completions is most correct? If investors prefer capital gains to dividends, then
a. Dividend policy as determined by the residual dividend policy is the only dividend policy which will maximize the price per share of common stock.
b. The equilibrium return, rs, will increase as dividends are reduced because of the tax effects on capital gains.
c. rs will decrease as dividends are reduced.
d. The equilibrium return, rs, will be positively related to the tax rate on dividends, as the tax rate on dividends increases, rs will decrease.
e. rs will decrease as the retention rate decreases.

3. Which of the following statements is most correct?
a. A key disadvantage of the residual dividend policy is that it usually results in a variable dividend payout policy which is unattractive to investors.
b. Stock splits tend to reduce the number of shares outstanding.
c. An increase in the capital gains tax rate should work to discourage corporations from repurchasing their shares.
d. The bird-in-hand theory of dividends suggests that firms that decrease their dividend payout should expect to realize a higher share price and a lower cost of equity capital.
e. Answers a and c are correct.

4. Marsland Industries follows a strict residual dividend policy. The company has a capital budget of $4,000,000. It has a target capital structure which consists of 40 percent debt and 60 percent equity. Marsland forecasts that its net income will be $3,000,000. What will be the company's expected dividend payout ratio this year?
a. 20%
b. 30%
c. 35%
d. 40%
e. 45%

5. Carney Corporation faces an IOS schedule calling for a capital budget of $20 million. Its optimal capital structure is 40 percent equity and 60 percent debt. Its earnings before interest and taxes (EBIT) were $36 million for the year. The firm has $180 million in assets, pays an average of 10 percent on all its debt, and faces a marginal tax rate of 40 percent. If the firm maintains a residual dividend policy and will keep its optimal capital structure intact, what will be the amount of the dividends it pays out after financing its capital budget?
a. $0
b. $5.4 million
c. $7.1 million
d. $12.0 million
e. $15.1 million

6. Which of the following statements is most correct?
a. Investors are indifferent to stock repurchases or cash dividends, because they are taxed the same way.
b. Modigliani and Miller suggested that investors prefer capital gains rather than dividends from their stock investments.
c. The clientele effect suggests that firms attract a certain type of investor based upon their dividend policy.
d. Both A and C are correct.
e. None of the above are correct.

7. Which of the following statements is most correct?
a. Empirical tests have shown that investors prefer higher dividend payout ratios.
b. Firms are often reluctant to change dividend policy for fear of signaling effects.
c. If a firm retains and reinvests income rather than paying dividends, stockholders who need current income would be disadvantaged.
d. Both A and B are correct.
e. Both B and C are correct.

8. Rust Foods posted a net income of $15 million this year. Financial planners at Rust anticipate having a capital budget of approximately $18 million. The firm also anticipates retaining its target capital structure of 60% equity and 40% debt. If the firm follows a strict residual dividend policy, what is their expected dividend payout ratio?
a. 28%
b. 36%
c. 50%
d. 64%
e. 72%

9. Mitts Inc. stock currently sells for $120 a share. They have just announced a 3:1 stock split to occur today. The market saw this as a positive announcement, and the firm's market capitalization rose 10%. What is Mitts' new stock price?
a. $36
b. $40
c. $44
d. $46
e. $48

10. Which of the following statements is most correct?
a. In general, a company's stock price will rise when it announces it is engaging in a stock repurchase plan.
b. A problem with following a residual dividend policy is that it can often lead to erratic dividend payouts.
c. All else equal, if the capital gains tax rate were increased, this would provide an incentive for firms to increase their dividend payout ratio.
d. Both A and B are correct.
e. All of the above are correct.

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