Assignment I: DIVIDEND POLICY

Assignment I: DIVIDEND POLICY

Part I: MULTIPLE CHOICE
1. The dividend irrelevance hypothesis is based on all of the following assumptions except:
a. investment decisions will not be altered by the amount of dividend payments
b. investors do not need cash dividends to supplement their current income
c. perfect capital markets
d. borrowing decisions will not be altered by the amount of dividend payments
e. none of the above
2. JB Corporation has a retained earnings balance of $1,000,000. The company reported net income of
$200,000, sales of $2,000,000, and has 100,000 shares of common stock outstanding. The company
announced a dividend of $1 per share. Therefore, the company's dividend payout ratio is ________.
a. 10% d. 100%
b. 20% e. None of the above
c. 50%
3. Willows Corporation is experiencing high demand for its products and high growth rates. The
company just reported earnings per share of $5 for the most recent year and has many positive NPV
projects to fund. One vice president wants to pay a dividend of $5 per share, arguing that this will
maximize shareholder value. You argue that a much smaller dividend will maximize value. Your
argument may be based on ________.
a. the bird-in-the-hand theory
b. the residual dividend theory
c. the information effect
d. the very high agency costs of the corporation
e. none of the above
4. A corporation with very high growth prospects and many positive NPV projects to fund may want to
increase its dividend based on ________.
a. the tax bias against capital gains
b. the residual dividend theory
c. the information effect
d. the very low agency costs of the corporation
e. none of the above
5. Jones Corporation declared a dividend of $1 per share on January 1. The date of record is January
15th, and the payment date is February 1st. The most likely ex-dividend date is ________.
a. December 31st d. February 2nd
b. January 2nd e. None of the above
c. January 13th
6. All of the following are likely to result in a lower dividend, other things the same, except:
a. statutory restrictions c. liquidity constraints
b. debt covenants d. highly diverse ownership
7. CDE Corporation declared a $2 per share dividend on October 1. The date of record is October 20th,
the ex-dividend date is October 18th, and the payment date is October 31st. Joe owns a share of stock
on October 1. Joe sells his share to Mary on October 19th, and Mary sells the share to Tom on
October 29th. Who will receive the dividend?
a. Joe
b. Mary

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c. Tom
d. No one, since the share was not owned consistently by one person over the period.
e. None of the above
8. CDE Corporation declared a $2 per share dividend on October 1. The date of record is October 20th,
the ex-dividend date is October 18th, and the payment date is October 31st. Joe owns a share of stock
on October 1. Joe sells his share to Mary on October 18th, Mary sells the share to Tom on October
20th, and Tom sells the share to William on October 30th. Who will receive the dividend?
a. Joe
b. Mary
c. Tom
d. William
e. None of the above
9. All of the following are potential benefits of stock repurchases except:
a. A means for providing an internal investment opportunity
b. An approach for maintaining the existing capital structure while still making a distribution to
shareholders
c. A favorable impact on earnings per share
d. The elimination of a minority ownership group of stockholders
e. None of the above
10. Low dividends may increase stock value according to the ________.
a. bird-in-the-hand theory
b. information effect
c. impact of agency costs
d. tax bias in favor of capital gains
e. none of the above
11. The “bird-in-the-hand” dividend theory suggests that ________.
a. high dividends increase stock value because shareholders believe they can earn a higher
return than the company
b. high dividends increase stock value because shareholders are more certain of the dividend
yield than of potential future capital gains
c. high dividends increase stock value because capital markets are inefficient and dividends are
the only sure way to get money from an equity investment
d. high dividends decrease stock value because dividend payments take money out of the
corporate “nest” and reduce the ability of the corporation to function effectively
e. none of the above
12. The residual dividend theory suggests that dividends will only be paid ________.
a. if the tax rate on capital gains is higher than the tax rate on dividends
b. if the corporation has more positive NPV projects than it can fund
c. if interest rates available to shareholders are higher than the required return on the company’s
stock
d. if current retained earnings exceed the equity portion of the firm’s capital budget
e. none of the above

13. Dividend changes may be used by management as a credible communication tool to signal investors
about future earnings under which of the following dividend policy theories?
a. the clientele effect
b. the residual dividend theory
c. the information effect

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d. the expectations theory

e. none of the above
14. The payment of dividends may indirectly result in closer monitoring of management’s investment
activities, thus increasing shareholder value by ________.
a. reducing agency costs
b. increasing information asymmetry
c. increasing a company’s amount of free cash flow
d. reducing auditing fees
e. none of the above
15. All of the following factors support the proposition that dividend policy matters except:
a. investors desire to minimize and defer taxes, and capital gains get preferential tax treatment
over dividend income
b. perfect capital markets
c. information asymmetry exists between shareholders and managers
d. flotation costs significantly increase the cost of new common stock compared to retained
earnings
e. none of the above
16. JLI Corp. had earnings per share of $4 per share last year and paid a dividend of $1 per share. For the
current year, JLI Corp. generated earnings per share of $6 and paid a dividend of $1 per share. This is
an example of what type of dividend policy?
a. constant dividend payout ratio
b. stable dollar dividend per share
c. small, regular dividend plus a year-end extra
d. payout ratio equal to zero
e. none of the above
17. Which of the following factors would most likely be present if a company increases its dividend
payout ratio significantly?
a. a high debt/equity ratio (i.e., use of a large amount of financial leverage)
b. a quick ratio that is significantly below the industry average
c. current shareholders cannot participate in a new offering and desire to maintain ownership
control
d. the variability of expected future earnings decreases
e. none of the above
18. John owns 100 shares of XYZ Corporation's common stock. The stock has a par value of $10 per
share and is currently selling for $50 per share. XYZ declares a 25% stock dividend. In a perfect
capital market, after the dividend John will have ________.
a. 100 shares selling for $37.50 each
b. 125 shares selling for $47.50 each
c. 100 shares selling for $52.50 each
d. 125 shares selling for $40.00 each
e. None of the above
19. An increase in flotation costs will most likely result in which of the following?
a. smaller dividend payments so that less external equity financing is needed
b. larger dividend payments so shareholders are able to earn their required returns
c. larger dividend payments to offset higher taxes paid by investors
d. no change in dividend policies because flotation costs are paid by purchasers of common
stock
e. none of the above

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20. High dividends may increase stock values due to all of the following reasons except:
a. dividends are more certain than capital gains
b. higher dividends are used to signal higher expected future earnings
c. dividends are used as a tool to minimize agency costs
d. higher dividends allow companies to increase their proportion of external equity financing
e. none of the above
21. According to the clientele effect, ________.
a. companies should have dividend payout ratios of either 100% or 0%
b. companies should avoid making capricious changes in their dividend policies
c. companies should change their dividend policies to please their target group of investors
d. even if capital markets are perfect, dividend policy still matters
e. none of the above
22. A corporation has been paying out $1 million per year in dividends for the past several years. This
year, the company wants to pay the $1 million dividend, but can't. All of the following are reasons
the company cannot continue its dividend payment policy except:
a. the company's net income this year is less than $1 million
b. the company's retained earnings balance at the end of the year is less than $1 million
c. the company's cash balance is less than $1 million
d. the company's liabilities exceed its assets
e. none of the above
23. The CEO of Marletti Pasta Company wants a dividend policy that minimizes the likelihood of
decreasing the company’s dividend per share. Which of the following policies should the CEO
select?
a. constant dividend payout ratio
b. stable dollar dividend per share
c. regular dividend plus a year-end extra
d. all policies have the same likelihood of a dividend decrease because dividend changes are
dependent on changes in earnings
e. none of the above
24. John owns 500 shares of stock in Zebar Corporation with a market value of $2,000. Zebar declares a
10% stock dividend. After the dividend is paid, John owns ________.
a. 550 shares with a market value of $2,000
b. 500 shares with a market value of $2,200
c. 550 shares with a market value of $2,200
d. 550 shares with a market value of $2,050
e. None of the above
25. Which of the following strategies may be used to alter a firm’s capital structure toward a higher
percentage of debt compared to equity?
a. stock dividend
b. stock split
c. maintain a low dividend payout ratio
d. stock repurchase
e. none of the above
26. According to the perfect markets approach to dividend policy ________.
a. other things equal, the greater the payout ratio, the greater the share price of the firm
b. the price of a share of stock is unrelated to dividend policy
c. the firm should retain earnings so stockholders will receive a capital gain
d. the firm should pay a dividend only after current equity financing needs have been met

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e. none of the above

27. According to the residual theory of dividends ________.
a. dividends are a residual after investment financing needs have been met
b. earnings remaining after payment of preferred stock dividends should be paid to common
stockholders
c. dividend payments are a constant percentage of earnings per share
d. a dividend is the residual above the payout ratio
e. none of the above
28. All of the following may influence a firm's dividend payment except:
a. investment opportunities
b. investor transaction costs
c. common stock par value
d. flotation costs
e. none of the above
29. A justification for no dividend payments that would be pleasing to shareholders could be ________.
a. insufficient cash available for dividend payments
b. positive NPV investment projects that require the firm to retain cash for investment purposes
c. an investor clientele that prefers current liquidity
d. cash will be used for a stock dividend
e. none of the above
30. All of the following conclusions on the importance of a dividend policy are true except:
a. As a firm's investment opportunities increase, the dividend payout ratio should decrease.
b. The firm's expected earning power and the riskiness of these earnings are more important to
the investor than the dividend policy.
c. Dividends may influence stock price by the investor's desire to minimize and/or defer taxes
and from the role of dividends in minimizing agency costs.
d. In order to avoid surprising investors, management should anticipate financing needs for the
short-term, but not for the long term.
e. None of the above

Part II: ESSAY questions

1. Baker, Inc. expects earnings per share this year to be $6. If earnings per share grow at an average
annual rate of 8 percent and if Baker pays 70 percent of its earnings as dividends, what will the
expected dividend per share be in 5 years?

2. Cyberco Corporation has 2 million shares of stock outstanding. Cyberco’s after-tax profits are $10
million and the corporation’s stock is selling at a price-earnings multiple of 12, for a stock price of
$60 per share. Cyberco management issues a 25% stock dividend.

a. Calculate Cyberco’s earnings per share before and after the stock dividend.
b. Suppose an investor owns 1000 shares of Cyberco before the stock dividend. Use the price
earnings multiple to estimate the value of the investor’s holdings both before and after the
dividend.
c. Comment on the results of the stock dividend for current shareholders.

3. The Clydesdale Corporation has an optimal capital structure consisting of 60 percent debt and 40
percent equity. The marginal cost of capital is calculated to be 14.5 percent. Total earnings available

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to common stockholders for the coming year total $1,500,000. Investment opportunities are:

Project Investment IRR (%)

A $1,000,000 22
B $250,000 18
C $1,150,000 15
D $300,000 14

a. According to the residual dividend theory, what should the firm's total dividend payment be?
b. If the firm paid a total dividend of $1,000,000, and restricted equity financing to internally
generated funds, which projects should be selected? Assume the marginal cost of capital is
constant.

4. XYZ has 400,000 shares of common stock outstanding, a P/E ratio of 8, and $500,000 earnings
available for common stockholders. The board of directors has just voted a 3:2 stock split.
a. If you had 100 shares of stock before the split, how many shares will you have after the split?
b. What was the total value of your investment in XYZ stock before the split?
c. What should be the total value of your investment in XYZ stock after the split?
d. In view of your answers to (b) and (c) above, why would a firm's management want to have a
stock split?
5. Coppell Timber Company had total earnings last year of $5,000,000, but expects total earnings to
drop to $4,750,000 this year because of a slump in the housing industry. There are currently
1,000,000 shares of common stock outstanding. The company has $4,000,000 worth of investments to
undertake this year. The company finances 40 percent of its investments with debt and 60 percent
with equity capital. The company paid $3.00 per share in dividends last year.
a. If the company follows a pure residual dividend policy, how large a dividend will each
shareholder receive this year?
b. If the company maintains a constant dividend payout ratio each year, how large a dividend
will each shareholder receive this year?
c. If the company follows a constant dollar dividend policy, how large a dividend will each
shareholder receive this year?
6. Ernest T. Bass Frozen Frog Legs, Inc. has found three acceptable investment opportunities. The three
projects require a total of $3 million in financing. It is the company's policy to finance its investments
by using 35% debt and 65% common equity. The firm has generated $2.2 million dollars from its
operations that could be used to finance the common equity portion of its investments.
a. What portion of the new investments will be financed by common equity and what portion by
debt?
b. According to the residual dividend theory, how much would be paid out in dividends?
7. Ted Tech Inc. is offering a 10% stock dividend. The firm currently has 200,000 shares outstanding
and after-tax profits of $800,000. The current price of the stock is $48.
a. Calculate the new earnings per share.
b. What is the original price/earnings multiple?
c. Providing that the price/earnings multiple stays the same, what will the new stock price be after
the stock dividend?
8. Outpost has 2 million shares of common stock outstanding; net income is $300,000; the P/E ratio is 9;
and management is considering an 18% stock dividend. What will be the expected effect on the price
of the common stock? If an investor owns 300 shares in the company, how does this affects his total
value? Explain.
9. Trevor Co.'s future earnings for the next four years are predicted below. Assuming there are 500,000

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shares outstanding, what will the yearly dividend per share be if the dividend policy is:

Trevor & Co.

1 $ 900,000
2 1,200,000
3 850,000
4 1,350,000

a. a constant payout ratio of 40%

b. stable dollar dividend targeted at 40% of the average earnings over the four-year period

c. small, regular dividend of $0.75 plus a year-end extra of 40% of profits exceeding $1,000,000

10. Describe the types of dividend policies that corporations frequently use. Which is most common?
Why?
11. What is the information effect associated with dividends? Why does it occur?

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