1. The optimal dividend policy for a firm strikes a balance between payment of current dividends and retention of earnings for future growth, and results in the maximization of stock price.
2. The dividend irrelevance theory, proposed by Miller and Modigliani, says that as long as a firm pays a dividend, how much it pays does not affect either its cost of capital or its stock price.
3. MM’s dividend irrelevance theory says that dividend policy does not affect a firm’s value but can affect its cost of capital.
4. If investors do, in fact, prefer that firms retain most of their earnings, then firms that want to maximize stock price should hold dividend payments to low levels.
5. The announcement of an increase in the cash dividend always causes an increase in the price of the firm’s common stock.
6. If a firm adopts a residual dividend policy, dividends are determined as a residual item. Therefore, the better the firm’s investment opportunities, the lower its dividend payments should be.
7. A stock dividend and a stock split should, at least conceptually, have the same effect on shareholders’ wealth.
8. A reverse split reduces the number of shares outstanding.
9. Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk.
10. A firm that follows a residual dividend policy must believe that the dividend irrelevance theory is correct.
11. How a firm splits its income between retained earnings and dividends does not affect its rate of growth, which is determined by the firm’s basic earning power.
12. One implication of the bird-in-the-hand theory of dividends is that a reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm’s required return constant, other things held constant.
13. If the shape of the curve depicting a firm’s WACC versus its debt ratio is more like a sharp “V”, as opposed to a shallow “U”, the easier it will be for the firm to maintain a steady dividend in the face of varying investment opportuni¬ties from year to year.
14. While the DCF-based empirical tests of dividend theory have generated inconclusive results, CAPM-based tests have demonstrated that low payout ratio stocks have lower required returns because of tax considerations.
15. Even if a stock split has no information content, and even if the dividend per share adjusted for the split does not increase, there can still be a real benefit (i.e., a higher value for shareholders) from such a split, but any such benefit is probably small.
16. If the information content, or signaling, hypothesis is correct, then changes in dividend policy can be important with respect to firm value and capital costs.
17. Myron Gordon and John Lintner believe that the re¬quired return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that
a. Investors are indifferent between dividends and capital gains.
b. Investors require that the dividend yield and capital gains yield equal a constant.
c. Capital gains are taxed at a higher rate than dividends.
d. Investors view dividends as being less risky than potential future capital gains.
e. Investors value a dollar of expected capital gains more highly than a dollar of expected divi¬dends because of the lower tax rate on capital gains.
18. Which of the following statements is most correct?
a. In general, stock repurchases are taxed the same way as dividends.
b. One nice feature of dividend reinvestment plans is that they enable investors to reduce the taxes paid on their dividends.
c. On average, companies send a negative signal to the marketplace when they announce an increase in their dividend.
d. If a company is interested in issuing new equity capital, a new stock dividend reinvestment plan probably makes more sense than an open market dividend reinvestment plan.
e. Statements b and d are correct.
19. In the real world, we find that dividends
a. Usually exhibit greater stability than earnings.
b. Fluctuate more widely than earnings.
c. Tend to be a lower percentage of earnings for mature firms.
d. Are usually changed every year to reflect earnings changes.
e. Are usually set as a fixed percentage of earnings.
20. A decrease in a firm’s willingness to pay dividends is likely to result from an increase in its
a. Earnings stability.
b. Access to capital markets.
c. Profitable investment opportunities.
d. Collection of accounts receivable.
e. Stock price.
21. Which of the following statements best describes the theories of investors’ preferences for dividends?
a. Modigliani and Miller argue that investors prefer dividends to capital gains.
b. The bird-in-hand theory suggests that a company can reduce its cost of equity capital by reducing its dividend payout ratio.
c. The tax preference theory suggests that a company can increase its stock price by increasing its dividend payout ratio.
d. One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy.
e. The clientele effect suggests that companies should follow a stable dividend policy.
22. Which of the following statements is most correct?
a. The bird-in-the-hand theory implies that a company can reduce its WACC by reducing its dividend payout.
b. The bird-in-the-hand theory implies that a company can increase its stock price by reducing its dividend payout.
c. One problem with following a residual dividend policy is that it can lead to erratic dividend payouts which may prevent the firm from establishing a reliable clientele of investors who prefer a particular dividend policy.
d. Statements a and c are correct.
e. All of the statements above are correct.
23. Which of the following would not have an influence on the optimal dividend policy?
a. The possibility of accelerating or delaying investment projects.
b. A strong shareholders’ preference for current income versus capital gains.
c. Bond indenture constraints.
d. The costs associated with selling new common stock.
e. All of the statements above can have an effect on dividend policy.
24. A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?
b. Common stock.
c. Paid-in capital.
d. Retained earnings.
e. None of the above.
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