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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.
a. True
b. False
Dividend irrelevance
ii
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.
a. True
b. False
Dividend irrelevance
iii
MM's dividend irrelevance theory says that dividend policy does not affect a firm's value
but can affect its cost of capital.
a. True
b. False
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.
a. True
b. False
The announcement of an increase in the cash dividend always causes an increase in the
price of the firm's common stock.
a. True
b. False
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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.
a. True
b. False
A stock dividend and a stock split should, at least conceptually, have the same effect on
shareholders wealth.
a. True
b. False
Reverse split
viii
Medium:
Dividend irrelevance
ix
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.
a. True
b. False
Dividend irrelevance
x
A firm that follows a residual dividend policy must believe that the dividend irrelevance
theory is correct.
a. True
b. False
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.
a. True
b. False
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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 opportunities from year to year.
a. True
b. False
Empirical tests
xiv
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.
a. True
b. False
Stock split
xv
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.
a. True
b. False
Signaling hypothesis
xvi
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Myron Gordon and John Lintner believe that the required return on equity increases as
the dividend payout ratio is decreased. Their argument is based on the assumption that
a.
b.
c.
d.
e.
Dividend payout
xix
Dividend payout
xx
Earnings stability.
Access to capital markets.
Profitable investment opportunities.
Collection of accounts receivable.
Stock price.
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Dividend theories
xxi
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.
Which of the following would not have an influence on the optimal dividend policy?
a.
b.
c.
d.
e.
Stock split
xxiv
A stock split will cause a change in the total dollar amounts shown in which of the
following balance sheet accounts?
a.
b.
c.
d.
e.
Cash.
Common stock.
Paid-in capital.
Retained earnings.
None of the above.
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Stock split
xxv
You currently own 100 shares of stock in Beverly Brothers Inc. The stock currently
trades at $120 a share. The company is contemplating a 2-for-1 stock split. Which of the
following best describes your position after the proposed stock split takes place?
a.
b.
c.
d.
e.
You will have 200 shares of stock, and the stock will trade at or near $120 a share.
You will have 200 shares of stock, and the stock will trade at or near $60 a share.
You will have 100 shares of stock, and the stock will trade at or near $60 a share.
You will have 50 shares of stock, and the stock will trade at or near $120 a share.
You will have 50 shares of stock, and the stock will trade at or near $60 a share.
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i
.
ii
Answer: a
Diff: E
Dividend
irrelevance
Answer: b
iii
Diff: E
Dividend
irrelevance
Answer: b
iv
Investor's
dividend
Answer: a
Dividends
and
vii
viii
Residual
Stock
and
Answer: a
Diff: E
irrelevance
irrelevance
dividends,
WACC
and
growth
Diff: M
tradeoff
Diff: M
policy
Diff: M
Empirical
Answer: b
xv
and
dividend
Answer: b
xiv
Diff: M
Dividend-growth
Answer: a
xiii
Diff: M
Dividend
Earnings,
split
Diff: E
Dividend
splits
Reverse
Answer: b
xii
policy
dividends
Diff: E
Diff: E
Answer: b
xi
prices
Answer: a
Answer: a
x
Diff: E
dividend
Answer: a
ix
preference
stock
Answer: b
vi
Diff: E
Diff: M
Stock
Answer: a
tests
Diff: M
split
xvi
Signaling
hypothesis
Answer: a
xvii
Dividends
versus
Diff: M
capital
Answer: d
xviii.
Answer: d
Dividends,
Diff: E
DRIPs,
gains
Diff: E
and
repurchases
Dividend
Answer: a
payout
xx
Diff: E
Dividend
Answer: c
payout
Diff: E
xxi
Dividend theories
Answer: e
Diff: E
Answer: c
Diff: E
Optimal
dividend
Answer: e
xxiv
xxv.
Stock split
policy
Diff: E
Stock
Answer: e
Diff: E
Answer: b
Diff: E
split
With a 2-for-1 stock split, the price is (roughly) halved and the number of
shares doubles.