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24) Omicron Technologies has $60 million in excess cash and no debt. The irm expects to
generate additional free cash lows of $48 million per year in subsequent years and will pay
out these future free cash lows as regular dividends. Omicron's unlevered cost of capital is
9% and there are 12 million shares outstanding. Omicron's board is meeting to decide
whether to pay out its $60 million in excess cash as a special dividend or to use it to
repurchase shares of the irm's stock.
Assume that Omicron uses the entire $60 million to repurchase shares. The amount of the
regular yearly dividends in the future is closest to ________.
A) $3.56
B) $5.34
C) $4.45
D) $8.90
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
21
25) Omicron Technologies has $40 million in excess cash and no debt. The irm expects to
generate additional free cash lows of $32 million per year in subsequent years and will pay
out these future free cash lows as regular dividends. Omicron's unlevered cost of capital is
8% and there are 8 million shares outstanding. Omicron's board is meeting to decide
whether to pay out its $40 million in excess cash as a special dividend or to use it to
repurchase shares of the irm's stock.
Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $40
million to repurchase shares. Suppose you are unhappy with Omicron's decision and would
prefer that Omicron used the excess cash to pay a special dividend. The number of shares
that you would have to sell in order to receive the same amount of cash as if Omicron paid
the special dividend is closest to ________ shares.
A) 227.27
B) 272.73
C) 454.55
D) 181.82
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
22
26) Omicron Technologies has $50 million in excess cash and no debt. The irm expects to
generate additional free cash lows of $40 million per year in subsequent years and will pay
out these future free cash lows as regular dividends. Omicron's unlevered cost of capital is
9% and there are 10 million shares outstanding. Omicron's board is meeting to decide
whether to pay out its $50 million in excess cash as a special dividend or to use it to
repurchase shares of the irm's stock.
Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $50
million to pay a special dividend. Suppose you are unhappy with Omicron's decision and
would prefer that Omicron used the excess cash to repurchase shares. The number of
shares that you would have to buy in order to undo the special cash dividend that Omicron
paid is closest to ________ shares.
A) 225.00
B) 337.50
C) 562.50
D) 281.25
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
23
27) A irm has $75 million of assets that includes $12 million of cash and 25 million shares
outstanding. If the irm uses $12 million of cash to repurchase shares, what is the new
price per share?
A) $2.40
B) $1.50
C) $3.00
D) $6.00
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
28) Which of the following is NOT a method for a irm to payout excess cash to its
shareholders?
A) issue new shares
B) issue new shares and pay a high dividend
C) pay a dividend with the excess cash
D) repurchase shares
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
29) What is the efect on the stock price when a irm repurchases its shares?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
24
30) What is the bird-in-the-hand fallacy in dividend theory under perfect capital markets?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
17.3 The Tax Disadvantage of Dividends
1) Long-term investors can defer capital gains tax until they sell, and therefore, there is a
tax advantage for share repurchases over dividends.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) The optimal dividend policy when dividend tax rates exceed capital gains tax rates is to
pay dividends only.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3) Diferent investor groups have difering tax preferences that create clientele efects in
which dividend policy of a irm is optimized for the tax preferences of its investors.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
25
4) Share repurchases have a tax advantage over dividends because ________.
A) dividend payments are tax deductible
B) share repurchases increase the value of debt
C) capital gains can be deferred by long-term investors
D) repurchases are associated with increased customer loyalty
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
5) Historical evidence shows that over the last few decades a larger proportion of irms
have used ________ for payouts.
A) repurchases
B) dividends
C) stock reverse splits
D) stock splits
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
6) The fact that irms continue to issue dividends despite their tax disadvantage is often
referred to as the ________.
A) issuance puzzle
B) dividend puzzle
C) payback puzzle
D) policy puzzle
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
26
7) When a irm pays out a dividend, the share price ________, and when it conducts a share
repurchase at the market price, the share price ________.
A) increases, increases
B) is unchanged, decreases
C) decreases, decreases
D) decreases, is unchanged
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
8) Tax rates on dividends and capital gains difer across investors for a variety of reasons
including ________.
A) income
B) investment horizon
C) tax jurisdiction
D) all of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
9) Corporations enjoy a tax advantage associated with dividends due to ________.
A) personal tax exemptions
B) the 70% exclusion rule
C) laddered tax rates
D) concave tax structure
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
27
10) Which of the following statements is FALSE?
A) Unlike with capital structure, taxes are not an important market imperfection that
inluence a irm's decision to pay dividends or repurchase shares.
B) If dividends are taxed at a higher rate than capital gains, which has been true until the
most recent change to the tax code, shareholders will prefer share repurchases to
dividends.
C) Shareholders typically must pay taxes on the dividends they receive. They must also pay
capital gains taxes when they sell their shares.
D) Because long-term investors can defer the capital gains tax until they sell, there is still a
tax advantage for share repurchases over dividends.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
11) Which of the following statements is FALSE?
A) When a irm pays a dividend, shareholders are taxed according to the dividend tax rate.
If the irm repurchases shares instead, and shareholders sell shares to create a homemade
dividend, the homemade dividend will be taxed according to the capital gains tax rate.
B) When the tax rate on dividends exceeds the tax rate on capital gains, shareholders will
pay lower taxes if a irm uses share repurchases rather than dividends for all payouts.
C) Firms that use dividends will have to pay a lower after-tax return to ofer their investors
the same pretax return as irms that use share repurchases.
D) The optimal dividend policy when the dividend tax rate exceeds the capital gain tax rate
is to pay no dividends at all.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
28
12) Which of the following statements is FALSE?
A) While irms do still pay dividends, substantial evidence shows that many irms have
recognized their tax disadvantage.
B) The fact that irms continue to issue dividends despite their tax disadvantage is often
referred to as the dividend puzzle.
C) At the end of the 1990s, dividend payments exceeded the value of repurchases for U.S.
industrial irms.
D) While evidence is indicative of the growing importance of share repurchases as a part of
irms' payout policies, it also shows that dividends remain a key form of payouts to
shareholders.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
13) The JRN Corporation will pay a constant dividend of $3 per share per year in
perpetuity. Assume that all investors pay a 25% tax on dividends and that there is no
capital gains tax. The cost of capital for investing in JRN stock is 14%.
The price of a share of JRN's stock is closest to ________.
A) $16.07
B) $12.86
C) $19.29
D) $32.14
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
29
14) The JRN Corporation will pay a constant dividend of $5 per share per year in
perpetuity. Assume that all investors pay a 25% tax on dividends and that there is no
capital gains tax. The cost of capital for investing in JRN stock is 10%.
Assume that management makes a surprise announcement that JRN will no longer pay
dividends but will use the cash to repurchase stock instead. The price of a share of JRN's
stock is now closest to ________.
A) $40.00
B) $50.00
C) $60.00
D) $100.00
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
15) The WTC Corporation will pay a constant dividend of $4.20 per share, per year, in
perpetuity. If all investors pay a 20% tax on dividends, there is no capital gains tax, and the
cost of capital for investing in WTC stock is 14%, what is the price for a share of WTC
stock?
A) $24.00
B) $19.20
C) $28.80
D) $48.00
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
30
