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16) The largest proportion of investors in common stock are ________.
A) mutual funds
B) pension funds
C) corporations
D) individual investors
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
17) What is the general trend of dividend payments of U.S. corporations over the last few
decades?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
18) What is the general trend over the last few decades of total payouts by irms to
shareholders be it through share repurchase or dividends?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
19) What is the general trend of share repurchase as a percentage of total payout over the
last few decades?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
31
17.4 Payout Versus Retention of Cash
1) In perfect capital markets, buying and selling securities is a zero-NPV transaction, so
retaining cash versus paying it out does not afect irm value.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) Because the dividend tax will be paid whether the irm pays the cash immediately or
retains cash and pays the interest over time, the dividend tax rate does not afect the cost
of retaining cash.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3) Palo Alto Enterprises has $200,000 in cash. They wish to invest the money in Treasury
bills at 5% and use the returns to pay dividends to shareholders after a year. Alternatively
they can pay a dividend and allow shareholders to make the investment. In perfect capital
markets, which option will shareholders prefer?
A) immediate cash dividend
B) dividend after one year
C) prefer half from each source
D) indiferent between options
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
32
4) Palo Alto Enterprises has $200,000 in cash. They wish to invest the money in Treasury
bills at 5% and use the returns to pay dividends to shareholders after a year. Alternatively
they can pay a dividend and allow shareholders to make the investment. If corporate tax
rates are 30%, which option will shareholders prefer in perfect capital markets?
A) immediate cash dividend
B) dividend after one year
C) prefer half from each source
D) indiferent between options
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
5) Palo Alto Enterprises has $300,000 in cash. They wish to invest the money in Treasury
bills at 8% and use the returns to pay dividends to shareholders after a year. Alternatively
they can pay a dividend and allow shareholders to make the investment. In perfect capital
markets, which option will shareholders prefer?
A) immediate cash dividend
B) dividend after one year
C) prefer half from each source
D) indiferent between options
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
6) Palo Alto Enterprises has $100,000 in cash. They wish to invest the money in Treasury
bills at 6% and use the returns to pay dividends to shareholders after a year. Alternatively
they can pay a dividend and allow shareholders to make the investment. In perfect capital
markets, which option will shareholders prefer?
A) immediate cash dividend
B) dividend after one year
C) prefer half from each source
D) indiferent between options
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
33
7) Palo Alto Enterprises has $100,000 in cash. They wish to invest the money in Treasury
bills at 6% and use the returns to pay dividends to shareholders after a year. Alternatively
they can pay a dividend and allow shareholders to make the investment. If corporate tax
rates are 35%, which option will shareholders prefer?
A) immediate cash dividend
B) dividend after one year
C) prefer half from each source
D) indiferent between options
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
8) Palo Alto Enterprises has $300,000 in cash. They wish to invest the money in Treasury
bills at 8% and use the returns to pay dividends to shareholders after a year. Alternatively,
they can pay a dividend and allow shareholders to make the investment. If corporate tax
rates are 35%, which option will shareholders prefer?
A) immediate cash dividend
B) dividend after one year
C) prefer half from each source
D) indiferent between options
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
9) When a irm retains cash, it pays corporate tax on the interest it earns and the investor
will owe capital gains tax on the increased irm value—in essence the interest on retained
cash is taxed ________.
A) once
B) at a rate of zero
C) twice
D) none of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
34
10) Firms may retain large amounts of cash to cover future potential needs that allows a
irm to avoid ________.
A) transaction costs and inancial distress costs
B) tax payments
C) clientele efects
D) none of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
11) When a irm has excessive cash, managers may make use of the funds in an ineicient
manner. This is also referred to as the ________ cost of retaining cash.
A) ixed
B) agency
C) interest
D) special
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
12) Prada has ten million shares outstanding, generates free cash lows of $ 50 million each
year and has a cost of capital of 10%. It also has $50 million of cash on hand. Prada wants
to decide whether to repurchase stock or invest the cash in a project that generates free
cash lows of $5 million each year. Should Prada invest or repurchase the shares?
A) indiferent between options
B) repurchase
C) invest
D) cannot say for sure
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
35
13) Prada has nine million shares outstanding, generates free cash lows of $ 40 million
each year and has a cost of capital of 10%. It also has $30 million of cash on hand. Prada
wants to decide whether to repurchase stock or invest the cash in a project that generates
free cash lows of $5 million each year. Should Prada invest or repurchase the shares?
A) indiferent between options
B) repurchase
C) invest
D) cannot say for sure
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
14) Prada has ten million shares outstanding, generates free cash lows of $ 60 million each
year and has a cost of capital of 10%. It also has $40 million of cash on hand. Prada wants
to decide whether to repurchase stock or invest the cash in a project that generates free
cash lows of $2 million each year. Should Prada invest or repurchase the shares?
A) indiferent between options
B) repurchase
C) invest
D) cannot say for sure
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
15) According to the ________ theory of payout policy, managers pay out cash only when
pressured to do so by investors.
A) agency
B) supply
C) price pressure
D) managerial entrenchment
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
16) Luther Industries has $6 million in excess cash and 1.2 million shares outstanding.
Luther is considering investing the cash in one-year Treasury bills that are currently paying
6% interest and then using the cash to pay a dividend next year. Alternatively, Luther can
pay the cash out as a dividend immediately and the shareholders can invest in the Treasury
bills themselves. Assume that capital markets are perfect.
If Luther invests the excess cash in Treasury bills, then the dividend per share next year
will be closest to ________.
