978-0134083285 Chapter 13 Part 3

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75) What is the information effect associated with dividends? Why does it occur?

Keywords: Information Effect, Dividend Policy

Learning Obj.: L.O. 13.2

AACSB: Reflective Thinking

76) A corporation decides to cut its dividend from $2 per share to $1.50 per share. Give two

rationales/theories to explain why this action may cause the stock price to decrease and two

rationales/theories to explain why this action may cause the stock price to increase.

Keywords: Dividend Policy, Information Effects, Liquidity, Residual Dividend Theory, Tax Effects

Learning Obj.: L.O. 13.2

AACSB: Reflective Thinking

77) Describe the three divergent views of dividend policy’s effect on share price.

Keywords: Dividend Policy, Dividend Irrelevance Theory, Bird-in-the-Hand Theory, Clientele Effect, Capital Gains

Taxation

Learning Obj.: L.O. 13.2

AACSB: Reflective Thinking

78) Distinguish between the residual dividend theory and the clientele effect.

Keywords: Capital Structure Theory

Learning Obj.: L.O. 13.2

AACSB: Reflective Thinking

Learning Objective 13.3

1) The higher the dividend payout ratio, the more a company must rely on external financing.

Keywords: Dividend Payout Ratio, External Financing

Learning Obj.: L.O. 13.3

AACSB: Analytical Thinking

2) A corporation with $1 million in retained earnings at the end of the year could easily pay a dividend of

$500,000.

Keywords: Retained Earnings, Liquidity

Learning Obj.: L.O. 13.3

AACSB: Analytical Thinking

3) As long as a firm has a positive level of retained earnings, it can pay a dividend.

Keywords: Dividends, Retained Earnings

Learning Obj.: L.O. 13.3

AACSB: Analytical Thinking

4) Statutory restrictions may prevent a company from paying dividends if the firm‘s assets are less than

the firm’s liabilities.

Keywords: Legal Restrictions on Dividends

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

5) Other things equal, in imperfect markets a firm that maintains a stable dividend will have a lower

required rate of return on its equity.

Keywords: Imperfect Markets, Stable Dividend Policy, Required Return on Equity

Learning Obj.: L.O. 13.3

AACSB: Analytical Thinking

6) The ex-dividend date occurs prior to the declaration date.

Keywords: Ex-dividend Date, Declaration Date

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

7) The ex-dividend date is typically two days prior to the payment date of the dividend.

Keywords: Ex-Dividend Date

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

8) Salashar, Inc.‘s balance sheet is as follows:

Cash

$1,000,000

Current Liabilities

$1,300,000

Other Current Assets

$2,000,000

Long-term Debt

$4,100,000

Long-term Assets

$8,000,000

Common Stock

$5,000,000

Retained Earnings

$600,000

Total Assets

$11,000,000

Total Liab. And Equity

$11,000,000

Salashar decides to pay a dividend. Which of the following statements is MOST correct?

A) The dividend cannot exceed $1,000,000, the amount of cash available.

B) The dividend cannot exceed $1,700,000, the amount of net working capital.

C) The dividend cannot exceed $600,000, the amount of retained earnings.

D) The dividend cannot exceed $11,000,000, the amount of total assets.

Keywords: Dividends, Statutory Restrictions

Learning Obj.: L.O. 13.3

AACSB: Analytical Thinking

9) Statutory restrictions on dividend payments include all of the following EXCEPT

A) if liabilities exceed assets.

B) if the amount of the dividend exceeds the firm’s retained earnings.

C) if the dividend is being paid from capital invested in the firm.

D) if, because of the dividend payment, the firm intends to sell new common stock to fund its capital

budget.

Keywords: Statutory Restrictions, Dividend Policy

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

10) All of the following are likely to result in a lower dividend, other things the same, EXCEPT

A) statutory restrictions.

B) debt covenants.

C) liquidity constraints.

D) highly diverse ownership.

Keywords: Ownership Control, Dividend Decision

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

11) Each of the following factors may cause a corporation to lower its dividend payout ratio EXCEPT

A) the corporation’s earnings predictability is high.

B) the corporation’s current and quick ratios are higher than industry average.

C) the corporation’s retained earnings balance is high.

D) current common shareholders are unable to participate in new equity offerings.

Keywords: Dividend Payout Ratio, Earnings Predictability, Liquidity, Ownership Control, Legal Restrictions

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

12) 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.

Keywords: Dividend Policy, Dividend Payout Ratio, Earnings Predictability

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

13) 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.

Keywords: Statutory Restrictions, Retained Earnings, Dividends

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

14) Flotation costs

A) include the fees paid to the investment bankers, lawyers, and accountants involved in selling a new

security issue.

B) encourage firms to pay large dividends.

C) are encountered whenever a firm fails to pay a dividend.

D) are incurred when investors fail to cash their dividend check.

Keywords: Flotation Costs

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

15) Dividend policy is influenced by

A) a company‘s investment opportunities.

B) a firm‘s capital structure mix.

C) a company‘s availability of internally generated funds.

D) all of the above.

Keywords: Dividend Policy, Investment Opportunities, Capital Structure

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

16) 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.

Keywords: Dividend Policy

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

17) While Rogue Corporation has been in business for over 50 years, newly developed products pushed

the firm’s year-over-year growth rate to 35% during the latest three years. The firm is proud of its history

of paying dividends, but the vigorous recent growth of the firm has left it cash challenged. Which of the

following policies/procedures would you consider best under the circumstances?

A) Borrow long-term to pay the current dividend.

B) Look seriously for a merger partner.

C) Enter into a long-term stock repurchase program.

D) Substitute a stock dividend for the current cash dividend.

Keywords: Stock Dividend, Liquidity

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

18) Sinkmaster Corp. settled a large lawsuit that caused earnings to be negative for the quarter. This

quarterly loss was the first in 22 years. In addition, the company has a record of 48 consecutive quarters

of dividend payments. Which of the following is correct?

A) The company cannot pay dividends this quarter since the company had no earnings.

B) The company can use cash generated through prior retention of earnings, or borrowed funds to pay

the dividend.

C) The company can omit the dividend; shareholders are always understanding about the riskiness of

business.

D) The clientele effect says that investor choice of investment vehicle is independent of dividend policy

and therefore the payment/omission of the dividend is immaterial.

Keywords: Retained Earnings, Legal Restrictions, Liquidity

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

19) AFB, Inc. had earnings per share of $4 per share last year and paid a dividend of $1 per share. For the

current year, AFB, Inc. 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

Keywords: Dividend Policy, Stable Dollar Dividend Per Share

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

20) AFB, Inc.’s dividend policy is to maintain a constant payout ratio. This year AFB, Inc. paid out a total

of $2 million in dividends. Next year, AFB, Inc.’s sales and earnings per share are expected to increase.

Dividend payments are expected to

A) remain at $2 million.

B) increase above $2 million.

C) decrease below $2 million.

D) increase above $2 million only if the company issues additional shares of common stock.

Keywords: Constant Dividend Payout Ratio

Learning Obj.: L.O. 13.3

AACSB: Analytical Thinking

21) The president of Smith Brothers, Inc. 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.

Keywords: Stable Dollar Dividend Per Share

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

22) Which of the following dividend policies will cause dividends per share to fluctuate the most?

A) constant dividend payout ratio

B) stable dollar dividend

C) small, low, regular dividend plus a year-end extra

D) no difference between the various dividend policies

Keywords: Dividend Policy, Constant Dividend Payout Ratio, Stable Dollar Dividend, Small Regular Dividend Plus

a Year-end Extra

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

23) A firm that maintains a “stable dollar dividend per share” will generally not increase the dividend

unless

A) a stock split occurs.

B) the firm merges with another profitable firm.

C) the firm is sure that a higher dividend level can be maintained.

D) the P/E ratio has increased steadily over the past 5 years.

Keywords: Stable Dollar Dividend Per Share

Learning Obj.: L.O. 13.3

AACSB: Analytical Thinking

24) The problem with the constant dividend payout ratio is

A) investors may come to expect a specified amount.

B) the dollar amount of the dividend fluctuates from year to year.

C) management is reluctant to cut the dividend even if there are low profits that year.

D) management cannot decrease the dividend when times are tough.

Keywords: Constant Dividend Payout Ratio

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

25) You are a retired worker whose income is derived from your company pension plan and social

security. However, you are highly dependent upon the income generated from your 401(k) plan, which is

heavily weighted in stocks that pay substantial dividends. Which of the following dividend policies

would you prefer?

A) constant dividend payment ratio

B) stable dollar dividend per share

C) small, regular dividend plus a year-end extra

D) Any of the above would be equally desirable.

Keywords: Stable Dollar Dividend Per Share

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

26) Which of the following is (are) false?

A) The constant dividend payout ratio policy seeks to pay a constant percentage of earnings each year.

B) The stable dollar dividend per share policy seeks to maintain a relatively stable percentage dividend

over time.

C) The small, regular dividend plus a year-end extra policy pays a small, regular dividend plus a year–

end extra dividend in good years.

D) The constant dividend payout ratio policy will result in more variability in dividends than the stable

dollar dividend per share policy.

Keywords: Stable Dollar Dividend Per Share

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

27) AFB Corp. Declared a $1.00 dividend on January 5th, with an ex-dividend date of January 19th, a

record date of January 21st, and a payment date of March 15th. Doug purchased AFB stock on January

6th. Which of the following statements is MOST correct?

A) Doug will not receive the dividend because he purchased the stock after the declaration date.

B) Doug will not receive the dividend because he purchased the stock prior to the record date.

C) Doug will receive the dividend if he still sells his stock on January 20th because he owned the stock on

the ex-dividend date.

D) Doug will receive the dividend if he still owns the stock on January 21st, even if he sells the stock

before the payment date.

Keywords: Declaration Date, Ex-Dividend Date, Date of Record, Payment Date

Learning Obj.: L.O. 13.3

AACSB: Analytical Thinking

28) Plantain, Inc. declared a dividend of $1 per share on March 1. The ex-dividend date is March 15th,

and the payment date is April 1st. The most likely record date is

A) February 27th.

B) March 17th.

C) March 13th.

D) March 29th.

Keywords: Ex-Dividend Date

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

29) DAS, Inc. declared a $0.50 per share dividend on June 1. The date of record is June 20th, the ex–

dividend date is June 18th, and the payment date is June 31st. Andre owns a share of stock on June 1.

Andre sells his share to Brett on June 19th, and Brett sells the share to LaMarcus on June 29th. Who will

receive the dividend?

A) Andre

B) Brett

C) LaMarcus

D) no one, since the share was not owned consistently by one person over the period

Keywords: Ex-Dividend Date, Date of Record

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking

30) EveningFall, Inc. pays a quarterly dividend of $3.40 per share. Which of the following statements is

most accurate concerning which shareholders will receive the dividend payment?

A) The shareholders who own the stock on the date the dividend is declared will receive the dividend,

even if they sell their stock before the dividend checks are mailed.

B) The shareholders who are identified as owning the stock on the record date will receive the dividend,

even if they sell their stock before the dividend checks are mailed.

C) The shareholders who own the stock the day the dividend is paid will receive the dividend.

D) All shareholders who own the stock on the record date, but sell the stock before the dividend checks

are mailed, forfeit their right to receive the dividend and the money reverts back to the corporation.

Keywords: Date of Record, Declaration Date, Payment Date

Learning Obj.: L.O. 13.3

AACSB: Reflective Thinking