Chapter 15—DIVIDEND POLICY
MULTIPLE CHOICE
1. The dividend “clientele effect” concept was originally developed by
a.
Myron Gordon
b.
Merton Miller and Franco Modigliani
c.
Milton Friedman
d.
Paul Samuelson
2. Dividend reinvestment plans involve the purchase of
a.
newly issued stock
b.
existing stock
c.
letter stock
d.
newly issued and existing stock
3. Most states limit dividend policy by requiring
a.
that dividends may not be paid unless the firm generates net earnings during the most
recent year
b.
that dividends may only be paid out of retained earnings
c.
that dividends may not be paid when the firm is insolvent
d.
that dividends may be paid when the firm is insolvent
4. The following factors influence a firm’s ability and/or willingness to pay dividends:
a.
liquidity
b.
borrowing capacity and access to capital markets
c.
earnings stability
d.
All of these answers are correct.
5. In the theoretical world of Miller and Modigliani
a.
a firm should pay out 100 percent of earnings as dividends, to maximize shareholder
wealth
b.
the marginal tax rates facing investors are the most important single determinant of
dividend policy
c.
dividends are important only for their informational content
d.
dividends should not be paid at all
6. Finance researcher Myron Gordon argues that
a.
risk-averse shareholders may prefer some dividends over the promise of future capital
gains if the interest rate is expected to decline
b.
dividends reduce uncertainty, and thus the payment of dividends will increase the firm’s
value
c.
the clientele effect has no influence on share value
d.
the existence of transaction costs has no impact on the dividend decision
7. The passive residual dividend policy asserts that
a.
dividends should be paid out only if the firm does not have enough acceptable investment
projects to utilize all earnings internally.
b.
dividends should be paid only when the firm has ready access to new equity markets
c.
retained earnings, being the residual earnings of the firm, should always be paid out to
existing stockholders
d.
investment policy and dividend policy decisions should always be made independently
8. The passive residual dividend policy seems to be inconsistent with
a.
a world having significant transactions costs associated with new stock issues
b.
a stable dividend policy
c.
a policy of paying only stock dividends
d.
a share-repurchase policy
9. Many firms try to maintain a stable dividend policy
a.
because of the informational content of dividend changes
b.
in order to satisfy investors who rely on dividends as a primary source of income
c.
in order to remain as eligible investments for many financial institutions
d.
All of these answers are correct.
10. The record date in the normal dividend payment procedure is
a.
the same day as the declaration date
b.
the same day as the ex-dividend date
c.
the date when the firm makes a list from its stock transfer books of shareholders eligible to
receive the dividend
d.
one day prior to the payment date
11. A passive residual dividend policy suggests that the firm will:
a.
pay the same dollar amount of dividends every year
b.
pay the same percentage of earnings in dividends every year
c.
pay a dividend only after all viable investment projects have been exhausted
d.
omit a dividend in the next period
12. Which phrase below best summarizes the arguments supporting a stable dollar dividend policy?
a.
earnings stability
b.
beta
c.
capital structure
d.
informational content
13. In a large, widely-held corporation, the financial manager should consider all of the following in
establishing a dividend policy except
a.
individual shareholder preferences
b.
cash flow needs
c.
informational content of dividends
d.
investment opportunities
14. Which of the following is not a direct result of a stock dividend?
a.
the number of shares outstanding is increased
b.
the market price of each outstanding share is increased
c.
the amounts shown in the firm’s capital accounts are redistributed
d.
none of these are correct.
15. Firms carry out share repurchase agreements in a number of ways, including all of the following
except
a.
buy from shareholders through a tender offer
b.
buy outstanding shares in the open market
c.
buy treasury shares
d.
negotiate a purchase privately from large holders, particularly institutions
16. Rank in chronological sequence the payment date, ex-dividend date, declaration date, and record date.
a.
record date, declaration date, ex-dividend date, payment date
b.
declaration date, record date, ex-dividend date, payment date
c.
declaration date, record date, payment date, ex- dividend date
d.
declaration date, ex-dividend date, record date, payment date
17. Firms with the ____ earnings growth tend to have the ____ dividend payout ratio.
a.
highest, highest
b.
highest, lowest
c.
lowest, lowest
d.
lowest, highest
18. The capital impairment restriction, a legal constraint on dividend payments, states that
a.
only the current year’s earnings may be used for dividend payments
b.
dividends may not be paid out of stockholder’s equity
c.
a firm’s permanent capital cannot be used to make dividend payments
d.
a firm can liquidate its assets to pay dividends
19. A legal constraint that dividends must be paid out of a firm’s present and past net earnings is known as
the ____ restriction.
a.
net earnings
b.
net operating earnings
c.
initial investment
d.
earned capital
20. Restrictive covenants are contained in all of the following except
a.
preferred stock agreements
b.
lease contracts
c.
bond indentures
d.
agency restrictions
21. Dividend payments reduce all of the following balance sheet items except
a.
cash
b.
fixed assets
c.
stockholder’s equity
d.
retained earnings
22. A firm with stable earnings is usually more willing to
a.
retain more earnings
b.
have a higher dividend payout ratio
c.
have a sinking fund agreement
d.
seek aggressive growth
23. All of the following are alternative dividend policies except
a.
constant payout
b.
stable dollar
c.
constant earnings
d.
passive residual
24. In order for a stock to qualify for inclusion on the “legal lists,” a firm must
a.
register with the Securities Exchange Commission (SEC)
b.
have assets in excess of $500,000
c.
have 10 continuous profitable quarters
d.
have a record of continuous and stable dividends
25. A stock dividend will not affect which of the following balance sheet items.
a.
total assets
b.
retained earnings
c.
contributed capital in excess of par
d.
common stock at par
26. On the ex-dividend date, the
a.
seller of the stock is entitled to the dividend
b.
buyer has 4 business days to register his/her purchase
c.
buyer of the stock is entitled to the dividend
d.
corporation records all security owners
27. Under dividend reinvestment plans, shareholders can automatically
a.
reduce their taxable income
b.
increase their cash inflows
c.
use dividends to purchase additional shares
d.
increase their taxable income
28. The net effect of a stock dividend is to
a.
increase the firm’s total stockholders’ equity
b.
increase the number of shares outstanding
c.
increase total dividends
d.
increase stock prices
29. The fundamental question in dividend policy is
a.
the tax consideration
b.
the amount of growth the firm considers optimal
c.
not violating any restrictive covenants
d.
determining what portion of earnings will be paid out
30. The dividend ____ states that investors will tend to be attracted to firms that have dividend policies
consistent with the investor’s objectives
a.
“clientele effect”
b.
“informational content”
c.
signal
d.
passive residual theory
31. From an accounting standpoint, stock splits are accomplished by
a.
increasing the number of shares authorized
b.
increasing par value of existing shares
c.
reducing the par value of existing shares
d.
both a and c
32. According to the ____ dividend policy, a firm that has more funds than it needs should pay a cash
dividend to shareholders.
a.
constant payout ratio
b.
stable dollar
c.
passive residual
d.
year-end extras
33. As part of a share repurchase program by a company, a tender offer involves the ____.
a.
purchase of stock on the open market
b.
purchase of stock directly from its stockholders
c.
private negotiation of purchases from large institutions, such as insurance companies
d.
Dutch auction
34. Dividend policy can affect the value of the firm for which of the following reasons?
a.
personal taxes
b.
flotation costs
c.
shareholder transaction costs
d.
All of these answers are correct.
35. According to Miller and Modigliani it is ____ that really determines a firm’s value.
a.
investment policy
b.
dividend policy
c.
both investment and dividend policy
d.
transaction and issuance cost
36. The theoretical post-stock dividend price is equal to the pre-stock dividend price ____.
a.
multiplied by 1 minus the percentage stock dividend rate
b.
multiplied by 1 plus the percentage stock dividend rate
c.
divided by 1 minus the percentage stock dividend rate
d.
divided by 1 plus the percentage stock dividend rate
37. All of the following are arguments for the relevance of dividends except:
a.
existence of issuance costs
b.
reduction of agency costs
c.
protection against dilution
d.
risk aversion
38. A firm that employs a constant payout ratio dividend policy pays ____.
a.
a constant (fixed) dollar dividend
b.
out a certain percentage of each year’s earnings
c.
a constant quarterly dividend
d.
none of the above is correct
39. When a firm purchases its own stock in the open market, the repurchased shares become known as
____.
a.
treasury stock
b.
preferred stock
c.
option stock
d.
reinvestment stock
40. All of the following are advantages of share repurchase as a dividend decision except:
a.
effectively converts dividend income into capital gains income
b.
provide firm with greater financial flexibility in timing the payment of returns to
shareholders.
c.
all current shareholders are able to sell their shares at a higher price
d.
they represent a signal to investors that the company expects higher earnings in the future
41. The Percolator Company has the following capital structure:
Common stock ($5 par, 250,000 shares)
$1,250,000
Contributed capital in excess of par
$5,000,000
Retained earnings
$4,000,000
The company declares a 10 percent stock dividend. The pre-stock dividend market price of the
company’s stock is $50. Determine the balance in the retained earnings account after the stock
dividend.
a.
$4,000,000
b.
$1,375,000
c.
$2,750,000
d.
$1,250,000
42. The Percolator Company has the following capital structure:
Common stock ($5 par, 250,000 shares)
$1,250,000
Contributed capital in excess of par
$5,000,000
Retained earnings
$4,000,000
The company declares a 10 percent stock dividend. The pre-stock dividend market price of the
company’s stock is $50. Determine the balance in the common stock account after the stock dividend.
a.
$1,250,000
b.
$1,375,000
c.
$125,000
d.
$2,500,000
43. The Wagner Company tries to follow a pure “residual” dividend policy. Earnings and dividends last
year were $100 million and $20 million respectively. Anticipated earnings for this year are $80
million. The company is financed completely with common equity. The required rate of return on
retained earnings is 15 percent and the cost of new equity is 16 percent. If Wagner has $70 million of
investment projects having expected returns greater than 15 percent, determine the total amount of
dividends Wagner should pay.
a.
None
b.
$10 million
c.
$20 million in dividends and raise needed investment funds externally
d.
$80 million in dividends and raise needed investment funds externally
44. The Wagner Company tries to follow a pure “residual” dividend policy. Earnings and dividends last
year were $100 million and $20 million respectively. Anticipated earnings for this year are $80
million. The company is financed completely with common equity. The required rate of return on
retained earnings is 15 percent while the cost of new equity is 16 percent. If Wagner has $90 million of
investment projects having expected returns greater than 16 percent, determine Wagner’s dividend and
investment policies.
a.
Pay out $20 million in dividends and raise $30 million externally
b.
Pay no dividends and invest only in the first $80 million in projects.
c.
Pay out $10 million in dividends and raise $20 million externally
d.
Pay no dividends and raise $10 million externally
45. Last year, Quality’s earnings per share were $2.34 and it paid a dividend of $1.10. What was Quality’s
dividend payout ratio?
a.
21.2%
b.
42.7%
c.
47%
d.
53%
46. The Earth Shoe Company, whose stock has a market value of $20, has the following common equity
accounts on its balance sheet:
Common stock ($1 par, 1,000,000 shares)
$ 1,000,000
Contributed capital in excess of par
$14,000,000
Retained earnings
$52,000,000
Total Common stockholders’ equity
$67,000,000
If the firm declares a 5% stock dividend, what will be the “Retained earnings” figure after the dividend
is paid?
a.
$1,000,000
b.
$51,000,000
c.
$14,950,000
d.
$1,050,000
47. HiTec is growing fast and wishes to retain all its earnings to finance future growth. Instead of a cash
dividend, HiTec declares a 10 percent stock dividend. If the price per share of HiTec stock is $30
before the ex-dividend date, what will be the price on the ex-dividend date?
a.
$27.27
b.
$27.94
c.
$33.00
d.
$27.00
48. Saturn Corporation has just declared a 25 percent stock dividend. The stock was selling for $18 before
the stock dividend. The stock will pay a quarterly cash dividend of 8 cents per share after the stock
dividend. If the 8-cent dividend is maintained over the next year what is the post-stock dividend yield?
a.
2.13%
b.
2.22%
c.
0.56%
d.
3.19%
49. Last year, Toluca Engineering paid a $0.25 dividend per share each quarter. If Toluca announces both
a 5 percent stock dividend and an increase in the quarterly dividend to $0.27, what is the effective rate
of the dividend increase?
a.
13.0%
b.
8.0%
c.
11.2%
d.
13.4%
50. Grabill Aerospace Company has just declared a 15% stock dividend. Immediately prior to the stock
dividend, the stock was selling for $23 and had a P/E ratio of 14. Calculate the post-stock dividend
price of Grabill’s stock.
a.
$26.45
b.
$20.00
c.
$26.22
d.
$20.18
51. Heintz Corp. has just declared a 10% stock dividend. The company’s pre-stock dividend common
stockholders’ equity was as follows:
Common stock ($0.50 par, 10,000,000 shares)
$ 5,000,000
Contributed capital in excess of par
$ 48,000,000
Retained earnings
$ 97,500,000
Total common stockholders‘ equity
$150,500,000
If the common stock of Heintz was selling at $32 a share prior to the stock dividend, what will the
retained earnings be after the stock dividend is distributed?
a.
$ 65,500,000
b.
$118,500,000
c.
$ 66,000,000
d.
$ 97,500,000
52. Sorsi has declared a 15% stock dividend. If the stock was selling for $34 before the ex-dividend date,
what should its price be on the ex-dividend date?
a.
$34.00
b.
$29.57
c.
$28.90
d.
$30.91
53. Haulsee Inc. paid a quarterly dividend of $0.12 and has announced both a 10% stock dividend and an
increase in the quarterly dividend to $0.14. What is the effective rate of the dividend increase?
a.
26.7%
b.
18.3%
c.
28.3%
d.
15.7%
54. Badger Tool and Die Company has 100,000 shares outstanding and plans to pay $1.00 per share in
dividends each quarter next year. Badger has a capital budget of $700,000 for next year and plans to
maintain its present debt ratio of 0.30. If earnings are expected to be $7.20 per share, how much
external equity must Badger raise?
a.
$210,000
b.
$490,000
c.
$170,000
d.
none
55. Cycle Out has 1,000,000 shares outstanding and currently has annual earnings per share of $5.20. If
Cycle’s stock price is $62.40, what would be the expected stock price if Cycle repurchases 50,000
shares?
a.
$65.52
b.
$65.68
c.
$75.72
d.
Can not calculate with the information given.
56. Cafe de Oro earns $4.25 per share and has a dividend payout ratio of 0.40. If Cafe de Oro has a capital
budget of $200,000 and 70,000 shares outstanding, what are the annual dividends per share?
a.
$1.70
b.
$1.39
c.
$2.55
d.
$0.94
57. The Altern Music Co. earns $4.25 per share, has 70,000 shares outstanding, and a capital budget of
$200,000. If Altern Music raises all of its funds internally and follows the “passive residual policy,”
what are its annual dividends per share?
a.
$1.70
b.
$1.39
c.
$2.55
d.
$0.94
58. WPI Inc. has the following current equity accounts on its balance sheet:
Common stock ($2.50 par, 500,000 shares)
$ 1,250,000
Contributed capital in excess of par
$10,000,000
Retained earnings
$15,540,000
Total
$26,790,000
If WPI earned $3.20 per share this year, what is the maximum dividend per share that WPI may pay if
the state capital impairment provisions are limited to the par value and the contributed capital in excess
of par accounts?
a.
$3.20
b.
$31.08
c.
$34.28
d.
$32.17
59. Nova earned $7.20 per share and maintains a stable payout ratio of 60 percent. Nova has 1,000,000
shares outstanding and a capital budget of $5 million. If Nova maintains a debt ratio of 0.50, what
were the dividends per share?
a.
$4.32
b.
$2.88
c.
$2.20
d.
cannot be computed with the information provided
60. Excelsior Company’s capital structure is as follows:
Common stock ($2 par value, 2,000,000 shares)
$ 4,000,000
Contributed capital in excess of par
16,000,000
Retained earnings
23,000,000
Total common stockholders‘ equity
$43,000,000
The current market price of the firm’s common stock is $30. If the firm declares a 10% stock dividend,
determine the balance in the contributed capital in excess of par and retained earnings accounts.
a.
$22,000,000; $17,000,000
b.
$21,600,000; $17,000,000
c.
$21,600,000; $23,000,000
d.
$17,000,000; $22,000,000
61. Peterson Company expects earnings per share and dividends per share to be $4.50 and $2.50
respectively next year. Peterson currently has 5,000,000 shares of common stock outstanding. The
company’s capital budget for next year is projected to be $25,000,000. Peterson plans to maintain its
present debt ratio (debt to total assets) at 40% next year. (Assume that Peterson’s capital structure
includes only common equity and debt and that these will be the only sources of funds to finance
capital budgeting projects next year.) Determine how much external equity the company must raise to
finance its capital budget.
a.
$15,000,000
b.
0
c.
$5,000,000
d.
$7,500,000
62. Kaneb Services, Inc. has just declared a 3 for 2 stock split. The company’s pre-split common
stockholders’ equity was as follows:
Common stock($1.25 par, 2,000,000 shares)
$ 2,500,000
Contributed capital in excess of par
$ 17,500,000
Retained earnings
182,100,000
Total common stockholders‘ equity
$202,100,000
If the pre-split price of common stock was $42, what will be the amount of retained earnings after the
split?
a.
$140,100,000
b.
$139,200,000
c.
$182,100,000
d.
$141,350,000
63. Kaneb Services, Inc. has just declared a 3 for 2 stock split. If the pre-split price of common stock was
$42 a share, what will be the post-split price per share (assuming no other changes occur).
a.
$31.50
b.
$26.25
c.
$25.15
d.
$28.00
64. The Barden Corporation has the following equity accounts on its balance sheet:
Common Stock ($1.25 par, 3,000,000 shares)
$ 3,750,000
Contributed capital in excess of par
24,250,000
Retained earnings
153,600,000
Total common stockholders’ equity
$181,600,000
What is the maximum amount of dividends per share that may be paid by the Barden Corp. if the
capital impairment provisions of state law are limited to the par value and the capital in excess of par
accounts?
a.
$59.28
b.
$51.20
c.
$60.53
d.
$ 8.08
65. Interim Systems has 1.5 million shares outstanding. This year Interim will have operating income
(EBIT) of $18.2 million, interest expenses of $2.4 million, depreciation expenses of $3.1 million.
What will the dividend per share be if Interim’s dividend payout ratio is 40%? Assume a marginal tax
rate of 40%.
a.
$2.53
b.
$3.39
c.
$2.03
d.
$6.32
66. Zycad has operating earnings (EBIT) of $8.6 million and annual interest expenses are $1.5 million.
Zycad wishes to maintain its annual dividend of $1.00 per share on the 1,900,000 shares outstanding.
The firm has a bond issue outstanding that requires the retirement of $3 million (face value) of the
issue each year through purchases of the bonds in the market. What is the maximum dividend per
share that may be paid if the current market price of the bonds is $85? Assume the marginal tax rate is
40% and that earnings are the only source of funds that can be used to pay the dividend and retire the
bonds.
a.
$0.66
b.
$0.16
c.
$1.37
d.
$0.90
67. Omega Sports has the following equity accounts on its balance sheet:
Common stock ($0.50 par, 900,000 shares)
$ 450,000
Contributed capital in excess of par
5,580,000
Retained earnings
21,204,000
Total common stockholders‘ equity
$27,234,000
The current market price of the firm’s shares is $20. If the firm declares a 10 percent stock dividend
and a cash dividend of $0.10 per share, the retained earning account would change to ____.
a.
$21,060,000
b.
$19,305,000
c.
$25,335,000
d.
$19,404,000
68. Zimmer Corp. has just declared a 5 for 4 stock split. If the pre-split price of common stock was $36 a
share, what will be the post-split price per share (assuming no other changes occur)?
a.
$30.00
b.
$27,00
c.
$28.80
d.
$32.00
69. Leigh Fibers has 6 million shares outstanding. This year Leigh will have operating income (EBIT) of
$36.4 million, interest expenses of $5.8 million, and depreciation expenses of $6.2 million. What will
be Leigh’s dividend per share if the company has a payout ratio of 30%? Assume a marginal tax rate of
40%.
a.
$0.92
b.
$0.73
c.
$1.09
d.
$0.61
70. If Sulzer has 10 million shares outstanding, operating income (EBIT) of $42.4 million, and interest
expenses of $6.8 million, what is Sulzer’s dividend payout ratio, given that the dividend per share is
$0.80? Assume a marginal tax rate of 40%.
a.
56.3%
b.
31.5%
c.
50.4%
d.
37.5%
71. Wrenn Corp. has 5.6 million shares outstanding, interest expenses of $4.4 million, and depreciation
expenses of $3.7 million. What is Wrenn’s operating income if the dividend per share is $0.80 and the
dividend payout ratio is 35%? Assume a marginal tax rate of 40%.
a.
$15.89 million
b.
$25.73 million
c.
$21.33 million
d.
$29.43 million
72. Metromat has the following equity accounts on its balance sheet:
Common stock ($2 par, 2.4 million shares)
$ 4,800,000
Contributed capital in excess of par
33,600,000
Retained earnings
134,400,000
Total common stockholders‘ equity
$172,800,000
The current market price of Metromat’s shares is $16. If the firm declares a 15% stock dividend and a
$0.15 per share cash dividend, what will be the impact on contributed capital in excess of par? Assume
a marginal tax rate of 40%.
a.
decreases $2.56 million
b.
increases $5.04 million
c.
increases $5.76 million
d.
does not change
73. Sadaplast has just declared a 25 percent stock dividend. The annual dividend, before the stock
dividend was declared, was $1.00. Sadaplast intends to pay a dividend of $1.05 per share after the
stock dividend is paid. What is the percentage increase in the cash dividend that will accompany the
stock dividend?
a.
6.25%
b.
26.25%
c.
31.25%
d.
5.00%
74. Urguhart has just declared a 4 for 3 stock split. If the pre-split price of common stock was $54 a share,
what do you expect the post-split price will be?
a.
$72.00
b.
$36.18
c.
$42.23
d.
$40.50
75. Concin has the following equity accounts on its balance sheet:
Common stock ($0.25 par, 9 million shares)
$ 2,250,000
Contributed capital in excess of par
89,400,000
Retain earnings
67,503,189
$159,153,189
The current market price for a share of Concin’s stock is $24.25. If the firm declares a 10% stock
dividend and a $0.06 per share cash dividend, what will be the impact on Common stock on the above
equity account?
a.
no change
b.
increase of $225,000
c.
increase of $54,000
d.
increase of $21,600,000
ESSAY
1. What is the signaling effect of a change in dividends?
2. List the determinants of dividend policy.
