Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of
$40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. omicrons
unlevered cost of capital is 10% 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 firm’s stock.
1)
Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend.
Omicron’s ex–dividend price is closest to:
1)
A)
$45.00
B)
$50.00
C)
$40.00
D)
$5.00
2)
Consider the following equation:
Pcum – Pex = Div ×1–
d–g
1–g
The term d is
2)
A)
the personal tax rate for capital gains.
B)
the personal tax rate for dividend.
C)
the price per share before a dividend is paid.
D)
the price per share after a dividend is paid.
B
C
3)
Which of the following statements is false?
3)
A)
To compare investor preferences, we must quantify the combined effects of dividend and
capital gains taxes to determine an effective dividend tax rate for an investor.
B)
Differences in tax preferences create clientele effects, in which the dividend policy of a firm is
optimized for the tax preference of its investor clientele.
C)
The dividend–capture theory states that absent transaction costs, investors can trade shares at
the time of the dividend so that non–taxed investors receive the dividend.
D)
Individuals in the highest tax brackets have a preference for stocks that pay high dividends,
whereas tax–free investors and corporations have a preference for stocks with no or low
dividends.
4)
Consider the following equation:
Pcum – Pex = Div ×1–
d–g
1–g
The term Pex is
4)
A)
the price per share after a dividend is paid.
B)
the personal tax rate for capital gains.
C)
the price per share before a dividend is paid.
D)
the personal tax rate for dividend.
A
D
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of
$40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. omicrons
unlevered cost of capital is 10% 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 firm’s stock.
5)
Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $50 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:
5)
A)
310
B)
275
C)
125
D)
250
Use the information for the question(s) below.
Rockwood Industries has 100 million shares outstanding, a current share price of $25, and no debt. Rockwood’s
management believes that the shares are under–priced, and that the true value is $30 per share. Rockwood plans to pay $250
million in cash to its shareholders by repurchasing shares. Management expects that very soon new information will come
out that will cause investors to revise their opinion of the firm and agree with Rockwood’s assessment of the firm’s true
value.
6)
Assume that Rockwood is not able to repurchase shares prior to the market becoming aware of the
new information regarding Rockwood’s true value. After the release of the new information
regarding the true value of Rockwood, and following the repurchase, the firm’s share price is
closest to:
6)
A)
$28.75
B)
$31.50
C)
$30.00
D)
$30.60
Use the information for the question(s) below.
Iota Industries is an all–equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free
cash flows of $75 million per year. Management plans to use the cash to expand the firm’s operations, which in turn will
increase future free cash flows by 12%. Iota’s cost of capital is 10% and assume that capital markets are perfect.
7)
The value of Iota if they not to use the $200 million to expand and hold the cash instead is closest to:
7)
A)
$688 million
B)
$950 million
C)
$840 million
D)
$825 million
8)
The price per share of Iota if they not to use the $200 million to expand and hold the cash instead is
closest to:
8)
A)
$16.80
B)
$16.50
C)
$19.00
D)
$13.75
9)
The date on which the board authorizes the dividend is the
9)
A)
distribution date.
B)
declaration date.
C)
record date.
D)
ex–dividend date.
Use the information for the question(s) below.
Iota Industries is an all–equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free
cash flows of $75 million per year. Management plans to use the cash to expand the firm’s operations, which in turn will
increase future free cash flows by 12%. Iota’s cost of capital is 10% and assume that capital markets are perfect.
10)
The value of Iota if they use the $200 million to expand is closest to:
10)
A)
$688 million
B)
$825 million
C)
$840 million
D)
$950 million
Use the information for the question(s) below.
The JRN Corporation will pay a constant dividend of $3 per share, per year, in perpetuity. Assume that all investors pay a
20% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 12%.
11)
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:
11)
A)
$24.00
B)
$20.00
C)
$25.00
D)
$18.00
Use the information for the question(s) below.
Rockwood Industries has 100 million shares outstanding, a current share price of $25, and no debt. Rockwood’s
management believes that the shares are under–priced, and that the true value is $30 per share. Rockwood plans to pay $250
million in cash to its shareholders by repurchasing shares. Management expects that very soon new information will come
out that will cause investors to revise their opinion of the firm and agree with Rockwood’s assessment of the firm’s true
value.
12)
Assume that Rockwood is able to repurchase shares prior to the market becoming aware of the new
information regarding Rockwood’s true value. After the repurchase, and following the release of
the new information regarding the true value of Rockwood, the firm’s share price is closest to:
12)
A)
$31.50
B)
$28.75
C)
$30.60
D)
$30.00
13)
If Rockwood is able to repurchase shares prior to the market becoming aware of the new
information regarding Rockwood‘s true value, then the number of shares outstanding following the
repurchase is closest to:
13)
A)
90 million
B)
92 million
C)
75 million
D)
10 million
Use the information for the question(s) below.
Luther Industries currently has 5 million shares outstanding and it stock is currently trading at $40 per share.
14)
Assuming Luther issues a 25% stock dividend, then Luther’s new share price is closest to:
14)
A)
$30.00
B)
$32.00
C)
$24.00
D)
$16.00
15)
Consider the following equation:
Pretain =Pcum ×
(1 –c)(1 –g)
(1 –i)
The term i in this equation represents
15)
A)
the investor’s tax rate on interest income.
B)
the corporation’s tax rate on interest income.
C)
the investor’s tax rate on capital gains.
D)
the investor’s tax rate on cumulative dividends.
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of
$40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. omicrons
unlevered cost of capital is 10% 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 firm’s stock.
16)
Assume that Omicron uses the entire $50 million to repurchase shares. The number of shares that
Omicron will repurchase is closest to:
16)
A)
1.0 million
B)
1.2 million
C)
0.9 million
D)
1.1 million
17)
Which of the following statements is false?
17)
A)
When the tax rate on dividends exceeds the tax rate on capital gains, shareholders will pay
lower taxes if a firm uses share repurchases for all payouts rather than dividends.
B)
The optimal dividend policy when the dividend tax rate exceeds the capital gain tax rate is to
pay no dividends at all.
C)
Firms that use dividends will have to pay a lower after–tax return to offer their investors the
same pre–tax return as firms that use share repurchases.
D)
When a firm pays a dividend, shareholders are taxed according to the dividend tax rate. If the
firm 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.
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of
$40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. omicrons
unlevered cost of capital is 10% 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 firm’s stock.
18)
Assume that Omicron uses the entire $50 million to repurchase shares. The amount of the regular
yearly dividends in the future is closest to:
18)
A)
$5.00
B)
$4.00
C)
$9.00
D)
$4.50
Use the information for the question(s) below.
Luther Industries currently has 5 million shares outstanding and it stock is currently trading at $40 per share.
19)
Assuming Luther issues a 5:2 stock split, then Luther’s new share price is closest to:
19)
A)
$16.00
B)
$32.00
C)
$30.00
D)
$24.00
20)
Assuming Luther issues a 5:2 stock split, then the number of shares Luther will have outstanding
following the split is closest to:
20)
A)
25.0 million
B)
16.0 million
C)
2.0 million
D)
12.5 million
Use the information for the question(s) below.
Consider the following tax rates:
Year
Capital
Gains Rate
Ordinary
Income Rate
Dividend
Rate
1997–2000 20% 40% 40%
2001–2002 20% 39% 39%
2003–15% 35% 15%
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held
for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the
highest bracket); the same is true for dividends if the assets are held for less than 61 days.
21)
The effective dividend tax rate for a one–year individual investor in 2006 is closest to:
21)
A)
20%
B)
35%
C)
0%
D)
15%
Use the information for the question(s) below.
Luther Industries has $5 million in excess cash and 1 million shares outstanding. Luther is considering investing the cash in
one–year treasury bills that are currently paying 5% 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.
22)
If Luther invests the excess cash in treasury bills, then the dividend per share next year will be
closest to:
22)
A)
$4.75
B)
$5.00
C)
$1.05
D)
$5.25
23)
Which of the following statements is false?
23)
A)
Stocks generally trade in lots of 1000 shares, and in any case do not trade in units less than
one share.
B)
If a company declares a 10% stock dividend, each shareholder will receive one new share of
stock for every 10 shares already owned.
C)
Non–cash special dividends are commonly used to spin off assets or a subsidiary as a
separate company.
D)
The typical motivation for a stock split is to keep the share price in a range thought to be
attractive to small investors.
A
24)
Consider the following equation:
Pcum – Pex = Div ×1–
d–g
1–g
The term g is
24)
A)
the price per share after a dividend is paid.
B)
the price per share before a dividend is paid.
C)
the personal tax rate for capital gains.
D)
the personal tax rate for dividend.
C
D
25)
A firm can repurchase shares through a(n) ________ in which it offers to buy shares at a
prespecified price during a short time period–generally within 20 days.
25)
A)
targeted repurchase
B)
Dutch auction share repurchase
C)
tender offer
D)
open market share repurchases
26)
Which of the following statements is false?
26)
A)
Unlike with capital structure, taxes are not an important market imperfection that influence a
firm’s decision to pay dividends or repurchase shares.
B)
Shareholders typically must pay taxes on the dividends they receive. They must also pay
capital gains taxes when they sell their shares.
C)
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.
D)
But because long–term investors can defer the capital gains tax until they sell, there is still a
tax advantage for share repurchases over dividends.
Use the information for the question(s) below.
Consider the following tax rates:
Year
Corporate
Tax Rate
Capital
Gains Rate
Ordinary
Income Rate
Dividend
Rate
1997–2000 35% 20% 40% 40%
2001–2002 35% 20% 39% 39%
2003–35% 15% 35% 15%
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held
for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the
highest bracket); the same is true for dividends if the assets are held for less than 61 days.
27)
The effective tax disadvantage for retaining cash in 2002 is closest to:
27)
A)
14.75%
B)
35.00%
C)
15.00%
D)
30.00%
Use the information for the question(s) below.
Consider the following tax rates:
Year
Capital
Gains Rate
Ordinary
Income Rate
Dividend
Rate
1997–2000 20% 40% 40%
2001–2002 20% 39% 39%
2003–15% 35% 15%
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held
for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the
highest bracket); the same is true for dividends if the assets are held for less than 61 days.
28)
The effective dividend tax rate for a buy and hold individual investor in 1999 is closest to:
28)
A)
20%
B)
40%
C)
0%
D)
25%
29)
The effective dividend tax rate for a pension fund in 2006 is closest to:
29)
A)
20%
B)
25%
C)
15%
D)
0%
Use the information for the question(s) below.
The JRN Corporation will pay a constant dividend of $3 per share, per year, in perpetuity. Assume that all investors pay a
20% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 12%.
30)
The price of a share of JRN’s stock is closest to:
30)
A)
$24.00
B)
$18.00
C)
$25.00
D)
$20.00
Use the information for the question(s) below.
Iota Industries is an all–equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free
cash flows of $75 million per year. Management plans to use the cash to expand the firm’s operations, which in turn will
increase future free cash flows by 12%. Iota’s cost of capital is 10% and assume that capital markets are perfect.
31)
The price per share of Iota if they use the $200 million to expand is closest to:
31)
A)
$13.75
B)
$16.80
C)
$19.00
D)
$16.50
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of
$40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. omicrons
unlevered cost of capital is 10% 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 firm’s stock.
32)
Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. The
amount of the regular yearly dividends in the future is closest to:
32)
A)
$9.00
B)
$5.00
C)
$4.00
D)
$4.50
33)
Which of the following statements is false?
33)
A)
While evidence is indicative of the growing importance of share repurchases as a part of
firms’ payout policies, it also shows that dividends remain a key form of payouts to
shareholders.
B)
While firms do still pay dividends, substantial evidence shows that many firms have
recognized their tax disadvantage.
C)
At the end of the 1990s dividend payments exceeded the value of repurchases for U.S.
industrial firms.
D)
The fact that firms continue to issue dividends despite their tax disadvantage is often referred
to as the dividend puzzle.
34)
Which of the following statements is false?
34)
A)
Rather than pay a dividend using cash or shares of its own stock, a firm can also distribute
shares of a subsidiary in a transaction referred to as a off–shoot.
B)
Stock dividends of 50% or higher are generally referred to as stock splits.
C)
If the price of the stock falls too low, a company can engage in a reverse split and reduce the
number of shares outstanding.
D)
With a stock dividend, a firm does not pay out any cash to shareholders. As a result, the total
market value of the firm’s assets and liabilities, and therefore of its equity, is unchanged.
Use the information for the question(s) below.
Consider the following tax rates:
Year
Corporate
Tax Rate
Capital
Gains Rate
Ordinary
Income Rate
Dividend
Rate
1997–2000 35% 20% 40% 40%
2001–2002 35% 20% 39% 39%
2003–35% 15% 35% 15%
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held
for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the
highest bracket); the same is true for dividends if the assets are held for less than 61 days.
35)
The effective tax disadvantage for retaining cash in 2006 is closest to:
35)
A)
35.00%
B)
15.00%
C)
14.75%
D)
12.50%
36)
Which of the following statements is false?
36)
A)
In perfect capital markets, an open market share repurchase has no effect on the stock price,
and the stock price is the same as the ex–dividend price if a dividend were paid instead.
B)
In a perfect capital market, when a dividend is paid, the share price drops by the amount of
the dividend when the stock begins to trade ex–dividend.
C)
In perfect capital markets, investors are indifferent between the firm distributing funds via
dividends or share repurchases. By reinvesting dividends or selling shares, they can replicate
either payout method on their own.
D)
In perfect capital markets, holding fixed the investment policy of a firm, the firm’s choice of
dividend policy is irrelevant and does not affect the initial share price.
37)
Which of the following statements is false?
37)
A)
Making positive–NPV investments will create value for the firm’s investors, whereas saving
the cash or paying it out will not.
B)
In perfect capital markets, if a firm invests excess cash flows in financial securities, the firm’s
choice of payout versus retention is irrelevant and does not affect the initial share price.
C)
In perfect capital markets, buying and selling securities is a zero–NPV transaction, so it
should not affect firm value.
D)
After adjusting for investor taxes, there remains a substantial tax advantage for the firm to
retain excess cash.
Use the information for the question(s) below.
Consider the following tax rates:
Year
Capital
Gains Rate
Ordinary
Income Rate
Dividend
Rate
1997–2000 20% 40% 40%
2001–2002 20% 39% 39%
2003–15% 35% 15%
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax rates shown are for financial assets held
for one year. For assets held less than one year, capital gains are taxed at the ordinary income tax rate (currently 35% for the
highest bracket); the same is true for dividends if the assets are held for less than 61 days.
38)
The effective dividend tax rate for a one–year individual investor in 1999 is closest to:
38)
A)
40%
B)
0%
C)
25%
D)
20%
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of
$40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. omicrons
unlevered cost of capital is 10% 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 firm’s stock.
39)
Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. The
amount of the special dividend is closest to:
39)
A)
$9.00
B)
$4.00
C)
$4.50
D)
$5.00
Use the information for the question(s) below.
Luther Industries has $5 million in excess cash and 1 million shares outstanding. Luther is considering investing the cash in
one–year treasury bills that are currently paying 5% 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.
40)
If Luther decides to pay the dividend immediately the dividend per share will be closest to:
40)
A)
$5.00
B)
$4.75
C)
$1.05
D)
$5.25
41)
Which of the following statements is false?
41)
A)
Managers will clearly be more likely to repurchase shares if they believe the stock to be
under–valued.
B)
While an increase of a firm’s dividend may signal management’s optimism regarding its
future cash flows, it might also signal a lack of investment opportunities.
C)
Managers are much less committed to dividend payments than to share repurchases.
D)
Share repurchases are a credible signal that the shares are under–priced, because if they are
over–priced a share repurchase is costly for current shareholders.
42)
Another to method to repurchase shares is the ________, in which the firm lists different prices at
which it is prepared to buy shares, and shareholders in turn indicate how many shares they are
willing to sell at each price.
42)
A)
tender offer
B)
targeted repurchase
C)
open market share repurchases
D)
Dutch auction share repurchase
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of
$40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. omicrons
unlevered cost of capital is 10% 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 firm’s stock.
43)
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:
43)
A)
250
B)
310
C)
125
D)
275
44)
Which of the following statements is false?
44)
A)
While cutting the dividend is costly for managers in terms of their reputation and the reaction
of investors, it is by no means as costly as failing to make debt payments.
B)
Because of the increasing popularity of repurchases, firms cut dividends much more
frequently than they increase them.
C)
If firms smooth dividends, the firm’s dividend choice will contain information regarding
management’s expectations of future earnings.
D)
Announcing a share repurchase today does not necessarily represent a long–term
commitment to repurchase shares.
45)
The firm mails dividend checks to the registered shareholders on the
45)
A)
record date.
B)
distribution date.
C)
declaration date.
D)
ex–dividend date.
46)
The firm will pay the dividend to all shareholders who are registered owners on a specific date, set
by the board, called the
46)
A)
distribution date.
B)
record date.
C)
ex–dividend date.
D)
declaration date.
B
47)
Which of the following formulas is incorrect?
47)
A)
Pretain =Pcum ×
(1 –c)(1 –g)
(1 –i)
B)
*retain =1 –
(1 –i)(1 –g)
(1 –c)
C)
Pretain =
Div × (1 –d)
rf× (1 –i)
D)
Pretain =Pcum × (1 –*retain)
B
(1 –C)(1 –g)
48)
Which of the following statements is false?
48)
A)
The average size of the stock price reaction increases with the magnitude of the dividend
change, and is larger for dividend cuts.
B)
Firms adjust dividends relatively infrequently, and dividends are much less volatile than
earnings. This practice of maintaining relatively constant dividends is called dividend
signaling.
C)
When a firm increases its dividend, it sends a positive signal to investors that management
expects to be able to afford the higher dividend for the foreseeable future.
D)
When managers cut the dividend, it may signal that they have given up hope that earnings
will rebound in the near term and so need to reduce the dividend to save cash.
B
B