B) $2
C) $3
D) $4
56) Which of the following is NOT a method for a firm 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
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
57) What is the effect on the stock price when a firm repurchases its shares?
58) What is the bird–in–the–hand fallacy in dividend theory under perfect capital markets?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F‘ if the statement is false.
59) Long–term investors can defer capital gains tax until they sell, and therefore, there is a tax advantage for
share repurchases over dividends.
60) The optimal dividend policy when dividend tax rates exceed capital gains tax rates is to pay dividends only.
61) Different investor groups have differing dividend policy preferences that creates clientele effects in which
dividend policy of a firm is optimized for its investors.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
62) 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.
63) Historical evidence shows that over the last few decades a larger proportion of firms have used ________ for
payouts.
A) repurchases
B) dividends
C) stock reverse splits
D) stock splits
64) The fact that firms 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.
65) When a firm 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
66) Tax rates on dividends and capital gains differs across investors for a variety of reasons including
A) income.
B) investment horizon.
C) tax jurisdiction.
D) all of the above
67) 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.
68) Which of the following statements is FALSE?
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) 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.
69) Which of the following statements is FALSE?
A) 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.
B) When the tax rate on dividends exceeds the tax rate on capital gains, shareholders will pay lower taxes
if a firm uses share repurchases rather than dividends for all payouts.
C) Firms that use dividends will have to pay a lower after–tax return to offer their investors the same
pretax return as firms 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.
70) Which of the following statements is FALSE?
A) While firms do still pay dividends, substantial evidence shows that many firms have recognized their
tax disadvantage.
B) The fact that firms 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 firms.
D) 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.
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%.
71) The price of a share of JRN’s stock is closest to:
A) $20.00
B) $24.00
C) $25.00
D) $18.00
72) 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) $20.00
B) $25.00
C) $18.00
D) $24.00
73) The WTC Corporation will pay a constant dividend of $3.20 per share, per year, in perpetuity. If all
investors pay a 15% tax on dividends, there is no capital gains tax, and the cost of capital for investing in
WTC stock is 9%, what is the price for a share of WTC stock?
A) $30.22
B) $26.67
C) $18.77
D) $16.45
74) The largest proportion of investors in common stock are:
A) mutual funds.
B) pension funds.
C) corporations.
D) individual investors.
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
75) What is the general trend of dividend payments of U.S. corporations over the last few decades?
76) What is the general trend over the last few decades of total payouts by firms to shareholders be it through
share repurchase or dividends ?
77) What is the general trend of share repurchase as a percentage of total payout over the last few decades?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F‘ if the statement is false.
78) In perfect capital markets, buying and selling securities is a zero–NPV transaction, so retaining cash versus
paying it out does not affect firm value.
79) Because the dividend tax will be paid whether the firm pays cash immediately or retains cash and pays the
interest over time, the dividend tax rate does not affect the cost of retaining cash.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
80) 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. Alternately 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) indifferent between options
81) 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. Alternately 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) indifferent between options
82) 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. Alternately 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) indifferent between options
83) 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. Alternately 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) indifferent between options
84) 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. Alternately 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) indifferent between options
85) 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. Alternately, 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) indifferent between options
86) When a firm retains cash, it pays corporate tax on the interest it earns and the investor will owe capital gains
tax on the increased firm 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
87) Firms may retain large amounts of cash to cover future potential needs that allows a firm to avoid
A) transaction costs and financial distress costs.
B) tax payments.
C) clientele effects.
D) none of the above
88) When a firm has excessive cash, managers may make use of the funds in an inefficient manner. This is also
referred to as the ________ cost of retaining cash.
A) fixed
B) agency
C) interest
D) special
89) Prada has ten million shares outstanding, generates free cash flows 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 flows of $5 million each year. Should Prada invest or repurchase the shares?
A) indifferent between options
B) repurchase
C) invest
D) cannot say for sure
90) Prada has nine million shares outstanding, generates free cash flows 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 flows of $5 million each year. Should Prada
invest or repurchase the shares?
A) indifferent between options
B) repurchase
C) invest
D) cannot say for sure
91) Prada has ten million shares outstanding, generates free cash flows 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 flows of $2 million each year. Should Prada invest or
repurchase the shares?
A) indifferent between options
B) repurchase
C) invest
D) cannot say for sure