Principles of Managerial Finance, 15e (Zutter)
Chapter 14 Payout Policy
14.1 The basics of payout policy
1) Payout policy refers to the decisions that firms make about whether to distribute cash to shareholders,
how much cash to distribute, and by what means the cash should be distributed.
2) Rapidly growing firms pay high dividends to shareholders.
3) Dividends are the only means by which firms can distribute cash to shareholders.
4) Companies can distribute cash to shareholders through dividends or share repurchases, but they rarely
do both.
5) Because retained earnings are a form of internal financing, the dividend decision can significantly
affect a firm’s external financing requirements.
6) In the aggregate, firms distribute far more cash to shareholders by paying dividends than they do by
repurchasing shares.
7) In the U.S. over the last 40 years or so, in the aggregate ________.
A) the dollar volume of share repurchases has been growing faster than the volume of dividend
payments
B) the dollar volume of dividend payments has been growing faster than the volume of share repurchases
C) the dollar volume of dividend payments and share repurchases have been growing at about the same
pace
D) firms have been cutting back on share repurchase activities
8) In the aggregate, over time dividend payments tend to fluctuate more than share repurchases.
9) In the aggregate and over a long period of time ________.
A) earnings grow faster than dividends
B) earnings and dividends grow at a similar pace
C) earnings grow more slowly than dividends
D) dividend payments exceed earnings
10) When firms’ earnings fluctuate, they tend to adjust their payout policy by ________.
A) allowing dividends to fluctuate while holding share repurchases relatively steady
B) allowing share repurchases to fluctuate while holding dividends relatively steady
C) adjusted both dividends and share repurchases so the total payout as a percentage of earnings remains
relatively steady
D) stop paying dividends and repurchasing shares
11) Over many years, share repurchases have accounted for an increasing percentage of the total cash
paid out by firms to shareholders.
12) After a recession when the economy starts to expand again, firms tend to ________.
A) increase share repurchases faster than they increase dividends
B) increase dividends faster than they increase share repurchases
C) increase share repurchases and dividends at a similar rate
D) increase dividends and hold share repurchases constant until they are confident that the recovery will
last for a few years
14.2 The mechanics of payout policy
1) Holders of record are stockholders whose names are recorded on the date of record receive the
declared dividend.
2) Purchasers of a stock selling ex dividend receive the current dividend.
3) The date of record (dividends) is the actual date on which a company will mail the dividend payment
to the holders of record.
4) The dividend payment date is set by a firm’s board of directors and represents the actual date on which
the firm mails the dividend payment to the holders of record.
5) The payment date is five days after the date of record, on which the company will mail the dividend
payment to the holders of record.
6) The ex dividend period begins four business days prior to the payment date.
7) The payment of cash dividends to corporate stockholders is decided based on the recommendation of
the auditors.
8) The repurchase of common stock results in a type of reverse dilution, since the earnings per share
increases as the number of shares outstanding falls.
9) The repurchase of shares reduces the number of outstanding shares.
10) In a tender offer share repurchase, a firm announces the price it is willing to pay to buy back shares
and the quantity of shares it wishes to repurchase.
11) With the passage of the Tax Cuts and Jobs Act of 2017, dividends paid by corporations are not taxable
at the shareholder level.
12) The Jobs and Growth Tax Relief Reconciliation Act of 2003 significantly reduced the double taxation
of dividends.
13) By purchasing shares through a firm’s dividend reinvestment plan (or DRIP), shareholders typically
can acquire shares at a value that is below the prevailing market price.
14) By purchasing shares through a firm’s dividend reinvestment plan (or DRIP), shareholders typically
can acquire shares at a value that is above the prevailing market price.
15) Dividend reinvestment plans (DRIPs) enable stockholders to use dividends received on a firm’s stock
to acquire additional shares—even fractional shares—at little or no transaction (brokerage) cost.
16) In theory, when a stock begins to trade ex dividend, the price of the stock should drop by roughly the
amount of the dividend.
17) When common stock is repurchased and retired, the underlying motive is to ________.
A) delay taxes
B) boost the stock’s dividends
C) distribute cash to the owners
D) reduce the retained earnings balance
18) Which of the following type of firms are most likely to pay cash dividends?
A) rapidly growing firms
B) firms encouraging innovation
C) large mature firms
D) firms expanding their operations
19) At a firm’s quarterly dividend meeting held April 9, the directors declared a $0.50 per share cash
dividend for the holders of record on Monday, May 19. The firm’s stock will sell ex dividend on about
________.
A) April 11
B) April 9
C) May 19
D) May 17
20) The term ex dividend refers to ________.
A) a period beginning 2 business days prior to the date of record, during which a stock is sold without
the right to receive the current dividend
B) the date on which all investors whose names are recorded as stockholders receive a declared dividend
at a specified future time
C) a period beginning 7 business days prior to the date of record, during which a stock is sold without the
right to receive the current dividend
D) the actual date on which a firm mails the dividend payment to the holders of record
21) The payment of cash dividends to corporate stockholders is decided by the ________.
A) creditors
B) stockholders
C) SEC
D) board of directors
22) In a(n) ________, a firm specifies a range of prices that it is willing to repurchase shares and the
quantity of shares that it desires.
A) Dutch auction
B) tender offer
C) American option
D) self-tender offer
23) In a(n) ________, a firm announces the price it is willing to pay to buy back shares and the quantity of
shares it wishes to repurchase.
A) Dutch auction
B) tender offer
C) American option
D) European auction
24) A tender offer repurchase is a repurchase program in which a firm ________.
A) offers to repurchase a fixed number of shares, usually at a discount relative to the market value
B) offers to repurchase a fixed number of shares, usually at a premium relative to the market value
C) offers to repurchase a fixed number of shares, usually at par relative to the market value
D) has a right to repurchase a fixed number of shares at a premium relative to the market value
25) Which of the following is a reason for a firm for repurchasing its shares?
A) to diminish the shareholder value by increasing the number of shares outstanding and thereby raising
earnings per share
B) to help encourage a friendly takeover by increasing the number of publicly traded shares
C) to distribute cash to stockholders
D) to make shares available for cash dividends
26) The net effect of a stock repurchase is ________.
A) similar to an interest payment
B) similar to a cash dividend
C) similar to a stock split
D) similar to a reverse stock split
27) Which of the following is true of a dividend payout?
A) When a firm announces that it will increase its dividend, the share price usually decreases on that
news.
B) Dividend payments send a positive signal to investors in the marketplace that management believes
that the stock is overvalued.
C) When a stock begins to trade ex dividend the share price will fall.
D) When a stock begins to trade ex dividend there is no impact on the share price if the market. is
efficient
28) Which of the following methods can be utilized by a firm when it wants to purchase outstanding
shares of common stock?
A) a purchase of stock through private placement
B) a tender offer at varying prices
C) a tender offer at a specified price
D) an European auction plan
29) Repurchase of stock ________ the earnings per share and ________ the market price of stock.
A) increases; increases
B) decreases; decreases
C) increases; decreases
D) decreases; increases
30) In a Dutch auction, ________.
A) a firm offers to repurchase a fixed number of shares, at a discount
B) a firm offers to repurchase a fixed number of shares, at a premium
C) a firm specifies a range of prices at which it is willing to repurchase shares and the quantity of shares
that it desires
D) a firm enables stockholders to use dividends received on the firm’s stock to acquire additional shares
31) Under the Jobs and Growth Tax Relief Reconciliation Act of 2003, the maximum rate of taxation on
dividends received by shareholders was set at ________.
A) 18%
B) 20%
C) 25%
D) 15%
32) A dividend reinvestment plan enables stockholders to ________.
A) reinvest the dividends in money market instruments which are risk free
B) reinvest all dividends in the firm with no accompanying increase in equity
C) acquire additional dividends through redemption of stock
D) acquire shares at little or no transaction costs
33) At the quarterly meeting of Tangshan Mining Corporation, held on September 10th, the directors
declared a $1.00 per share dividend for the firm’s 100,000 shares of common stock outstanding. The net
effect of declaring and paying this dividend would be to ________.
A) decrease total assets by $100,000 and increase stockholders equity by $100,000
B) decrease total assets by $100,000 and decrease stockholders equity by $100,000
C) increase total assets by $100,000 and increase stockholders equity by $100,000
D) increase total assets by $100,000 and decrease stockholders equity by $100,000
34) The stock repurchase can be viewed as a cash dividend.
1) The residual theory of dividends suggests that the dividend paid by a firm should be viewed as a
residual, the amount left over after all acceptable investment opportunities have been undertaken.
2) The residual theory of dividends implies that if a firm’s available retained earnings are in excess of its
financing needs, it should distribute the earnings by paying dividends to stockholders.
3) The residual theory of dividends, as espoused by Modigliani and Miller, suggests that dividends
represent an earnings residual rather than an active decision variable that affects firm value; this means
that a firm’s decision to pay dividends or not will not have any impact on a firm’s share price.
4) The representative theory of dividends, as espoused by Modigliani and Miller, suggests that dividends
represent a significant active decision variable that affects firm value.
5) The clientele effect is the argument that a firm attracts shareholders whose preferences with respect to
the payment and stability of dividends corresponds to the payment pattern and stability of the firm itself.
6) According to Modigliani and Miller, a firm’s value is determined solely by the earning power and risk
of its assets and that the manner in which it splits its earnings stream between dividends and internally
retained funds does not affect this value.
7) Due to a clientele effect, Modigliani and Miller argue that shareholders with different dividend
preferences align with firms with different dividend policies in such a way that the value of a firm’s stock
is unaffected by dividend policy.
8) According to the bird-in-the-hand argument, current dividend payments reduce investor uncertainty
and result in a higher value for a firm’s stock.
9) As per dividend relevance theory, current dividend payments are believed to reduce investor’s
uncertainty, thereby—all else being equal—placing a lower value on a firm’s stock after its payment.
10) The bird–in-the-hand argument espousing the importance of dividends or dividend relevance
suggests that investors view current dividends as less risky than future dividends or capital gains.
11) The informational content of dividends refers to a link between dividend and future earnings. In
other words, investors view a change in dividends, up or down, as a signal that management expects
future earnings to change in the same direction.
12) Dividend payment policy is a form of ________.
A) capital budgeting policy
B) financing policy
C) working capital policy
D) dividend reinvestment policy
13) The residual theory of dividends suggests that ________.
A) different payout policies attract different types of investors but still do not change the value of a firm
B) dividends are irrelevant in determining the value of a firm
C) as long as a firm’s equity need exceeds the amount of retained earnings, no cash dividend is paid
D) the payout policies of different firms have no impact on the taxes that investors have to pay
14) According to the residual theory of dividends, if a firm’s equity need is less than the amount of
retained earnings, the firm would ________.
A) borrow to pay the cash dividend
B) declare a dividend equal to the remaining balance
C) pay no cash dividends
D) pay dividends higher than the remaining balance to gain credibility
15) According to the residual theory of dividends, if a firm’s equity need exceeds the amount of retained
earnings, the firm would ________.
A) borrow to pay the cash dividend
B) sell additional stock to pay the cash dividend
C) pay no cash dividends
D) pay less dividends
16) The clientele effect refers to ________.
A) the relevance of dividend policy on a firm’s share value
B) a firm’s ability to attract stockholders whose dividend preferences are similar to the firm’s dividend
policy
C) the informational content of dividends that helps in predicting the future earnings and growth of a
firm
D) the “bird–in-the-hand” argument
17) Modigliani and Miller suggest that the value of a firm is not affected by the firm’s dividend policy,
due to ________.
A) the relevance of dividends
B) the clientele effect
C) the informational content
D) the optimal capital structure
18) Gordon and Lintner, recognizing that dividends affect stock prices, suggest that positive effects of
dividend increases are attributable ________.
A) directly to the dividend policy
B) directly to the optimal capital structure
C) not to the informational content but to the consistency in the payment of dividends
D) to the informational content of the dividends with respect to future earnings
19) Gordon’s “bird–in-the-hand” argument suggests that ________.
A) dividends are irrelevant
B) firms should have a 100 percent payout policy
C) shareholders are risk averse and attach less risk to current dividends
D) the market value of a firm is unaffected by dividend policy
20) The information content of dividends refers to ________.
A) the nonpayment of dividends by corporations
B) dividend changes as indicators of a firm‘s future
C) a stable and continuous dividend
D) a study of firm’s history of dividend payments
21) Which of the following is true of arguments for dividend relevance?
A) A firm’s value is determined solely by the earning power and risk of its assets.
B) Investors are generally risk averse and attach less risk to current dividends than future dividends or
capital gains.
C) The value of a firm is unaffected as it functions in a perfect market.
D) A clientele effect exists which causes a firm’s shareholders to receive the dividends that they expect.
14.4 Factors affecting dividend policy
1) While an earnings requirement limiting the amount of dividends paid is sometimes imposed, a firm is
not prohibited from paying more in dividends than its current earnings.
2) Since lenders are generally reluctant to grant loans to a firm to pay dividends, the firm’s ability to pay
cash dividends is generally constrained by the amount of excess cash available.
3) In most states, legal capital is measured not only by the par value and paid-in capital in excess of par,
but also by any accumulated retained earnings.
4) In most states, legal capital is measured either by the par value of common stock; other states, however,
define legal capital to include not only the par value of the stock, but also any paid-in capital in excess of
par.
5) If a firm has overdue liabilities or is legally insolvent or bankrupt, most states prohibit its payment of
cash dividends.
6) Legal constraints prohibit the payment of cash dividends until a certain level of earnings has been
achieved or limit the amount of dividends paid to a certain dollar amount or percentage of earnings.
7) The level of dividends a firm expects to pay is often directly related to how rapidly it expects to grow
and expand its operations.
8) The level of dividends a firm expects to pay is generally unrelated to how rapidly it expects to grow as
well as the level of asset investments required.
9) Because dividends are taxed at the same rate as capital gains under the 2003 Tax Act, a firm’s strategy
of paying low or no dividends primarily offers tax advantages to wealthy stockholders through tax
deferral.