10) In establishing a dividend policy, a firm should retain funds for investment in projects yielding higher
returns than the owners could obtain from external investments of equal risk.
11) If a firm pays out a higher percentage of earnings, new equity capital will have to be raised with
common stock, which will result in higher control and earnings for the existing owners.
12) Firms are usually prohibited by state law from distributing ________.
A) retained earnings as dividends
B) paid-in capital in excess of par as dividends
C) dividends in a year the firm has a net loss
D) preferred dividends
13) Tangshan Mining has common stock at par of $200,000, paid-in capital in excess of par of $400,000,
and retained earnings of $280,000. In states where the firm’s legal capital is defined as the par value of
common stock, the firm could pay out ________ in cash dividends without impairing its capital.
A) $200,000
B) $680,000
C) $600,000
D) $880,000
14) Tangshan Mining has common stock at par of $200,000, paid-in capital in excess of par of $400,000,
and retained earnings of $280,000. In states where the firm’s legal capital is defined as the total of par
value and paid-in capital in excess of par, the firm could pay out ________ in cash dividends without
impairing its capital.
A) $280,000
B) $400,000
C) $480,000
D) $600,000
15) Legal capital refers to ________.
A) a legal constraint imposed by lenders of a firm to maintain a certain level of debt to equity ratio and
capital
B) capital impairment restrictions are generally established to provide a sufficient equity base to protect
creditors’ claims
C) the capital which is typically measured by the retained earnings
D) the capital which is typically measured by net income
16) A firm has the following stockholders’ equity balances:
In states where the firm’s legal capital is defined as the par value of its common stock, the maximum cash
dividend the firm could pay is ________.
A) $3,600,000
B) $400,000
C) $3,200,000
D) $1,600,000
17) An excess earnings accumulation tax is levied when ________.
A) shareholders receive dividends which exceed a firm’s earnings
B) firms do not pay dividends in order to delay the owners’ tax liability
C) firms do not pay dividends to reinvest in the firm
D) earnings exceed accumulated dividends over the years
18) The capital impairment restrictions are established to ________.
A) reduce dividends equal to or below the current earnings level
B) constrain the firm to paying dividends which do not require additional borrowing
C) provide sufficient safety to equity holders
D) provide a sufficient equity base to protect creditors’ claims
19) With regard to dividend payments, which of the following is included in the contractual constraints
imposed by loan agreements?
A) limiting the payment to suppliers
B) limiting the percentage of earnings that can be paid out in dividends
C) sustaining a constant dividend payout ratio
D) making fixed payment to equityholders
20) Which of the following is considered in designing a dividend policy that is favorable to wealthy
owners?
A) the tax status of the firm’s owners
B) the political risk of the firm
C) the liability of the firm’s owners
D) the reinvestment risk of the firm
21) A firm that has a large percentage of ________ investors may pay out a lower percentage of its
earnings as dividends.
A) wealthy
B) domestic
C) middle-income
D) international
22) According to ________, investors’ demands for dividends fluctuate over time.
A) the catering theory
B) Modigliani and Miller theory
C) the residual theory of dividends
D) CAPM theory
23) According to the catering theory, firms cater to the preferences of ________.
A) investors
B) creditors
C) managers
D) government
14.5 Types of dividend policies
1) A constant-payout-ratio dividend policy is based on the payment of a certain percentage of earnings to
owners in each dividend period.
2) Regular dividend policy is a dividend policy based on the payment of a certain fixed percentage of
earnings to owners in each dividend period.
3) Regularly paying a fixed or increasing dividend reduces uncertainty about the frequency and
magnitude of dividends.
4) By calling the additional dividend an extra dividend, a firm avoids setting expectations that the
dividend increase will be permanent.
5) The dividend policy must be formulated considering two basic objectives, namely ________.
A) delaying the tax liability of the stockholder and information content
B) maximizing shareholder wealth and maintaining liquidity
C) maximizing shareholder wealth and providing for sufficient financing
D) maintaining liquidity and minimizing the weighted average cost of capital
6) A firm has current after-tax earnings of $1,000,000 and has declared a cash dividend of $400,000. The
firm’s dividend payout ratio is ________.
A) 2.5 percent
B) 2.0 percent
C) 4.0 percent
D) 40 percent
7) A firm’s dividend payout ratio is calculated by ________.
A) dividing cash dividend per share by its earnings per share
B) dividing earnings per share by its cash dividend per share
C) dividing cash dividend per share by its net income
D) dividing net income by its cash dividend per share
8) A firm has had the following earnings history over the last five years:
If the firm’s dividend policy was based on a constant payout ratio of 50 percent for all of the years with
earnings over $1.50 per share and a zero payout otherwise, the annual dividends for 2016 and 2019 were
________.
A) $0.50 and $1.25, respectively
B) $0 and $2.00, respectively
C) $0 and $1.25, respectively
D) $0 and $0.88, respectively
9) Which type of dividend payment policy has the disadvantage that if a firm’s earnings drop or if a loss
occurs in a given period, dividends may be low or nonexistent?
A) constant-payout-ratio policy
B) regular dividend policy
C) low-regular-and-extra dividend policy
D) stock dividend policy
10) The problem with a constant-payout-ratio dividend policy from the shareholders’ perspective is that
________.
A) it pays constant dividend irrespective of the earnings of a firm
B) if the firm’s earnings drop, the dividends tend to be lower
C) even when earnings are low, the company must pay a fixed dividend
D) there is no uniformity in this type of dividend policy
11) The problem with the regular dividend policy from a firm’s perspective is that ________.
A) it regularly pays dividends which fluctuate with earnings
B) if the firm’s earnings drop, the dividends may be low
C) even when earnings are low, the company must pay a fixed dividend
D) it increases the shareholders’ uncertainty
12) When a firm pays a stated dollar dividend and adjusts the payment as earnings increase, its dividend
policy can be called ________.
A) a low-regular-and-extra dividend policy
B) a regular dividend policy
C) a target dividend-payout ratio policy
D) a constant-payout-ratio dividend policy
13) Which type of dividend payment policy has the advantage that if a firm’s earnings drop, dividends
will still be maintained at a relatively constant level?
A) constant-payout-ratio policy
B) regular dividend policy
C) low-regular-and-extra dividend policy
D) target dividend policy
14) A firm has had the following earnings history over the last five years:
If the firm’s dividend policy is based on a $0.50 payout per share whenever it makes a positive earnings,
increasing by $0.05 to previous year dividends per share whenever earnings exceed $1.50 per share, the
annual dividends for 2018 and 2019 were ________.
A) $0.50 and $0.60, respectively
B) $0.50 and $0.55, respectively
C) $0.55 and $0.65, respectively
D) $0.60 and $0.65, respectively
15) At a firm’s quarterly dividend meeting held on December 5, the directors declared a $1.50 per share
cash dividend to be paid to the holders of record on Monday, January 1. Before the dividend was
declared, the firm’s accumulated retained earnings balance and cash balance were $1,280,000 and $30,000
respectively. The firm has 10,000 shares of common stock outstanding. On January 2, the cash, dividends
payable, and retained earnings accounts had balances of ________.
A) $15,000, $0, and $1,265,000, respectively
B) $30,000, $15,000, and $1,280,000, respectively
C) $30,000, $0, and $1,265,000, respectively
D) $15,000, $0, and $1,280,000, respectively
16) A firm has had the following earnings history over the last five years:
If the firm’s dividend policy was to pay $0.25 per share each period, except that when earnings exceed
$1.50 the firm pays an extra dividend equal to 50 percent of the earnings above $1.50, the annual
dividends for 2016 and 2019 were ________.
A) $0.25 and $1.25, respectively
B) $0.25 and $0.75, respectively
C) $0 and $0.25, respectively
D) $0.25 and $0.25, respectively
17) The advantage of using the extra dividend policy is that ________.
A) a firm can avoid giving false hopes to shareholders
B) if a firm’s earnings drop, so does the dividend payment
C) the extra dividend may become a regular event
D) cyclical shifts in earnings may be avoided
18) An advantage of a ________ is that it avoids giving shareholders false hopes.
A) constant-payout-ratio policy
B) regular dividend policy
C) low-regular-and-extra dividend policy
D) target dividend policy
19) A firm has had the indicated earnings per share over the last three years:
(a) If the firm’s dividend policy was based on a constant payout ratio of 50 percent, determine the annual
dividend for each year.
(b) If the firm’s dividend policy was based on a fixed dollar payout policy of 50 cents per share plus an
extra dividend equal to 75 percent of earnings per share above $1.00, determine the annual dividend for
each year.
14.6 Other forms of dividends
1) A stock split commonly increases the stock‘s per share par value.
2) The payment of a stock dividend is a shifting of funds between stockholders’ equity accounts rather
than an outflow of funds.
3) When a firm pays a stock dividend, the shareholder‘s proportion of ownership in a firm remains the
same, and as long as the firm’s earnings remain unchanged, so does his or her share of total earnings.
4) If a firm’s earnings remain constant and total cash dividends do not increase, a stock dividend results
in a lower per-share market value for the firm’s stock.
5) The shareholder receiving a stock dividend receives a share of common stock of equal value to their
existing shares of common stock.
6) After the stock dividend is paid, the per share value of a stockholder’s stock will remain the same as
the value before the stock dividend and, thus, the market value of his or her total holdings in the firm will
remain unchanged.
7) A shareholder receiving a stock dividend typically receives nothing of value.
8) The shareholder receiving a stock dividend receives ________.
A) a share of common stock of equal value to their existing shares of common stock
B) cash
C) additional shares of common stock and cash
D) nothing of value
9) Stock dividends are ________.
A) taxable at a higher level than dividend taxes
B) taxable at a lower level than dividend taxes
C) non taxable
D) are taxable only to the shareholders
10) Mr. R. owns 20,000 shares of ABC Corporation stock. The company is planning to issue a stock
dividend. Before the dividend Mr. R. owned 10 percent of the outstanding stock, which had a market
value of $200,000, or $10 per share. Upon receiving the 10 percent stock dividend the value of his shares is
________.
A) $220,000
B) $210,000
C) $200,000
D) $180,000
11) Paying a stock dividend ________.
A) decreases the retained earnings account
B) has no effect on the retained earnings account
C) increases the retained earnings account
D) reorganizes the income
12) Tangshan Mining has 100,000 shares outstanding and just declared a 20% stock dividend. Before the
announcement, the firm’s shares were trading at $50.00 per share. After the stock dividend, the firm’s
shares should trade at ________ per share.
A) $42.00
B) $41.67
C) $46.33
D) $50.00
13) In a 2-for-1 stock split, the number of shares outstanding decreases by fifty percent and the stock’s per
share par value will double.
14) Reverse stock splits are usually initiated when a stock is selling at a very low price.
15) A stock split is usually taxable to a firm as it restructures the capital.
16) A ________ has an effect on a firm’s share price similar to that of a ________.
A) stock repurchase; stock split
B) stock dividend; stock split
C) cash dividend; stock dividend
D) cash dividend; stock split
17) The purpose of a stock split is to ________.
A) change a firm’s capital structure
B) decrease the dividend
C) enhance the trading activity of the stock by lowering the market price
D) increase the market price of a stock
18) A stock split has ________.
A) little effect on a firm’s capital structure
B) no effect on a firm’s capital structure
C) a measurable effect on a firm’s capital structure
D) a detrimental effect on a firm’s capital structure
19) The purpose of a reverse stock split is to ________.
A) issue additional shares
B) increase the dividend
C) increase the price of a stock
D) decrease trading activity
20) The primary purpose of a stock split is to ________.
A) issue additional shares
B) increase the dividend
C) reduce the price of a stock
D) reduce trading activity
21) Tangshan Mining has 100,000 shares outstanding and just declared a 2-for-1 stock split. Before the
announcement, the firm’s shares were trading at $50.00 per share. After the stock split, the firm’s shares
should trade at ________ per share.
A) $100.00
B) $25.00
C) $50.00
D) $75.00
22) Tangshan Mining has 100,000 shares outstanding and just declared a 3-for-2 stock split. Before the
announcement, the firm’s shares were trading at $50.00 per share. After the stock split, the firm’s shares
should trade at ________ per share.
A) $33.33
B) $66.67
C) $75.00
D) $100.00
23) Hayley’s Optical has a stockholders’ equity account as shown below. The firm’s common stock
currently sells for $20 per share.
(a) What is the maximum dividend per share Hayley’s Optical can pay? (Assume capital includes all
paid-in capital.)
(b) Recast the partial balance sheet (the stockholders’ equity accounts) to show independently
(1) a 2-for-1 stock split of the common stock.
(2) a cash dividend of $1.50 per share.
(3) a stock dividend of 5% on the common stock.
(c) At what price would you expect Hayley’s Optical stock to sell after
(1) the stock split?
(2) the stock dividend?
24) Tangshan Mining Company has released the following information.
(a) What are Tangshan Mining’s current earnings per share?
(b) What is Tangshan Mining’s current P/E ratio?
(c) Tangshan Mining wants to use half of its earnings either to pay shareholders dividends or to
repurchase shares for inclusion in the firm’s employee stock ownership plan. If the firm pays a cash
dividend, what will be the dividend per share received by existing shareholders?
(d) Instead of paying the cash dividend, what if the firm uses half of its earnings to pay $55 per share to
repurchase the shares, what will be the firm’s new EPS? What should be the firm’s new share price?
(e) Compare the impact of a stock dividend and stock repurchase on shareholder wealth.