Dividend Policy 22 – 12
29. The Modigliani and Miller dividend irrelevance theorem is based on the argument that:
a) Dividends are preferred to capital gains
b) Dividends and capital gains are perfect substitutes
c) Capital gains are preferred to dividends
d) Investors don’t value dividends, hence dividends are irrelevant
30. The “bird in the hand” argument is based on the argument that:
a) Dividends are preferred to capital gains
b) Dividends and capital gains are perfect substitutes
c) Capital gains are preferred to dividends
d) Investors don’t value dividends, hence dividends are irrelevant
31. What is the major argument that supports the “bird in the hand theory”?
a) There is no difference between dividend yields and capital gains.
b) The risk profile of the firm depends on the risk of its cash flows, not its dividends.
c) Present value of growth opportunities are more volatile, hence increase the risk of the firm.
d) Dividend payments signal the good standing of the firm.
32. The empirical evidence suggests that:
a) Firms follow a residual dividend policy
b) Firms follow a constant proportional dividend payout policy
c) Firms follow a constant dividend amount policy
d) Firms follow a random dividend amount policy
33. What does the Lintner empirical model suggest?
a) Firms rapidly adjust their dividends to changing economic conditions.
b) Firms pay out a constant proportion of their earnings as dividends.
c) Dividends are very sticky (i.e., they do not change frequently).
d) Firms pay out a constant proportion of their revenue as dividends.
34. Use the following statements to answer this question:
I. The Lintner equation shows that the relationship between past and current dividends exists
II. “Stickiness” of dividends contradicts the M&M irrelevance theory
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
35. Toronto Skaters Company has just declared its regular dividend of $1 per share. On March
1, the stock traded at $5 per share. The next day, the ex-dividend date, what do we expect to
see?
a) The stock price fall by $1.
b) The stock price fall by less than $1 due to investor taxes.
c) The stock price fall by more than $1 due to investor taxes.
d) The stock price rise by less than $1 due to investor taxes.
36. Which of the following has a positive impact on the share price?
a) Unexpected dividend increase
b) Unexpected dividend decrease
c) Unexpected stock dividend
d) None of the above is expected to have a positive impact on share prices
37. Management will increase dividends when:
a) it is sure the increased payments can be sustained.
b) it has an exceptionally successful year.
c) it believes the stock is underpriced.
d) earnings have fallen over the past few years.
38. If management wishes to distribute some portion of the firm’s increased earnings, but does
not want to raise false expectations, it will distribute a(n) _______________ dividend.
a) additional
22 – 15 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
b) special
c) non-regular
d) unrepeatable
39. Transaction costs can have an impact on a firm’s dividend policy:
a) if they are too high then this would reduce the firm’s ability to raise new capital
b) since they would impact the frequency of dividend payments
c) they would increase the costs for sending out dividend payments
d) if they are low then this would increase the size and frequency of dividend payments
40. An investor will prefer a high dividend if:
I. the firm cannot reinvest the funds in projects where the yields exceed those that a shareholder
could get elsewhere.
II. the investor needs a high level of current income.
III. the investor faces high personal taxes.
a) I only
b) II only
c) I and II
d) I and III
41. An investor will prefer a low dividend if:
I. the firm cannot reinvest the funds in projects where the yields exceed those that a shareholder
could get elsewhere.
II. the investor needs a high level of current income.
III. the investor faces high personal taxes.
Dividend Policy 22 – 16
a) I only
b) III only
c) I and II
d) II and III
42. The tax clientele phenomenon reflects:
I. Investors with higher income levels face higher marginal tax rates
II. There are different tax treatments for dividends and capital gains
III. That firms would have tax benefits to pay higher dividends to investors
a) I only
b) III only
c) I and II
d) I and III
43. Income stripping refers to the process of:
a) creating strip bonds for raising new debt financing
b) repackaging securities to provide different types of income based on different parts of the
return
c) dividing net income into residual earnings and dividend payments
d) setting aside excess income for share repurchases
44. Split shares are:
a) securities that are a combination of bonds and preferred shares, pay a combination of
22 – 17 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
dividends and coupon payments
b) a form of stock dividends that increase the number of shares issued
c) shares with multiple votes for directors
d) shares sold as the dividends and capital gains parts of a security
45. Which of the following would impact management’s decision regarding the proportion of
earnings to be paid out in dividends and the proportion to be retained for reinvestment?
a) Investors’ reinvestment opportunities
b) Tax considerations
c) The firm’s reinvestment opportunities
d) All of the above
46. Which of the following is not a motivation for a share repurchase?
a) Offsetting the exercise of executive stock options
b) Repurchase of shares from dissident shareholders
c) Pay free cash flows to shareholders without generating an expectation of continued dividends
d) To indicate that the management feels the stock is overvalued
47. Use the following two statements to answer this question:
I. Managers only repurchase stocks to take advantage of their underpricing
II. Stock repurchases are exactly the same as cash dividends in the real world.
a) I and II are correct.
b) I and II are incorrect.
Dividend Policy 22 – 18
c) I is incorrect and II is correct.
d) I is correct and II is incorrect.
48. Which of these factors is not a motivation for share repurchases:
a) offset the exercise of executive stock options
b) repurchase dissident shares
c) take the firm private
d) to reduce the firm’s levels of debt
22 – 19 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
PRACTICE PROBLEMS
49. Describe the similarities and differences between stock dividends and dividend reinvestment
plans.
50. Explain the concept of a homemade dividend and how it affects the value of the firm.
51. Evaluate the following statement: “If a firm has a number of positive NPV projects, it can cut
its dividend so that it is not passing up good opportunities.”
52. How is a stock repurchase related to the dividend decision? What is the impact on earnings
per share?
53. Montreal Trust Corp. is facing reduced earnings. Its entire industry has been facing declining
demand due to a severe recession; however its stock price has suffered more than the stock
price of its competitors. The market believes that it is fundamentally weaker than its competitors.
Montreal Trust’s CEO has decided to prop up the stock price by increasing its dividend. He
believes that, according to the dividend discount model (DDM), if Montreal Trust increases its
dividend, then its stock price will rise. Why won’t this work?
54. Toronto Trust Corp. is expecting an earnings increase this year. The CEO thinks that the
earnings increase may be temporary. Instead of raising dividends, she decides to repurchase
stock. Why does she choose stock repurchases over dividend increases?
22 – 21 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
Dividend Policy 22 – 22
LEGAL NOTICE