Part 8 Financial Policies
CHAPTER 22
DIVIDEND POLICY
CHAPTER LEARNING OBJECTIVES
22.1 Explain what a cash dividend payment is, how dividend payments are made,
22.2 Describe typical dividend payouts and explain the importance of dividends.
22.3 Explain how Modigliani and Miller proved that dividend payments are
irrelevant, due to the existence of homemade dividends, and therefore have
22.4 Explain why dividend payments generally reflect the business risk of the
22.5 Explain why firms are reluctant to cut their dividends and why they smooth
22.6 Explain why dividends are not a residual, as implied by M&M.
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MULTIPLE CHOICE QUESTIONS
1. Place the following dates in chronological order from the earliest to the latest:
I. Holder of record date
II. Payment date
III. Declaration date
IV. Ex-dividend date
a) III, I, II, IV
b) III, IV, I, II
c) I, III, II, IV
d) IV, I, II, III
2. On January 1, 2015, you purchased 100 shares of Toronto Skaters Company. On February
1, 2015, the company declared a dividend of $2 per share for shareholders of record on March
15, 2015, payable on April 1, 2015. Assume the ex-dividend date is March 13, 2015. If you
wished to receive the dividend, you cannot sell your shares before:
a) February 2, 2015
b) March 13, 2015
c) March 16, 2015
d) April 2, 2015
3. Use the following statements to answer this question:
I. A DRIP is an investment plan that investors cannot choose to opt out from.
II. DRIPs and stock dividends are exactly the same thing.
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.
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4. Which of the following would result in a decrease in the number of shares outstanding and an
increase in the earnings per share?
a) Cash dividend
b) Stock dividend
c) Reverse stock split
d) None of the above result in a decrease in the number of shares outstanding
5. A dividend reinvestment plan (DRIP) differs from a stock dividend in which way?
a) DRIPs allow investors to use dividends to buy new shares, while a stock dividend is a
dividend paid in additional shares.
b) Stock dividends allow shareholders to purchase additional shares with their dividends at a
special discount, whereas a DRIP allows shareholders to purchase shares at the market price.
c) DRIPs allow shareholders to buy additional shares at a discount, whereas with a stock
dividend shareholders receive no discount.
d) Stock dividends are voluntary whereas DRIPs are mandatory.
6. With respect to a company paying a stock dividend, which of the following is false?
a) The capital account remains unchanged.
b) The overall value of the firm remains unchanged.
c) The corporation distributes additional stock certificates.
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d) There is no proportionate change in ownership.
7. Typically, when is the ex-dividend date?
a) The same as the payment date
b) The same as the declaration date
c) The record date
d) Two days before the record date
8. Which of the following is not a side effect of a stock dividend?
a) In terms of accounting, it is treated like a regular cash dividend.
b) Investors may ascribe an informational content to a stock dividend.
c) Investors pay the same amount of tax on stock dividends.
d) The stock price will increase.
9. A stock dividend differs from a stock split, in that:
a) The amount of a stock dividend is fully taxable, whereas there is no tax implication with a
stock split.
b) Stock dividends increase the number shares greater than 25 percent, whereas stock splits
increase shares by less than 25 percent
c) Stock splits always increase the average share price whereas for stock dividends the price
would remain the same
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d) Stock splits have an impact on retained earnings, whereas stock dividends have no impact
10. Which of the following is not a side effect of a stock split?
a) There is no effect on retained earnings account
b) Investors face no tax implications
c) The average share price will be reduced to reflect the split
d) There will be no change in the number of shares outstanding
11. Toronto Skaters Company currently has 100,000 shares outstanding. It has just declared a
2 for 1 stock split. After the split, the number of shares outstanding will be:
a) 50,000
b) 100,000
c) 200,000
d) Cannot be determined without knowing the dollar value of the stock on the ex-dividend date.
12. What is the most probable reason for stock splits?
a) The economic benefit for the firm
b) The increase in the number of shares where the price stays the same
c) Trading price at an acceptable level for small investors
d) Trading price at the penny stock level
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13. Toronto Skaters Company currently has 100,000 shares outstanding. It has just declared a
5 for 2 stock split. After the split, the number of shares outstanding will be:
a) 40,000
b) 100,000
c) 250,000
d) 500,000
14. Saguenay Resort Inc. and Gaspésie Spa Inc. both have 100,000 shares outstanding and
both stocks trade for $10 per share. Saguenay Resort Inc. pays a dividend of $1 per share while
Gaspésie Spa Inc. pays a 10% stock dividend. After the dividends are paid, the number of
shares outstanding for Saguenay Resort Inc. and Gaspésie Spa Inc., respectively, are:
a) 100,000; 100,000
b) 90,000; 100,000
c) 100,000; 110,000
d) 110,000; 90,000
15. St. Lawrence Ltd. and Mississippi Ltd. both have 50,000 shares outstanding and both stocks
trade for $8 per share. St. Lawrence Ltd. pays a dividend of $0.75 per share and Mississippi
Ltd. pays a 5% stock dividend. After the dividends are paid, the number of shares outstanding
for St. Lawrence Ltd. and Mississippi Ltd., respectively, are:
a) 50,000; 45,500
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b) 45,500; 50,000
c) 50,000; 52,500
d) 50,000; 50,000
16. Use the following statements to answer this question:
I. Dividends per share appear to be smoother than earnings.
II. Dividend yields are very different across firms in Canada
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.
17. Dividend payout ratios:
a) Usually do not vary from year to year, but remain constant
b) May be over 100 percent during times of economic expansion and high profits
c) May be over 100 percent during times of economic recession and low profits
d) Tend to be greater than 60 percent of profits.
18. Dividend yields:
a) Increase when share prices increase and dividends remain stable
b) Are similar among Canadian firms
c) Increase when dividends increase and share prices remain stable
d) Are always greater than 5%
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19. Dividend policy would be irrelevant if which of the following was true?
I. Capital gains and dividends were taxed equally
II. Markets were strong-form efficient
III. Transaction costs were negligible
a) I
b) III
c) II an III
d) I, II, and III
20. Subtracting capital expenditures from the cash flow from operations results in:
a) Capital financing amount
b) Free cash flow
c) Cash flow from capital expenditures
d) Residual capital amounts
21. Toronto Skaters Company has cash flows from operations of $100 million. Usually it pays a
total annual dividend of $100 million. In an M&M world, can reducing the dividend result in an
increase in the value of the firm?
a) No, according to M&M dividends are irrelevant so there should be no change in the value of
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the firm.
b) No, in fact it will decrease value because shareholders like dividends more than capital gains.
c) Yes, as long as the yield on the new investments the firm makes is greater than the return
required by the shareholders.
d) Yes, because shareholders like capital gains more than dividends.
22. According to the residual theory of dividends:
a) Paying dividends would affect the value of the firm
b) Dividends would be as volatile as earnings
c) Dividends should be very smooth
d) Mature companies would pay higher dividends
23. A cash cow is a firm that:
a) has high present value of growth opportunities, but lower present value of existing
opportunities
b) pays regular, but declining dividends to their investors
c) has a high present value of existing opportunities but a low present value of growth
opportunities
d) pays a constant level of dividends to their investors
24. The Northwest Territories Bikini Company has cash flows from operations of $150 million
and needs $105 million for investment purposes. Assume the firm has 15 million shares
outstanding and its shares are presently trading at $15 per share. If the M&M conditions hold,
what is the value of the firm after paying a $3 per share dividend?
a) $180 million
b) $205 million
c) $225 million
d) $270 million
25. Northwest Territories Bikini Company has cash flows from operations of $150 million and
needs $125 million for investment purposes. Assume the firm has 15 million shares outstanding
and its shares are presently trading at $15 per share. If the M&M conditions hold, how many
new shares must be issued if the firm plans to pay a $3 per share dividend?
a) 1.33 million shares
b) 1.46 million shares
c) 1.67 million shares
d) 3.00 million shares
26. Northwest Territories Bikini Company has cash flows from operations of $150 million and
needs $125 million for investment purposes. Assume the firm has 15 million shares outstanding
and its shares are presently trading at $15 per share. If the M&M conditions hold, what is the
price per share of the firm after paying a $3 per share dividend?
a) $18
b) $15
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c) $13.67
d) $12
27. The concept of homemade dividends requires the following:
I. No taxes, transactions costs, or other market imperfections.
II. Management cooperation to implement.
III. The actions of individuals through their own behaviour
a) I
b) II
c) III
d) I and III
28. The model that states, all else equal, dividend-paying companies are less risky than non-
dividend-paying companies is called:
a) Residual dividend model
b) Modigliani and Miller dividend irrelevance model
c) The “bird in the hand” model
d) The signalling model