Foundations of Financial Management, 17e (Block)
Chapter 18 Dividend Policy and Retained Earnings
1) The “marginal principle of retained earnings” states that corporate investment should provide
a return equal to or higher than what a stockholder could earn.
2) Dividends are the active variable in the “marginal principle of retained earnings.”
3) At the maturity stage (Stage IV) of the life cycle, the firm will usually pay out about 15-25%
of earnings in dividends.
4) A corporate life cycle shows the change of the company’s inventory and productivity.
5) Life cycle growth analysis can be helpful in determining a firm’s ability to pay dividends.
6) In the growth stage (Stage III) of the life cycle, the company focuses on growth of the stock
and usually doesn’t pay any cash dividends.
7) A major drawback to an investor is that dividends are viewed as a passive variable, so a fixed
income is never guaranteed.
8) One reason that investors may prefer stock dividends over cash dividends is so the investor is
provided with some growth or life cycle information about the company.
9) In Stage I of a firm’s life cycle, the firm will pay high dividends to shareholders in order to
attract additional investors.
10) In Stage II of a firm’s life cycle, expansion continues, but at a decreasing rate.
11) Generally, dividends should be changed when a corporation reaches a new level of
permanent income.
12) One of the major influences on dividends is the corporate growth rate in sales and the
subsequent return on assets.
13) When a firm raises its dividends, the information content is usually positive for investors.
14) Dividends may be relevant to distribute because they help resolve uncertainty about the firm
and its future.
15) Stable dividends may cause a higher discount rate for the firm, thereby raising the value of
the firm.
16) Stability of dividends is not important to stockholders, especially to those that rely on fixed
income.
17) Regardless of the situation, no well-managed firm would borrow money to pay dividends to
stockholders.
18) Dividends can only be distributed if the firm has positive income in the year the dividend is
paid.
19) Retained earnings accurately portray the liquidity position of the firm.
20) A firm will pay dividends as long as it has cash available.
21) Corporations are partially exempt from taxes on dividends received from other corporations.
22) Investors’ income level is used to determine their preference for dividends rather than capital
gains.
23) Stockholders in general prefer large dividends to small dividends.
24) If a stock dividend is given out and then a cash dividend, the stockholder will receive greater
total cash dividends.
25) The Internal Revenue Service generally places a higher tax rate on long-term capital gains
than it does upon ordinary or “qualified” dividends.
26) Because the capital gains tax is lower than other income, there are tax advantages to a stock
repurchase option.
27) A general rule of thumb would be that firms with a faster growth rate have smaller dividend
payout ratios.
28) Investors in high marginal tax brackets usually prefer companies that reinvest most of their
earnings, thus creating more growth in earnings and stock prices and deferring taxes into the
future.
29) A firm paying a stock dividend will experience a drop in its earnings per share but its
shareholders’ total claim on earnings will increase.
30) A rapid growth firm can often expect a shift in the type of its typical stockholder as the firm
moves into maturity.
31) Most dividends, like interest on corporate bonds, are paid semiannually.
32) Under current tax law (2013), long-term capital gains are taxed at a lower rate than
“ordinary” dividends.
33) Investors should try to invest in tax-exempt retirement accounts to try to avoid the higher
taxes placed on some investments.
34) Even though capital gains are taxed at a lower rate, there are some acts that charge higher
amounts of tax on investment income above a certain amount.
35) The dividend payout ratio is the dividend divided by the stock price.
36) The dividend payout ratio includes both stock dividends and cash dividends.
37) The dividend yield is the cash dividend divided by the current market price of the stock.
38) The dividend yield is defined by the amount of return the stockholder is getting in the form
of cash dividends compared to the stock market price.
39) Following the payment of a stock dividend, the firm’s stock price tends to drop slightly.
40) To receive a dividend on common stock, an investor must purchase the stock before the ex-
dividend date.
41) When a firm that previously paid regular dividends ceases to do so, the stock is ex-dividend
until the firm resumes regular dividend payments.
42) Stock dividends usually enhance the overall wealth of the company’s stockholders.
43) Stock dividends may be utilized to provide information to investors about growing
companies.
44) A stock split involves a reduction in the firm’s retained earnings account.
45) The accounting treatment for a stock split is different from a stock dividend in that there is
no transfer of funds from retained earnings to the capital accounts, but merely a reduction in par
value and a proportionate increase in the number of outstanding shares.
46) Distribution of 20-25% or greater of outstanding shares as a stock dividend is generally
treated as a stock split.
47) Stock splits are usually utilized to place stock in a lower-price trading range.
48) Stock splits increase the amount of shares, decreases the par value per share, and decreases
the overall value of common stock in the equity section of the balance sheet.
49) Stock dividends and stock splits have the same impact on retained earnings.
50) A reverse stock split is normally used by those firms whose stock price has been stable for
several years.
51) The repurchase of a corporation’s own stock will generally have a negative impact on the
stock market price.
52) Firms with extra money should always repurchase their own stock, thus increasing the value
of the firm.
53) Dividend reinvestment plans provide the stockholder with an opportunity to buy additional
shares of stock with the cash dividend paid by the company.
54) The cash savings from reduced dividend payments resulting from a stock repurchase strategy
can allow the company to increase its dividends for remaining shareholders.
55) The 2017 Tax Act reduced the corporate tax rate to 21% and instituted a territorial tax
system that taxes income in the country where income is generated.
56) The 2017 Tax Act has motivated companies to bring money home from other countries at
low tax rates and to buy back stock.
57) With a dividend reinvestment plan, an investor might receive fractional shares.
58) The goal of a company in the growth life-cycle stage should be to maximize dividends to
shareholders.
59) Investors in the retirement phase of their life cycle tend to prefer reinvestment of dividends
by firms.
60) Investors in the retirement phase of their life cycle tend to prefer steady cash dividends from
firms.
61) As tax rates on dividends have decreased, the preference for retention of earnings has
increased.
62) One situation in which a stock dividend may be beneficial to the investor is when the cash
dividend per share remains constant.
63) A stock dividend is often used when the company has high cash levels, but feels that a stock
dividend would be more beneficial to the investors.
64) The “ex-dividend date” will typically be before the “holder of record date.”
65) One way companies responded to the financial crisis of 2008-2009 was to cut their cash
dividends to stockholders.
66) For the most part, companies not directly associated with the financial crisis of 2008-2009
did not cut their dividend payments to stockholders.
67) A dividend reinvestment plan provides the investor with an opportunity to buy additional
shares of stock with the cash dividend paid by the company.
68) Research shows that firms that repurchase their shares exhibit positive stock price returns.