Chapter 17 - Dividends and Dividend Policy Chapter 17 Dividends and Dividend Policy Multiple Choice Questions Green Roof Motels has more cash on hand than its operations require Thus, the firm has decided to pay out some of its earnings in the form of cash to its shareholders What are these payments to shareholders called? A dividends B stock payments C repurchases D payments-in-kind E stock splits Lester's Frozen Foods just paid out $0.50 a share to its shareholders The cash for these payments came from a large sale of assets, not from any earnings of the firm What are these payments to shareholders called? A dividends B distributions C repurchases D payments-in-kind E stock splits A $0.60 quarterly cash payment paid by T.L Jones & Co to its shareholders in the normal course of business is called a: A repurchase B liquidating dividend C regular cash dividend D special dividend E extra cash dividend 17-1 Chapter 17 - Dividends and Dividend Policy The board of directors of Wilson Sporting Equipment met this afternoon and passed a resolution to pay a cash dividend of $0.42 a share next month In relation to this dividend, today is referred to as which one of the following dates? A decision date B date-of-record C declaration date D payment date E ex-dividend date The ex-dividend date is defined as _ business day(s) before the date of record A B C D E 10 Which one of the following dates is used to determine the names of shareholders who will receive a dividend payment? A ex-rights date B ex-dividend date C date of record D date of payment E declaration date Dividend payments are mailed on which one of the following dates? A ex-rights date B ex-dividend date C date of record D date of payment E declaration date 17-2 Chapter 17 - Dividends and Dividend Policy Which one of the following refers to the ability of shareholders to undo a firm's dividend policy and create an alternative dividend policy by reinvesting dividends or selling shares of stock? A perfect foresight model B personalization C recapitalization D offsetting leverage E homemade dividend policy What is the information content effect? A any type of new information that causes a firm to cease paying dividends B any news announcement that was anticipated and thus produces no reaction from investors C the primary contributing data that helps directors determine the amount of a particular dividend payment D any type of reaction from a shareholder in response to a news announcement related to the stock issuer E the financial market's reaction to a change in the amount of a firm's dividend 10 The common stock of Pierson Enterprises has historically had a high dividend yield and is expected to continue to so As a result, the majority of its shareholders are individuals and entities that are seeking a regular source of cash income Most of these shareholders pay either no taxes or a relatively low amount of taxes The fact that most of these shareholders have similar characteristics is referred to by which one of the following terms? A information content effect B clientele effect C efficient markets hypothesis D distribution effect E market reaction effect 11 HJ Corporation has excess cash and has opted to buy some of its shares of outstanding common stock What is this process of buying called? A stock dividend B stock split C stock repurchase D stock recap E stock repeal 17-3 Chapter 17 - Dividends and Dividend Policy 12 Which one of the following involves a payment in shares by a stock issuer that increases the number of shares a shareholder owns but also decreases the value per share? A cash dividend B stock dividend C stock repurchase D stock split E reverse stock split 13 Which one of the following does not affect the total equity of a firm but does increase the number of shares outstanding? A special dividend B stock split C share repurchase D rights offer E liquidating dividend 14 Bell Weather Markets has recently sold for as little as $8 a share and as much as $15 a share The difference between these two prices is referred to as the: A price variance B bid-ask spread C trading range D opening price E closing price 15 A reverse stock split is defined as: A an increase in the number of shares outstanding that does not affect owners' equity B a firm buying back existing shares of its stock on the open market C a firm selling new shares of stock on the open market D a decrease in the number of shares outstanding that does not affect owner's equity E a decrease in both the number of shares outstanding and the price per share 17-4 Chapter 17 - Dividends and Dividend Policy 16 Which one of the following statements related to cash dividends is correct? A Extra cash dividends cannot be repeated in the future B A dividend is never a liability until it has been declared C If a firm has paid regular quarterly dividends for at least five consecutive years it is legally obligated to continue doing so D Regular cash dividends reduce paid-in capital E The dividend yield expresses the annual dividend as a percentage of net income 17 Billingsley United declared a $0.20 a share dividend on Thursday, October 16 The dividend will be paid on Monday, November 10 to shareholders of record on Friday, October 31 Which one of the following is the ex-dividend date? A Tuesday, October 28 B Wednesday, October 29 C Thursday, October 30 D Wednesday, November E Thursday, November 18 Taylor's Tools declared a $0.48 a share dividend on Friday, March The dividend will be paid on Monday, April The ex-dividend date is Tuesday, March 18 What is the record date? A Friday, March 14 B Monday, March 17 C Wednesday, March 19 D Thursday, March 20 E Friday, March 21 19 The last date on which you can purchase shares of stock and still receive the dividend is the date which is _ business days prior to the date of record A B C D E 17-5 Chapter 17 - Dividends and Dividend Policy 20 Kate purchased 500 shares of Fast Deliveries stock on Wednesday, July 7th Ted purchased 100 shares of Fast Deliveries stock on Thursday, July 8th Fast Deliveries declared a dividend on June 20th to shareholders of record on July 12th and payable on August 1st Which one of the following statements concerning the dividend paid on August 1st is correct given this information? A Neither Kate nor Ted is entitled to the dividend B Kate is entitled to the dividend but Ted is not C Ted is entitled to the dividend but Kate is not D Both Ted and Kate are entitled to the dividend E Both Ted and Kate are entitled to one-half of the dividend amount 21 All else equal, the market value of a stock will tend to decrease by roughly the aftertax value of the dividend on the: A dividend declaration date B ex-dividend date C date of record D date of payment E day after the date of payment 22 Which one of the following statements related to dividend policy is correct? A The primary question related to dividend policy is whether or not a firm should ever pay a dividend B Both dividends and dividend policy are irrelevant C Dividend policy focuses on the timing of dividend payments D Homemade dividends increase the importance of a firm's dividend policy decisions E Whether or not a firm ever pays a dividend is irrelevant to equity valuation 17-6 Chapter 17 - Dividends and Dividend Policy 23 Automatic dividend reinvestment plans: I require that stockholders reinvest all of the dividends to which they are entitled II sometimes grant shareholders the privilege of purchasing additional shares at a discounted price III help shareholders create their own homemade dividend policies IV help make corporate dividend policies irrelevant to individual stockholders A II only B III only C II and III only D II, III, and IV only E I, II, III, and IV 24 Which of the following tends to increase the ability of a shareholder to create his or her own homemade dividend policy? I low taxes on capital gains II dividend reinvestment plans III large holdings of shares IV low cost equity purchases A II only B II and III only C I, II, and III only D II, III, and IV only E I, II, III, and IV 25 Which one of the following favors a low dividend policy? A the tax on capital gains is deferred until the gain is realized B few, if any, positive net present value projects are available to a firm C a majority of the shareholders has a low relevant tax rate D a majority of the shareholders has better investment opportunities with similar risks E corporate tax rates exceed personal tax rates 17-7 Chapter 17 - Dividends and Dividend Policy 26 The fact that flotation costs can be significant is an argument for: A a firm to issue larger dividends than its closest competitors B a firm to maintain a constant dividend policy even if it frequently has to issue new C shares D maintaining a constant dividend policy even when profits decline significantly E maintaining a high dividend policy F maintaining a low dividend policy and rarely issuing extra dividends 27 Which of the following tend to keep dividends low? I shareholders desiring current income II terms contained in bond indenture agreements III the desire to maintain constant dividends over time IV flotation costs A II and III only B I and IV only C II, III, and IV only D I, II, and III only E I, II, III, and IV 28 Which of the following shareholders tend to favor a high dividend policy? I retired individuals II endowment funds III corporate investors IV investors with high dividend tax rates but low capital gains tax rates A I and III only B II and IV only C I, II, and III only D II, III, and IV only E I, II, III, and IV 29 An investor is more likely to prefer a high dividend payout if a firm: A has high flotation costs B has few, if any, positive net present value projects C has lower tax rates than the investor D has a stock price that is increasing rapidly E offers substantial gains on its equities, which are taxed at a favorable rate 17-8 Chapter 17 - Dividends and Dividend Policy 30 The information content of a dividend increase generally signals that: A the firm has a one-time surplus of cash B the firm has few, if any, net present value projects to pursue C management believes earnings growth will be strong going forward D the firm has more cash than it needs due to a decline in future orders E dividends thereafter will be lower 31 S.L Moffatt, Inc has paid a quarterly dividend of $1.20 per share for the last ten quarters Which one of the following is most apt to cause the firm to reduce the amount of its next dividend payment? A decrease in the next quarter's revenue B decrease in the next quarter's net income C loss of a major customer which lowers the firm's outlook for the next few years D major lump sum cash outflow next month to settle a class action product liability lawsuit on a product that is no longer produced E decrease in the number of new projects under consideration as compared to last year 32 The dividend market is in equilibrium when: A all firms adopt a low dividend policy B half of the firms adopt a low dividend policy and half adopt a high dividend policy C all clienteles are satisfied D dividends remain constant and no special dividends are declared E the total amount of the annual dividends is equal to the net income for the year 33 Which one of the following statements related to stock repurchases is correct? A An open market stock repurchase increases the total wealth of a shareholder if you ignore taxes, costs, and market imperfections B Targeted repurchases must be offered to all shareholders but can be done in steps such that only a portion of the shareholders have the option to sell at any one point in time C When a firm wishes to repurchase shares in the open market, it will so in a special trading session that is set up by the SEC D A firm may spend more cash over the course of a year on stock repurchases than it does on cash dividends E Tender offer prices must be set equal to the opening market price on the day the tender offer is announced 17-9 Chapter 17 - Dividends and Dividend Policy 34 Which one of the following statements related to stock repurchases is correct? A U.S industrial firms have increased their stock repurchases every year for each of the past twenty years B A stock repurchase can be used as a means for incumbent officers to retain control of a firm C A tender offer indicates that a firm is willing and able to purchase how ever many shares the current shareholders wish to sell D All stock repurchases must be identified as such to the selling party E Stock repurchases can be a relatively tax-efficient method of distributing cash to shareholders 35 A stock repurchase program: A requires all shareholders to sell a fraction of their shares B is preferred over a high-dividend program only by tax-exempt shareholders C decreases both the number of shares outstanding and the market price per share D has no effect on a firm's financial statements E is essentially the same as a cash dividend program provided there are no taxes or other costs 36 Which one of the following is a result of a stock repurchase? A increase in the number of shares outstanding B increase in the market price per share C increase in the total equity of the repurchasing firm D decrease in EPS E PE ratio equal to that resulting from a comparable cash dividend 37 If you ignore taxes and costs, a stock repurchase will: I reduce the total assets of a firm II decrease the earnings per share III reduce the PE ratio more so than an equivalent stock dividend IV reduce the total equity of a firm A I and III only B I and IV only C II and IV only D I, III, and IV only E II, III, and IV only 17-10 Chapter 17 - Dividends and Dividend Policy 87 The Olive Vase has 56,000 shares of stock outstanding with a par value of $1 per share and a market value of $11 a share The company just announced a 3-for-4 reverse stock split Currently, you own 400 shares of this stock What will the total value of your shares be after the reverse stock split? A $3,300 B $4,400 C $5,500 D $5,867 E $6,333 The total value of your shares will not change Total value = 400(3/4)  $11(4/3) = $4,400 AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 17-3 Section: 17.8 Topic: Reverse stock split 88 The Green Florist has 28,000 shares of stock outstanding with a par value of $1 per share and a market value of $7 a share The company just announced a 2-for-5 reverse stock split Currently, you own 300 shares of this stock How many shares will you own after the reverse stock split? A 60 shares B 120 shares C 480 shares D 600 shares E 750 shares Number of shares = 300  2/5 = 120 shares AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 17-3 Section: 17.8 Topic: Reverse stock split 17-74 Chapter 17 - Dividends and Dividend Policy 89 City Center Pharmacy has 11,500 shares of stock outstanding with a par value of $1 per share and a market value of $10 a share The company just announced a 3-for-7 reverse stock split What will the market value per share be after the reverse stock split? A $4.29 B $7.00 C $10.00 D $23.33 E $25.21 Market value per share = $10  7/3 = $23.33 AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 17-3 Section: 17.8 Topic: Reverse stock split 17-75 Chapter 17 - Dividends and Dividend Policy Essay Questions 90 You are the CFO of a non-dividend paying firm that currently has excess cash reserves You are preparing for an internal management meeting where dividends are on the agenda You know that the CEO favors the commencement of a dividend program You, however, oppose any dividend plan at this time Write a good argument that you can use in the meeting to support your position While it is true that the firm currently has excess cash reserves, those reserves can best be utilized to fund positive NPV projects which will increase the value of the firm and thus, the value of the shares held by our current shareholders This increase in value does not create any tax liability for those shareholders until or unless they opt to sell their shares Dividends on the other hand, will create an immediate tax liability for the majority of our shareholders, who don't need or prefer dividend income at this time If we commence a dividend program, we may find that our clientele changes, which is not one of our current goals In addition, once we pay a dividend, we need to be prepared to maintain that dividend, as any decrease in the dividend at a later date would send the wrong message to our shareholders and to the market Lastly, should we deplete our excess cash reserves by implementing a dividend program, we might find ourselves in the uncomfortable position of seeking additional equity financing which would be expensive and possibly also dilutive to our shareholders Feedback: Refer to section 17.5 AACSB: Reflective thinking Bloom's: Analysis Difficulty: Intermediate Learning Objective: 17-2 Section: 17.5 Topic: Dividend policy 17-76 Chapter 17 - Dividends and Dividend Policy 91 Explain the meaning of the dividend clientele effect and why it is important There are certain groups that prefer low dividend payouts and certain groups that prefer high dividend payouts; these are dividend clienteles If clienteles exist, then whenever a firm changes its dividend policy, it just swaps one clientele for another In the end, the firm cannot affect its value by making changes in its dividend policy unless there are unsatisfied clienteles Feedback: Refer to section 17.5 AACSB: Reflective thinking Bloom's: Comprehension Difficulty: Basic Learning Objective: 17-2 Section: 17.5 Topic: Clienteles 17-77 Chapter 17 - Dividends and Dividend Policy 92 Stock repurchase programs appear to becoming more popular with business firms Explain the appeal of these programs as compared to that of cash dividend programs from the stock issuer's point of view Both stock repurchase and cash dividend programs are mechanisms for transferring excess funds from a corporation to its shareholders Dividend programs, once commenced, require an ongoing cash outflow that is difficult to reduce or terminate Stock repurchase programs on the other hand, are structured such that a firm can control both the timing and the amount of the cash outflows While a stock repurchase program is frequently announced, there is no commitment to actually purchase the shares This provides a lot more flexibility to the firm than a dividend program Feedback: Refer to section 17.6 AACSB: Reflective thinking Bloom's: Analysis Difficulty: Intermediate Learning Objective: 17-4 Section: 17.6 Topic: Stock repurchase 93 Identify some real-world factors which might make it more difficult for an individual to effectively create a homemade dividend policy Students should address factors such as taxes, transaction costs, and investment earnings If selling $100 of securities is not equal to receiving $100 of dividend income on an aftertax basis, then investors will have a preference for one over the other Selling small amounts of securities on a frequent basis tends to result in significant transaction costs making such trading undesirable Receiving dividend income today and then investing that income for a short period of time, say a year or two, may yield less than desirable results if the interest rate available for such investments is low, which would generally be the case for many shareholders Thus, effectively creating a homemade dividend policy may not be as simple as it sounds, especially for investors with smaller portfolios Feedback: Refer to section 17.2 AACSB: Reflective thinking Bloom's: Analysis Difficulty: Intermediate Learning Objective: 17-2 Section: 17.2 Topic: Homemade dividend 17-78 Chapter 17 - Dividends and Dividend Policy 94 Explain how cash dividends affect individual shareholders differently than an equal amount of funds spent on a repurchase Dividends are payable to all shareholders on an equal per share basis with the income taxed as dividend income when received Shareholders have no control over the timing of this dividend income and thus, no control over the timing of their tax liability A repurchase affects only those shareholders who opt to sell shares The shareholders who participate in a repurchase will generally pay taxes at the capital gains rate with the tax liability created at the time of sale, which is controlled by the shareholder Shareholders who not participate in the repurchase program receive no cash and incur no taxes Thus, a repurchase allows shareholders to control the timing of their income and their related tax liability Also, it should be noted that investor preferences for either dividends or capital gains depends upon the tax laws that are in existence at a particular point in time Feedback: Refer to section 17.6 AACSB: Reflective thinking Bloom's: Analysis Difficulty: Intermediate Learning Objective: 17-4 Section: 17.6 Topic: Stock repurchase versus cash dividend 17-79 Chapter 17 - Dividends and Dividend Policy Multiple Choice Questions 95 The Green Fiddle has declared an $8 per share dividend Suppose capital gains are not taxed, but dividends are taxed at 15 percent New IRS regulations require that taxes be withheld at the time the dividend is paid Green Fiddle stock sells for $71.50 per share, and the stock is about to go ex-dividend What will the ex-dividend price be? A $64.70 B $67.90 C $78.30 D $79.50 E $82.23 Ex-dividend price = $71.50 - [$8  (1 - 0.15)] = $64.70 AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 17-1 Learning Objective: 17-1 Section: 17.1 Topic: Ex-dividend price 17-80 Chapter 17 - Dividends and Dividend Policy 96 The owners' equity accounts for Blueswell Industries are shown here: If Blueswell Industries declares a 1-for-5 reverse stock split, there will be shares outstanding at a par value of _ per share A 1,800; $1.00 B 1,800; $5.00 C 9,000; $5.00 D 45,000; $0.20 E 45,000; $1.00 New shares = 9,000  1/5 = 1,800 shares New par value = $1  5/1 = $5 AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 17-3 Learning Objective: 17-3 Section: 17.8 Topic: Reverse stock split 97 The Turtle Cave currently has 160,000 shares of stock outstanding that sell for $60 per share Assume no market imperfections or tax effects exist What will the new share price be if the firm declares a 15 percent stock dividend? A $48.72 B $52.17 C $60.00 D $64.50 E $69.00 New price = $60 (1/1.15) = $52.17 AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 17-4 Learning Objective: 17-3 Section: 17.8 Topic: Stock dividend 17-81 Chapter 17 - Dividends and Dividend Policy 98 Glendale Paving currently has 120,000 shares of stock outstanding that sell for $54 per share Assume no market imperfections or tax effects exist What will the new share price be if the firm declares a 40 percent stock dividend? A $31.12 B $32.08 C $35.19 D $38.57 E $40.00 New price = $54 (1/1.40) = $38.57 AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 17-4 Learning Objective: 17-3 Section: 17.8 Topic: Stock dividend 17-82 Chapter 17 - Dividends and Dividend Policy 99 The balance sheet for Apple Pie Corp is shown here in market value terms There are 4,000 shares of stock outstanding The company has declared a dividend of $1.80 per share The stock goes ex-dividend tomorrow Ignore any tax effects What will the price of the stock be tomorrow? A $18.90 B $36.20 C $49.95 D $52.15 E $71.80 Tomorrow's stock price = ($207,000/4,000) - $1.80 = $49.95 AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 17-5 Learning Objective: 17-1 Section: 17.1 Topic: Cash dividend 17-83 Chapter 17 - Dividends and Dividend Policy 100 The balance sheet for Apple Pie Corp is shown here in market value terms There are 5,000 shares of stock outstanding The company has announced that it is going to repurchase $4,350 worth of stock What will the price of the stock be after this repurchase? A $35.00 B $36.19 C $39.21 D $42.50 E $43.33 Current price per share = $175,000/5,000 = $35 Number of shares repurchased = $4,350/$35 = 124.29 New shares outstanding = 5,000 - 124.29 = 4,875.71 New share price = ($175,000 - $4,350)/4,875.71 = $35 AACSB: Analytic Bloom's: Analysis Difficulty: Basic EOC #: 17-6 Learning Objective: 17-4 Section: 17.6 Topic: Stock repurchase 17-84 Chapter 17 - Dividends and Dividend Policy 101 The market value balance sheet for Inbox Manufacturing is shown here Inbox has declared a 23 percent stock dividend The stock goes ex-dividend tomorrow (the chronology for a stock dividend is similar to that for a cash dividend) There are 13,000 shares outstanding What is the ex-dividend stock price? A $21.21 B $23.51 C $25.06 D $26.86 E $28.92 New price = $376,000/(13,000  1.23) = $23.51 AACSB: Analytic Bloom's: Analysis Difficulty: Basic EOC #: 17-7 Learning Objective: 17-3 Section: 17.8 Topic: Stock dividend 17-85 Chapter 17 - Dividends and Dividend Policy 102 You own 1,000 shares of stock in Avondale Corporation You will receive an 80-cent per share dividend in one year In two years, Avondale will pay a liquidating dividend of $40 per share The required return on Avondale stock is 14 percent What will your dividend income be this year if you use homemade dividends to create two equal annual dividend payments? A $15,184 B $15,980 C $18,667 D $19,117 E $20,400 P0 = ($0.80/1.14) + ($40/1.142) = $31.48 $31.48 = (D/1.14) + (D/1.142); D = $19.117 Dividend income = 1,000  $19.117 = $19,117 AACSB: Analytic Bloom's: Analysis Difficulty: Intermediate EOC #: 17-14 Learning Objective: 17-2 Section: 17.2 Topic: Homemade dividend 17-86 Chapter 17 - Dividends and Dividend Policy 103 You own 1,000 shares of stock in Avondale Corporation You will receive a $0.80 per share dividend in one year In two years, Avondale will pay a liquidating dividend of $35 per share The required return on Avondale stock is 16 percent You only want $200 total in dividends in year one and accomplish this by using homemade dividends What will your total dividend amount be in year two? A $17,900 B $20,764 C $35,696 D $41,402 E $43,878 Dividends received in one year = 1,000  $0.80 = $800 Price of stock in one year = $35/1.16 = $30.1724 Number of shares purchased = ($800 - $200)/$30.1724 = 19.8857 shares Dividend in year two = $35  (1,000 + 19.8857) = $35,696 AACSB: Analytic Bloom's: Analysis Difficulty: Intermediate EOC #: 17-15 Learning Objective: 17-2 Section: 17.2 Topic: Homemade dividend 17-87 Chapter 17 - Dividends and Dividend Policy 104 Built Rite Corp is evaluating an extra dividend versus a share repurchase In either case, $5,500 would be spent Current earnings are $0.80 per share, and the stock currently sells for $33 per share There are 250 shares outstanding Ignore taxes and other imperfections You own one share of stock in this company If the company issues the dividend, your total investment will be worth as compared to if the company opts for a share repurchase A $11; $11 B $11; $22 C $11; $33 D $23; $33 E $33; $33 Dividend per share = $5,500/250 = $22 Ex-dividend stock price = $33 - $22 = $11 Shareholder value with dividend option = $22 + $11 = $33 Shares repurchased = $5,500/$33 = 166.6667 Shareholder value with repurchase = $33 Shareholder value if shares held = $33 AACSB: Analytic Bloom's: Analysis Difficulty: Intermediate EOC #: 17-16 Learning Objective: 17-4 Section: 17.6 Topic: Stock repurchase 17-88