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					                                               Chapter 14
Directions: Answer the following five questions on a separate document. Explain how you reached the
answer or show your work if a mathematical calculation is needed, or both. Submit your assignment
using the assignment link in the course shell. Each question is worth five points apiece for a total of 20
points for this homework assignment.

    1. Which of the following statements about dividend policies is CORRECT?
          A. Modigliani and Miller argue that investors prefer dividends to capital gains because
              dividends are more certain than capital gains. They call this the ―bird-in-the hand‖
              effect.
          B. One reason that companies tend to avoid stock repurchases is that dividend payments
              are taxed at a lower rate than gains on stock repurchases.
          C. One advantage of dividend reinvestment plans is that they allow shareholders to avoid
              paying taxes on the dividends that they choose to reinvest.
          D. One key advantage of a residual dividend policy is that it enables a company to follow a
              stable dividend policy.
          E. The clientele effect suggests that companies should follow a stable dividend policy.

    2. Which of the following statements is CORRECT?
          A. One disadvantage of dividend reinvestment plans is that they increase transactions
              costs for investors who want to increase their ownership in the company.
          B. One advantage of dividend reinvestment plans is that they enable investors to postpone
              paying taxes on the dividends credited to their account.
          C. Stock repurchases can be used by a firm that wants to increase its debt ratio.
          D. Stock repurchases make sense if a company expects to have a lot of profitable new
              projects to fund over the next few years, provided investors are aware of these
              investment opportunities.
          E. One advantage of an open market dividend reinvestment plan is that it provides new
              equity capital and increases the shares outstanding.

    3. Which of the following statements is CORRECT?
          A. When firms are deciding on the size of stock splits—say whether to declare a 2-for-1
              split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split,
              because then the after-split price will be higher than if the 3-for-1 split had been used.
          B. Back before the SEC was created in the 1930s, companies would declare reverse splits in
              order to boost their stock prices. However, this was determined to be a deceptive
              practice, and it is illegal today.

            C. Stock splits create more administrative problems for investors than stock dividends,
               especially determining the tax basis of their shares when they decide to sell them, so
               today stock dividends are used far more often than stock splits.
            D. When a company declares a stock split, the price of the stock typically declines—by
               about 50% after a 2-for-1 split—and this necessarily reduces the total market value of
               the equity.
            E. If a firm’s stock price is quite high relative to most stocks—say $500 per share—then it
               can declare a stock split of say 10-for-1 so as to bring the price down to something close
             to $50. Moreover, if the price is relatively low—say $2 per share—then it can declare a
             ―reverse split‖ of say 1-for-25 so as to bring the price up to somewhere around $50 per
             share.

4. Which of the following statements is CORRECT?
      A. If a firm follows the residual dividend policy, then a sudden increase in the number of
          profitable projects is likely to reduce the firm’s dividend payout.
      B. The clientele effect can explain why so many firms change their dividend policies so
          often.
      C. One advantage of adopting the residual dividend policy is that this policy makes it easier
          for corporations to develop a specific and well-identified dividend clientele.
      D. New-stock dividend reinvestment plans are similar to stock dividends because they both
          increase the number of shares outstanding but don’t change the firm’s total amount of
          book equity.
      E. Investors who receive stock dividends must pay taxes on the value of the new shares in
          the year the stock dividends are received.

5. DeAngelo Corp.'s projected net income is $150.0 million, its target capital structure is 25% debt
   and 75% equity, and its target payout ratio is 65%. DeAngelo has more positive NPV projects
   than it can finance without issuing new stock, but its board of directors had decreed that it
   cannot issue any new shares in the foreseeable future. The CFO now wants to determine how
   the maximum capital budget would be affected by changes in capital structure policy and/or the
   target dividend payout policy. Versus the current policy, how much larger could the capital
   budget be if (1) the target debt ratio were raised to 75%, other things held constant, (2) the
   target payout ratio were lowered to 20%, other things held constant, and (3) the debt ratio and
   payout were both changed by the indicated amounts. (Please show your work, please see the
   excel sheet for the math solution)



                                   Increase in Capital Budget

     Increase Debt 75%    Lower Payout Do Both to 20%
A.    $114.0                 $73.3                   $333.9
B.    $120.0                 $77.2                   $351.5
C.    $126.4                 $81.2                   $370.0
D.    $133.0                 $85.5                   $389.5
E.    $140.0                     $90.0                            $410.0




                                         Chapter 15
1. Which of the following statements best describes the optimal capital structure?
      A. The optimal capital structure is the mix of debt, equity, and preferred stock that
          maximizes the company’s earnings per share (EPS).
      B. The optimal capital structure is the mix of debt, equity, and preferred stock that
          maximizes the company’s stock price.
        C. The optimal capital structure is the mix of debt, equity, and preferred stock that
           minimizes the company’s cost of equity.
        D. The optimal capital structure is the mix of debt, equity, and preferred stock that
           minimizes the company’s cost of debt.
        E. The optimal capital structure is the mix of debt, equity, and preferred stock that
           minimizes the company’s cost of preferred stock.

2. Which of the following statements is CORRECT?
      A. A firm can use retained earnings without paying a flotation cost. Therefore, while the
          cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of
          debt.
      B. The capital structure that minimizes a firm’s weighted average cost of capital is also the
          capital structure that maximizes its stock price.
      C. The capital structure that minimizes the firm’s weighted average cost of capital is also
          the capital structure that maximizes its earnings per share.
      D. If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio
          must reduce its WACC.
      E. Other things held constant, if corporate tax rates declined, then the Modigliani-Miller
          tax-adjusted tradeoff theory would suggest that firms should increase their use of debt.

3. Which of the following statements is CORRECT?
      A. In general, a firm with low operating leverage also has a small proportion of its total
          costs in the form of fixed costs.
      B. There is no reason to think that changes in the personal tax rate would affect firms’
          capital structure decisions.
      C. A firm with high business risk is more likely to increase its use of financial leverage than
          a firm with low business risk, assuming all else equal.
      D. If a firm's after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce
          its WACC by increasing its use of debt.
      E. Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the
          point where it is at its optimal capital structure will decrease the costs of both debt and
          equity financing.

4. Companies HD and LD have identical amounts of assets, operating income (EBIT), tax rates, and
   business risk. Company HD, however, has a much higher debt ratio than LD. Company HD’s basic
   earning power ratio (BEP) exceeds its cost of debt (rd). Which of the following statements is
   CORRECT?
       A. Company HD has a higher return on assets (ROA) than Company LD.
       B. Company HD has a higher times interest earned (TIE) ratio than Company LD.
       C. Company HD has a higher return on equity (ROE) than Company LD, and its risk, as
           measured by the standard deviation of ROE, is also higher than LD’s.
       D. The two companies have the same ROE.
       E. Company HD’s ROE would be higher if it had no debt.

5. Which of the following statements is CORRECT?
      A. Generally, debt-to-total-assets ratios do not vary much among different industries,
          although they do vary among firms within a given industry.
B. Electric utilities generally have very high common equity ratios because their revenues
   are more volatile than those of firms in most other industries.
C. Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios
   because their earnings are very stable and, thus, they can cover the high interest costs
   associated with high debt levels.
D. Wide variations in capital structures exist both between industries and among individual
   firms within given industries. These differences are caused by differing business risks
   and also managerial attitudes.
E. Since most stocks sell at or very close to their book values, book value capital structures
   are almost always adequate for use in estimating firms' costs of capital.

				
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