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FIN 534 Week 9 Quiz 8 Questions 1 - Student Of Fortune

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FIN 534 Week 9 Quiz 8 Questions 1 - Student Of Fortune Powered By Docstoc
					Question 1

                                     1. In the real world, dividends

                                        Answer

         are usually more stable than earnings.
         fluctuate more widely than earnings.
         tend to be a lower percentage of earnings for mature firms.
         are usually changed every year to reflect earnings changes, and these changes are
         randomly higher or lower, depending on whether earnings increased or decreased.
         are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS
         = $2.00, then DPS will equal $0.80. Once the percentage is set, then dividend policy
         is on “automatic pilot” and the actual dividend depends strictly on earnings.


                                                                                        2 points
Question 2

                                     1. Which of the following should not
                                        influence a firm’s dividend policy decision?

                                        Answer

         The firm’s ability to accelerate or delay investment projects.
         A strong preference by most shareholders for current cash income versus capital
         gains.
         Constraints imposed by the firm’s bond indenture.
         The fact that much of the firm’s equipment has been leased rather than bought and
         owned.
         The fact that Congress is considering changes in the tax law regarding the taxation
         of dividends versus capital gains.
                                                                                        2 points
Question 3

                                     1. If a firm adheres strictly to the residual dividend
                                        policy, the issuance of new common stock would
                                        suggest that

                                        Answer

         the dividend payout ratio has remained constant.
         the dividend payout ratio is increasing.
no dividends were paid during the year.
the dividend payout ratio is decreasing.
the dollar amount of investments has decreased

Question 4

                                           1. If a firm adheres strictly to the
                                              residual dividend policy, then if its
                                              optimal capital budget requires the
                                              use of all earnings for a given year
                                              (along with new debt according to the
                                              optimal debt/total assets ratio), then
                                              the firm should pay

                                              Answer

            no dividends except out of past retained earnings.
            no dividends to common stockholders.
            dividends only out of funds raised by the sale of new common stock.
            dividends only out of funds raised by borrowing money (i.e., issue
            debt).
            dividends only out of funds raised by selling off fixed assets.


                                                                               2 points
Question 5

                                           1. Which of the following statements is
                                              correct?

                                              Answer

            Firms with a lot of good investment opportunities and a relatively small
            amount of cash tend to have above average payout ratios.
            One advantage of the residual dividend policy is that it leads to a stable
            dividend payout, which investors like.
            An increase in the stock price when a company decreases its dividend is
            consistent with signaling theory as postulated by MM.
            If the “clientele effect” is correct, then for a company whose earnings
            fluctuate, a policy of paying a constant percentage of net income will
            probably maximize the stock price.
            Stock repurchases make the most sense at times when a company
            believes its stock is undervalued.
                                                                           2 points
Question 6

                                    1. Which of the following statements is
                                       correct?

                                        Answer

         If a company has a 2-for-1 stock split, its stock price should roughly
         double.
         Capital gains earned in a share repurchase are taxed less favorably than
         dividends; this explains why companies typically pay dividends and
         avoid share repurchases.
         Very often, a company’s stock price will rise when it announces that it
         plans to commence a share repurchase program. Such an announcement
         could lead to a stock price decline, but this does not normally happen.
         Stock repurchases increase the number of outstanding shares.
         The clientele effect is the best explanation for why companies tend to
         vary their dividend payments from quarter to quarter.


                                                                           2 points
Question 7

                                    1. Firm M is a mature firm in a mature
                                       industry. Its annual net income and
                                       net cash flows are both consistently
                                       high and stable. However, M’s
                                       growth prospects are quite limited, so
                                       its capital budget is small relative to
                                       its net income. Firm N is a relatively
                                       new firm in a new and growing
                                       industry. Its markets and products
                                       have not stabilized, so its annual
                                       operating income fluctuates
                                       considerably. However, N has
                                       substantial growth opportunities, and
                                       its capital budget is expected to be
                                       large relative to its net income for the
                                       foreseeable future. Which of the
                                       following statements is correct?

                                        Answer
         Firm M probably has a lower debt ratio than Firm N.
         Firm M probably has a higher dividend payout ratio than Firm N.
         If the corporate tax rate increases, the debt ratio of both firms is likely
         to decline.
         The two firms are equally likely to pay high dividends.
         Firm N is likely to have a clientele of shareholders who want to receive
         consistent, stable dividend income.

                                                                               2 points
Question 8

                                      1. Which of the following statements is
                                         correct?

                                          Answer

         One disadvantage of dividend reinvestment plans is that they increase
         transactions costs for investors who want to increase their ownership in
         the company.
         One advantage of dividend reinvestment plans is that they enable
         investors to postpone paying taxes on the dividends credited to their
         account.
         Stock repurchases can be used by a firm that wants to increase its debt
         ratio.
         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.
         One advantage of an open market dividend reinvestment plan is that it
         provides new equity capital and increases the shares outstanding.


                                                                               2 points
Question 9

                                      1. Which of the following statements is
                                         correct?

                                          Answer

         The tax code encourages companies to pay dividends rather than retain
         earnings.
         If a company uses the residual dividend model to determine its dividend
         payments, dividends payout will tend to increase whenever its
         profitable investment opportunities increase.
         The stronger management thinks the clientele effect is, the more likely
         the firm is to adopt a strict version of the residual dividend model.
         Large stock repurchases financed by debt tend to increase earnings per
         share, but they also increase the firm’s financial risk.
         A dollar paid out to repurchase stock is taxed at the same rate as a
         dollar paid out in dividends. Thus, both companies and investors are
         indifferent between distributing cash through dividends and stock
         repurchase programs.


                                                                                2 points
Question 10

                                      1. Which of the following actions will
                                         best enable a company to raise
                                         additional equity capital?

                                          Answer

         Refund long-term debt with lower cost short-term debt.
         Declare a stock split.
         Begin an open-market purchase dividend reinvestment plan.
         Initiate a stock repurchase program.
         Begin a new-stock dividend reinvestment plan.
Question 11

                                      1. Which of the following statements is
                                         CORRECT?

                                          Answer

         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.
         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.
         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.
         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.
         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.


                                                                            2 points
Question 12

                                    1. Which of the following statements is
                                       correct?

                                        Answer

         If a firm repurchases some of its stock in the open market, then
         shareholders who sell their stock for more than they paid for it will be
         subject to capital gains taxes.
         An open-market dividend reinvestment plan will be most attractive to
         companies that need new equity and would otherwise have to issue
         additional shares of common stock through investment bankers.
         Stock repurchases tend to reduce financial leverage.
         If a company declares a 2-for-1 stock split, its stock price should
         roughly double.
         One advantage of adopting the residual dividend policy is that this
         makes it easier for corporations to meet the requirements of Modigliani
         and Miller’s dividend clientele theory.

                                                                            2 points
Question 13

                                    1. Trenton Publishing follows a strict
                                       residual dividend policy. All else
                                       equal, which of the following factors
                                       would be most likely to lead to an
                                       increase
                                       in the firm’s dividend per share?

                                        Answer

         The firm’s net income increases.
         The company increases the percentage of equity in its target capital
         structure.
         The number of profitable potential projects increases.
         Congress lowers the tax rate on capital gains. The remainder of the tax
         code is not changed.
         Earnings are unchanged, but the firm issues new shares of common
         stock.


                                                                           2 points
Question 14

                                     1. You own 100 shares of Troll
                                        Brothers’ stock, which currently sells
                                        for $120 a share. The company is
                                        contemplating a 2-for-1 stock split.
                                        Which of the following best describes
                                        what your position will be after such a
                                        split takes place?

                                         Answer

         You will have 200 shares of stock, and the stock will trade at or near
         $120 a share.
         You will have 200 shares of stock, and the stock will trade at or near
         $60 a share.
         You will have 100 shares of stock, and the stock will trade at or near
         $60 a share.
         You will have 50 shares of stock, and the stock will trade at or near
         $120 a share.
         You will have 50 shares of stock, and the stock will trade at or near $60
         a share.

                                                                           2 points
Question 15

                                     1. Which of the following would be most
                                        likely to lead to a decrease in a firm’s
                                        dividend payout ratio?

                                         Answer

         Its earnings become more stable.
         Its access to the capital markets increases.
         Its R&D efforts pay off, and it now has more high-return investment
         opportunities.
         Its accounts receivable decrease due to a change in its credit policy.
         Its stock price has increased over the last year by a greater percentage
         than the increase in the broad stock market averages.
                                                                            2 points
Question 16

                                     1. Which of the following statements is
                                        CORRECT?

                                        Answer

         When a company increases its debt ratio, the costs of equity and debt
         both increase. Therefore, the WACC must also increase.
         The capital structure that maximizes the stock price is generally the
         capital structure that also maximizes earnings per share.
         All else equal, an increase in the corporate tax rate would tend to
         encourage a company to increase its debt ratio.
         Since debt financing raises the firm’s financial risk, increasing a
         company’s debt ratio will always increase its WACC.
         Since debt is cheaper than equity, increasing a company’s debt ratio
         will always reduce its WACC.
                                                                            2 points
Question 17

                                     1. Blemker Corporation has $500
                                        million of total assets, its basic
                                        earning power is 15%, and it
                                        currently has no debt in its capital
                                        structure. The CFO is contemplating
                                        a recapitalization where it will issue
                                        debt at a cost of 10% and use the
                                        proceeds to buy back shares of the
                                        company’s common stock, paying
                                        book value. If the company proceeds
                                        with the recapitalization, its operating
                                        income, total assets, and tax rate will
                                        remain unchanged. Which of the
                                        following is most likely to occur as a
                                        result of the recapitalization?

                                        Answer

         The ROA would increase.
         The ROA would remain unchanged.
         The basic earning power ratio would decline.
         The basic earning power ratio would increase.
         The ROE would increase.

                                                                             2 points
Question 18

                                     1. An increase in the debt ratio will
                                        generally have no effect on which of
                                        these items?

                                         Answer

         Business risk.
         Total risk.
         Financial risk.
         Market risk.
         The firm's beta.

                                                                             2 points
Question 19

                                     1. Which of the following statements is
                                        CORRECT?

                                         Answer

         If corporate tax rates were decreased while other things were held
         constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of
         capital structure were correct, this would tend to cause corporations to
         decrease their use of debt.
         A change in the personal tax rate should not affect firms’ capital
         structure decisions.
         “Business risk” is differentiated from “financial risk” by the fact that
         financial risk reflects only the use of debt, while business risk reflects
         both the use of debt and such factors as sales variability, cost
         variability, and operating leverage.
         The optimal capital structure is the one that simultaneously (1)
         maximizes the price of the firm’s stock, (2) minimizes its WACC, and
         (3) maximizes its EPS.
         If changes in the bankruptcy code make bankruptcy less costly to
         corporations, then this would likely reduce the debt ratio of the average
         corporation.

                                                                         2 points
Question 20

                                   1. Companies HD and LD have the
                                      same total assets, operating income
                                      (EBIT), tax rate, and business risk.
                                      Company HD, however, has a much
                                      higher debt ratio than LD. Also HD’s
                                      basic earning power (BEP) exceeds
                                      its cost of debt (rd). Which of the
                                      following statements is CORRECT?

                                       Answer

         HD should have a higher return on assets (ROA) than LD.
         HD should have a higher times interest earned (TIE) ratio than LD.
         HD should have a higher return on equity (ROE) than LD, but its risk,
         as measured by the standard deviation of ROE, should also be higher
         than LD's.
         Given that BEP > rd, HD's stock price must exceed that of LD.
         Given that BEP > rd, LD's stock price must exceed that of HD.


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