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FM 13th Edition Distribution to Shareholders TB
Governance, Business Ethics, Risk Management, and Internal Control (University of San
Carlos)
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CHAPTER 14
ANSWERS AND SOLUTIONS
CHAPTER 15
DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND
SHARE REPURCHASES
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is some overlap between the T/F and the multiple choice questions, as some T/F
statements are used in the MC questions. See the preface for information on the AACSB letter
indicators (F, M, etc.) on the subject lines.
Multiple Choice: True/False
(15-1) Optimal distribution policy
FR
Answer: a EASY
1344. The optimal distribution policy strikes that balance between current dividends and capital gains
that maximizes the firm's stock price.
a. True
b. False
(15-1) Target payout ratio
FR
Answer: b EASY
1345. Other things held constant, the higher a firm's target payout ratio, the higher its expected
growth rate should be.
a. True
b. False
Chapter 15: Dividends
True/False
Page 670
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(15-1) Dividend irrelevance
FR
Answer: a EASY
1346. Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a
firm pays out in dividends has no effect on either its cost of capital or its stock price.
a. True
b. False
(15-1) Dividend irrelevance
FR
Answer: b EASY
1347. Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a
firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price.
a. True
b. False
(15-1) Investors' div. preferences
FR
Answer: a EASY
1348. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its
stock price should set a low payout ratio.
a. True
b. False
Chapter 15: Dividends
True/False
Page 671
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(15-6) Stock dividends and splits
FR
Answer: a EASY
1349. A 100% stock dividend and a 2:1 stock split should, at least conceptually, have the same effect
on the firm's stock price.
a. True
b. False
(15-6) Reverse split
FR
Answer: a EASY
1350. A “reverse split” reduces the number of shares outstanding.
a. True
b. False
(15-1) Dividends and stock prices
FR
Answer: b MEDIUM
1351. The announcement of an increase in the cash dividend should, according to MM, lead to an
increase in the price of the firm's stock, other things held constant.
a. True
b. False
(15-1) Dividends and stock prices
FR
Answer: b MEDIUM
1352. The federal government sometimes taxes dividends and capital gains at different rates. Other
things held constant, an increase in the tax rate on dividends relative to that on capital gains
would logically lead to an increase in dividend payout ratios.
a. True
b. False
(15-1) Dividends and stock prices
Chapter 15: Dividends
FR
Answer: b MEDIUM
True/False
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1353. The federal government sometimes taxes dividends and capital gains at different rates. Other
things held constant, if the tax rate on dividends is high relative to that on capital gains, then
individuals with low taxable incomes should favor stocks with low payouts and high-income
individuals should favor high-payout companies.
a. True
b. False
(15-1) Dividends and stock prices
FR
Answer: a MEDIUM
1354. It has been argued that investors prefer high-payout companies because dividends are more
certain (less risky) than the capital gains that are supposed to come from retained earnings.
However, Miller and Modigliani say that this argument is incorrect, and they call it the “bird-inthe-hand fallacy.” MM base their argument on the belief that most dividends are reinvested in
stocks, hence are exposed to the same risks as reinvested earnings.
a. True
b. False
Chapter 15: Dividends
True/False
Page 673
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(15-1) Dividend irrelevance
FR
Answer: a MEDIUM
1355. Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument
that the value of the firm is determined only by its basic earning power and its business risk.
a. True
b. False
(15-1) Dividend-growth tradeoff
FR
Answer: a MEDIUM
1356. One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend
yield must be offset by a more than proportionate increase in growth in order to keep a firm's
required return constant, other things held constant.
a. True
b. False
(15-2) Dividends and stock prices
FR
Answer: a MEDIUM
1357. If a retired individual lives on his or her investment income, then it would make sense for this
person to prefer stocks with high payouts so he or she could receive cash without going to the
trouble and expense of selling stocks. On the other hand, it would make sense for an individual
who would just reinvest any dividends received to prefer a low-payout company because that
would save him or her taxes and brokerage costs.
a. True
b. False
(15-2) Dividends and stock prices
FR
Answer: a MEDIUM
1358. Some investors prefer dividends to retained earnings (and the capital gains retained earnings
bring), while others prefer retained earnings to dividends. Other things held constant, it makes
sense for a company to establish its dividend policy and stick to it, and then it will attract a
clientele of investors who like that policy.
a. True
Chapter 15: Dividends
True/False
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b. False
(15-2) Dividends and stock prices
FR
Answer: b MEDIUM
1359. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend
payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from
$20 to $30. Some people would argue that this is proof that investors prefer dividends to
retained earnings. Miller and Modigliani would agree with this argument.
a. True
b. False
(15-2) Signaling hypothesis
FR
Answer: a MEDIUM
1360. If the information content, or signaling, hypothesis is correct, then a change in a firm's dividend
policy can have an important effect on its stock price and cost of equity.
a. True
b. False
(15-3) Residual dividend model
FR
Answer: a MEDIUM
1361. If a firm uses the residual dividend model to set dividend policy, then dividends are determined
as a residual after providing for the equity required to fund the capital budget. Under this
model, the better the firm's investment opportunities, the lower its payout ratio will be, other
things held constant.
a. True
b. False
(15-3) Residual dividend model
FR
Answer: b MEDIUM
1362. If a firm uses the residual dividend model to set dividend policy, then dividends are determined
as a residual after providing for the equity required to fund the capital budget. Under this
model, the higher the firm's debt ratio, the lower its payout ratio will be, other things held
constant.
Chapter 15: Dividends
True/False
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a. True
b. False
(15-3) Residual dividend model
FR
Answer: b MEDIUM
1363. If management wants to maximize its stock price, and if it believes that the dividend irrelevance
theory is correct, then it must adhere to the residual dividend policy.
a. True
b. False
(15-3) Dividend payment procedures
FR
Answer: b MEDIUM
1364. If on January 3, 2012, a company declares a dividend of $1.50 per share, payable on January 31,
2012, then the price of the stock should drop by approximate $1.50 on January 31.
a. True
b. False
(15-3) Dividend payment procedures
FR
Answer: a MEDIUM
1365. If on January 3, 2012, a company declares a dividend of $1.50 per share, payable on January 31,
2012, to holders of record on January 19, then the price of the stock should drop by
approximately $1.50 on January 17, which is the ex-dividend date.
a. True
b. False
(15-4) Dividend reinvestment plans
FR
Answer: b MEDIUM
1366. One advantage of dividend reinvestment plans is that they allow shareholders to delay paying
taxes on the dividends that they choose to reinvest.
a. True
Chapter 15: Dividends
True/False
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b. False
Chapter 15: Dividends
True/False
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(15-4) Dividend reinvestment plans
FR
Answer: a MEDIUM
1367. There are two types of dividend reinvestment plans. Under one type of plan, the firm uses the
cash that would have been paid as dividends to buy stock on the open market. Under the other
type, the company issues new stock, keeps the cash that would have been paid out, and in
effect sells new stock to those investors who choose to reinvest their dividends.
a. True
b. False
(15-4) Dividend reinvestment plans
FR
Answer: a MEDIUM
1368. If a firm pays out all of its earnings as dividends and its stockholders then elect to have all of
their dividends reinvested, the company should reconsider its dividend policy and possibly move
to a lower dividend payout ratio.
a. True
b. False
(15-6) Stock split
FR
Answer: a MEDIUM
1369. If a firm declares a 20:1 stock split, and the pre-split price was $500, then we might expect the
post-split price to be $25. However, it often turns out that the post-split price will be higher
than $25. This higher price could be due to signaling effects--investors believe that
management split the stock because they think the firm is going to do better in the future. The
higher price could also be because investors like lower-priced shares.
a. True
b. False
(15-3) Residual dividend model
FR
Answer: a HARD
1370. Your firm uses the residual dividend model to set dividend policy. Market interest rates
suddenly rise, and stock prices decline. Your firm's earnings, investment opportunities, and
capital structure do not change. If the firm follows the residual dividend model, then its
dividend payout ratio would increase.
Chapter 15: Dividends
True/False
Page 678
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a. True
b. False
(15-5) WACC and dividend policy
FR
Answer: b HARD
1371. Suppose you plotted a curve which showed a Firm U's WACC on the vertical axis and its debt
ratio on the horizontal axis. Then you plotted a similar curve for Firm V. The curve for firm U
resembled a shallow “U,” while that for Firm V resembled a sharp “V.” Both firms have debt
ratios that cause their WACCs to be minimized. Other things held constant, it would be easier
for Firm V than for Firm U to maintain a steady dividend in the face of varying investment
opportunities and earnings from year to year.
a. True
b. False
Chapter 15: Dividends
True/False
Page 679
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Multiple Choice: Conceptual
(15-3) Dividend payout
CR
Answer: a EASY
1372. In the real world, dividends
a. are usually more stable than earnings.
b. fluctuate more widely than earnings.
c. tend to be a lower percentage of earnings for mature firms.
d. are usually changed every year to reflect earnings changes, and these changes are randomly
higher to lower, depending on whether earnings increased or decreased.
e. are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS = $2.00,
then DPS would equal $0.80. Once the percentage is set, then dividend policy is on
“automatic pilot” and the dividend actually paid depends strictly on earnings.
(15-6) Stock split
CR
Answer: b EASY
1373. You own 100 shares of Troll Brothers' stock, which currently sells for $120 a share. The
company is about to declare a 2-for-1 stock split. Which of the following best describes your
likely position after the split?
a. You will have 200 shares of stock, and the stock will trade at or near $120 a share.
b. You will have 200 shares of stock, and the stock will trade at or near $60 a share.
c. You will have 100 shares of stock, and the stock will trade at or near $60 a share.
d. You will have 50 shares of stock, and the stock will trade at or near $120 a share.
e. You will have 50 shares of stock, and the stock will trade at or near $600 a share.
(15-1) Investors' div. preferences
CR
Answer: d MEDIUM
1374. Myron Gordon and John Lintner believe that the required return on equity increases as the
dividend payout ratio is lowered. Their argument is based on the assumption that
a. investors are indifferent between dividends and capital gains.
Chapter 15: Dividends
Conceptual M/C
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b. investors require that the dividend yield plus the capital gains yield equal a constant.
c. capital gains are taxed at a higher rate than dividends.
d. investors view dividends as being less risky than potential future capital gains.
e. investors prefer a dollar of expected capital gains to a dollar of expected dividends because
of the lower tax rate on capital gains.
Chapter 15: Dividends
Conceptual M/C
Page 681
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(15-3) Residual dividend model
CR
Answer: a MEDIUM
1375. Your firm adheres strictly to the residual dividend model. All else equal, which of the following
factors would be most likely to lead to an increase in the firm's dividend per share?
a. The firm's net income increases.
b. The company increases the percentage of equity in its target capital structure.
c. The number of profitable potential projects increases.
d. Congress lowers the tax rate on capital gains, leaving the rest of the tax code unchanged.
e. Earnings are unchanged, but the firm issues new shares of common stock.
(15-3) Residual dividend model
CR
Answer: b MEDIUM
1376. If a firm adheres strictly to the residual dividend policy, and if its optimal capital budget requires
the use of all earnings for a given year (along with new debt according to the optimal
debt/assets ratio), then the firm should pay
a. the same dividend as it paid the prior year.
b. no dividends to common stockholders.
c. dividends only out of funds raised by the sale of new common stock.
d. dividends only out of funds raised by borrowing money (i.e., issuing debt).
e. dividends only out of funds raised by selling off fixed assets.
(15-3) Residual dividend model
CR
Answer: c MEDIUM
1377. If a firm adheres strictly to the residual dividend model, the issuance of new common stock
would suggest that
a. the dividend payout ratio has remained constant.
b. the dividend payout ratio is increasing.
c. no dividends will be paid during the year.
d. the dividend payout ratio is decreasing.
Chapter 15: Dividends
Conceptual M/C
Page 682
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e. the dollar amount of capital investments had decreased.
(15-5) Factors in div. policy
CR
Answer: d MEDIUM
1378. Which of the following does NOT normally influence a firm's dividend policy decision?
a. The firm's ability to accelerate or delay investment projects without adverse consequences.
b. A strong preference by most of its shareholders for current cash income versus potential
future capital gains.
c. Constraints imposed by the firm's bond indenture.
d. The fact that much of the firm's equipment is leased rather than bought and owned.
e. The fact that Congress is considering changes in the tax law regarding the taxation of
dividends versus capital gains.
Chapter 15: Dividends
Conceptual M/C
Page 683
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(15-5) Factors in div. policy
CR
Answer: c MEDIUM
1379. Which of the following would be most likely to lead to a decrease in a firm's dividend payout
ratio?
a. Its earnings become more stable.
b. Its access to the capital markets increases.
c. Its research and development efforts pay off, and it now has more high-return investment
opportunities.
d. Its accounts receivable decrease due to a change in its credit policy.
e. Its stock price has increased over the last year by a greater percentage than the increase in
the broad stock market averages.
(15-6) Stock dividends and splits
CR
Answer: e MEDIUM
1380. 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 reverse splits are 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--for
example, by about 50% after a 2-for-1 split--and this necessarily reduces the total market
value of the firm's 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 20-for-1 so as to bring the price down to something close to $25.
Moreover, if the price is relatively low--say $2 per share--then it can declare a “reverse split”
of say 1-for-10 so as to bring the price up to somewhere around $20 per share.
(Comp.) Dividend theories
Chapter 15: Dividends
CR
Conceptual M/C
Answer: e MEDIUM
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1381. Which of the following statements about dividend policies is CORRECT?
a. Miller and Modigliani argued 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 favor distributing excess cash as dividends rather than
by repurchasing stock is that dividends are normally taxed at a lower rate than gains on
repurchased stock.
c. One advantage of dividend reinvestment plans is that they allow shareholders to delay
paying taxes on the dividends that they choose to reinvest.
d. One key advantage of the residual dividend model 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.
Chapter 15: Dividends
Conceptual M/C
Page 685
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(Comp.) Repurchases and DRIPS
CR
Answer: c MEDIUM
1382. 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 investment 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.
(Comp.) Divs., DRIPs, and repurch.
CR
Answer: d MEDIUM
1383. Which of the following statements is CORRECT?
a. Under the tax laws as they existed in 2011, a dollar received by an individual taxpayer as
interest income is taxed at the same rate as a dollar received as dividends.
b. One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes
investors would have to pay if they received cash dividends.
c. Empirical research indicates that, in general, companies send a negative signal to the
marketplace when they announce an increase in the dividend. As a result, share prices fall
when dividend increases are announced because investors interpret the increase as a signal
that the firm expects fewer good investment opportunities in the future.
d. If a company needs to raise new equity capital, a new-stock dividend reinvestment plan
would make sense. However, if the firm does not need new equity, then an open market
purchase dividend reinvestment plan would probably make more sense.
e. Dividend reinvestment plans have not caught on in most industries, and today over 99% of
all DRIPs are offered by utilities.
(Comp.) Div. policy and repurchases
CR
Answer: d MEDIUM
1384. Which of the following statements is CORRECT?
Chapter 15: Dividends
Conceptual M/C
Page 686
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a. Historically, the tax code has encouraged companies to pay dividends rather than retain
earnings.
b. If a company uses the residual dividend model to determine its dividend payments, dividend
payout will tend to increase whenever its profitable investment opportunities increase
relatively rapidly.
c. The more a firm's management believes in the clientele effect, the more likely the firm is to
adhere strictly to the residual dividend model.
d. Large stock repurchases financed by debt tend to increase expected earnings per share, but
they also tend to increase the firm's financial risk.
e. A dollar paid out to repurchase stock has the same tax benefit as a dollar paid out in
dividends. Thus, both companies and investors should be indifferent between distributing
cash through dividends and stock repurchase programs.
(Comp.) Dividend concepts
CR
Answer: c MEDIUM
1385. Which of the following statements is CORRECT?
a. If a company has a 2-for-1 stock split, its stock price should roughly double.
b. Capital gains earned on shares repurchased are taxed less favorably than dividends, which is
why companies typically pay dividends and avoid share repurchases.
c. 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.
d. Stock repurchases increase the number of outstanding shares.
e. The clientele effect is the best explanation for why companies tend to vary their dividend
payments from quarter to quarter.
(Comp.) Dividend concepts
CR
Answer: e MEDIUM
1386. Which of the following statements is CORRECT?
a. Firms with a lot of good investment opportunities and a relatively small amount of cash tend
to have above-average dividend payout ratios.
Chapter 15: Dividends
Conceptual M/C
Page 687
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b. One advantage of the residual dividend model is that it leads to a stable dividend payout,
which investors like.
c. An increase in the stock price when a company cuts its dividend is consistent with signaling
theory as postulated by MM.
d. 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 its stock price.
e. Stock repurchases make the most sense at times when a company believes its stock is
undervalued.
(Comp.) Dividend concepts
CR
Answer: b MEDIUM
1387. Which of the following statements is CORRECT?
a. One advantage of dividend reinvestment plans is that they enable investors to avoid paying
taxes on the dividends they receive.
b. If a company has an established clientele of investors who prefer a high dividend payout,
and if management wants to keep stockholders happy, it should not adhere strictly to the
residual dividend model.
c. If a firm adheres strictly to the residual dividend model, then, holding all else constant, its
dividend payout ratio will tend to rise whenever its investment opportunities improve.
d. If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends
unchanged, this would motivate companies to increase their dividend payout ratios.
e. Despite its drawbacks, following the residual dividend model will tend to stabilize actual
cash dividends, and this will make it easier for firms to attract a clientele that prefers high
dividends, such as retirees.
Chapter 15: Dividends
Conceptual M/C
Page 688
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(Comp.) Dividend concepts
CR
Answer: b MEDIUM
1388. Firm M is a mature company in a mature industry. Its annual net income and cash flows are
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 company 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?
a. Firm M probably has a lower target debt ratio than Firm N.
b. Firm M probably has a higher target dividend payout ratio than Firm N.
c. If the corporate tax rate increases, the debt ratio of both firms is likely to decline.
d. The two firms are equally likely to pay high dividends.
e. Firm N is likely to have a clientele of shareholders who want a consistent, stable dividend
income.
(Comp.) Dividend concepts
CR
Answer: a MEDIUM
1389. Which of the following statements is CORRECT?
a. 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.
b. 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.
c. Stock repurchases tend to reduce financial leverage.
d. If a company declares a 2-for-1 stock split, its stock price should roughly double.
e. One advantage of adopting the residual dividend model is that this makes it easier for
corporations to meet the requirements of Modigliani and Miller's dividend clientele theory.
(Comp.) Dividend concepts
CR
Answer: e MEDIUM
1390. Which of the following actions will best enable a company to raise additional equity capital,
other things held constant?
Chapter 15: Dividends
Conceptual M/C
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a. Refund long-term debt with lower cost short-term debt.
b. Declare a stock split.
c. Begin an open-market purchase dividend reinvestment plan.
d. Initiate a stock repurchase program.
e. Begin a new-stock dividend reinvestment plan.
Chapter 15: Dividends
Conceptual M/C
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(Comp.) Repurchases and splits
CR
Answer: e MEDIUM
1391. Which of the following statements is NOT CORRECT?
a. Stock repurchases can be used by a firm as part of a plan to change its capital structure.
b. After a 3-for-1 stock split, a company's price per share should fall, but the number of shares
outstanding will rise.
c. Investors may interpret a stock repurchase program as a signal that the firm's managers
believe the stock is undervalued, or, alternatively, as a signal that the firm does not have
many good investment opportunities.
d. A company can repurchase stock to distribute a large one-time cash inflow, say from the
sale of a division, to stockholders without having to increase its regular dividend.
e. Stockholders pay no income tax on dividends if the dividends are used to purchase stock
through a dividend reinvestment plan.
(Comp.) Dividend concepts
CR
Answer: a MEDIUM/HARD
1392. Which of the following statements is CORRECT?
a. If a firm follows the residual dividend model, then a sudden increase in the number of
profitable projects would be likely to lead to a reduction of the firm's dividend payout ratio.
b. The clientele effect explains why so many firms change their dividend policies so often.
c. One advantage of adopting the residual dividend model is that this policy makes it easier for
a corporation to attract 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.
(Comp.) Dividend concepts
CR
Answer: d MEDIUM/HARD
1393. Which of the following statements is CORRECT?
Chapter 15: Dividends
Conceptual M/C
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a. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend
payout, announces that it is increasing the dividend to $1.50. The stock price then jumps
from $20 to $30. Some people would argue that this is proof that investors prefer dividends
to retained earnings. Miller and Modigliani would agree with this argument.
b. Other things held constant, the higher a firm's target dividend payout ratio, the higher its
expected growth rate should be.
c. Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings
that a firm pays out in dividends has no effect on its cost of capital, but it does affect its
stock price.
d. The federal government sometimes taxes dividends and capital gains at different rates.
Other things held constant, an increase in the tax rate on dividends relative to that on
capital gains would logically lead to a decrease in dividend payout ratios.
e. If investors prefer firms that retain most of their earnings, then a firm that wants to
maximize its stock price should set a high dividend payout ratio.
Chapter 15: Dividends
Conceptual M/C
Page 692
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Multiple Choice: Problems
These problems can be changed algorithmically, and the computer can, at times, produce
combinations of variables where the residual policy results in zero dividends and a zero payout
ratio. We sometimes constrain the input variables to prevent this from occurring, but we
sometimes permit it. When this possibility exists, we so indicate.
(15-3) Residual dividend model
CR
Answer: d EASY
1394. Portland Plastics Inc. has the following data. If it follows the residual dividend model, what is its
forecasted dividend payout ratio?
Capital budget
$12,500
% Debt
40%
Net income (NI)
$11,500
a. 25.36%
b. 28.17%
c. 31.30%
d. 34.78%
e. 38.26%
(15-6) Stock split
CR
Answer: c EASY
1395. Becker Financial recently declared a 2-for-1 stock split. Prior to the split, the stock sold for $80
per share. If the firm's total market value is unchanged by the split, what will the stock price be
following the split?
a. $36.10
b. $38.00
c. $40.00
d. $42.00
e. $44.10
Chapter 15: Dividends
M/C Problems
Page 693
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(15-6) Stock split
CR
Answer: a EASY
1396. Toombs Media Corp. recently completed a 3-for-1 stock split. Prior to the split, its stock sold for
$90 per share. The firm's total market value was unchanged by the split. Other things held
constant, what is the best estimate of the stock's post-split price?
a. $30.00
b. $31.50
c. $33.08
d. $34.73
e. $36.47
(15-6) Stock split
CR
Answer: c EASY
1397. Mid-State BankCorp recently declared a 7-for-2 stock split. Prior to the split, the stock sold for
$80 per share. If the firm's total market value is unchanged by the split, what will the stock
price be following the split?
a. $20.63
b. $21.71
c. $22.86
d. $24.00
e. $25.20
(15-3) Residual dividend model
CR
Answer: b EASY/MEDIUM
1398. Fauver Industries plans to have a capital budget of $650,000. It wants to maintain a target
capital structure of 40% debt and 60% equity, and it also wants to pay a dividend of $225,000. If
the company follows the residual dividend model, how much net income must it earn to meet
its investment requirements, pay the dividend, and keep the capital structure in balance?
a. $584,250
b. $615,000
c. $645,750
Chapter 15: Dividends
M/C Problems
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d. $678,038
e. $711,939
(15-3) Residual dividend model
CR
Answer: b MEDIUM
1399. Ring Technology has a capital budget of $850,000, it wants to maintain a target capital structure
of 35% debt and 65% equity, and it also wants to pay a dividend of $400,000. If the company
follows the residual dividend model, how much net income must it earn to meet its capital
budgeting requirements and pay the dividend, all while keeping its capital structure in balance?
a. $ 904,875
b. $ 952,500
c. $1,000,125
d. $1,050,131
e. $1,102,638
(15-3) Residual dividend model
CR
Answer: a MEDIUM
1400. D. Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain a target capital
structure of 45% debt and 55% equity, and she also wants to pay a dividend of $500,000. If the
company follows the residual dividend model, how much income must it earn, and what will its
dividend payout ratio be?
a. $ 898,750; 55.63%
b. $ 943,688; 58.41%
c. $ 990,872; 61.34%
d. $1,040,415; 64.40%
e. $1,092,436; 67.62%
(15-3) Residual dividend model
CR
Answer: d MEDIUM
1401. Banerjee Inc. wants to maintain a target capital structure with 30% debt and 70% equity. Its
forecasted net income is $550,000, and its board of directors has decreed that no new stock
Chapter 15: Dividends
M/C Problems
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can be issued during the coming year. If the firm follows the residual dividend model, what is
the maximum capital budget that is consistent with maintaining the target capital structure?
a. $673,652
b. $709,107
c. $746,429
d. $785,714
e. $825,000
Chapter 15: Dividends
M/C Problems
Page 696
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(15-3) Residual dividend model
CR
Answer: d MEDIUM
1402. Dentaltech Inc. projects the following data for the coming year. If the firm follows the residual
dividend model and also maintains its target capital structure, what will its dividend payout ratio
be?
EBIT
Interest rate
$2,000,000
Capital budget
$850,000
10%
% Debt
40%
Debt outstanding
$5,000,000
% Equity
60%
Shares outstanding
5,000,000
Tax rate
40%
a. 37.2%
b. 39.1%
c. 41.2%
d. 43.3%
e. 45.5%
(15-3) Residual dividend model
CR
Answer: c MEDIUM
1403. Mortal Inc. expects to have a capital budget of $500,000 next year. The company wants to
maintain a target capital structure with 30% debt and 70% equity, and its forecasted net income
is $400,000. If the company follows the residual dividend model, how much in dividends, if any,
will it pay?
a. $45,125
b. $47,500
c. $50,000
d. $52,500
e. $55,125
(15-3) Residual dividend model
Chapter 15: Dividends
CR
M/C Problems
Answer: e MEDIUM
Page 697
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1404. Torrence Inc. has the following data. If it uses the residual dividend model, how much total
dividends, if any, will it pay out?
Capital budget
$1,000,000
% Debt
60%
Net income (NI)
$625,000
a. $183,264
b. $192,909
c. $203,063
d. $213,750
e. $225,000
(15-3) Residual dividend model
CR
Answer: e MEDIUM
1405. NY Fashions has the following data. If it follows the residual dividend model, how much total
dividends, if any, will it pay out?
Capital budget
% Debt
$1,500,000
65%
Net income (NI)
$550,000
a. $20,363
b. $21,434
c. $22,563
d. $23,750
e. $25,000
Chapter 15: Dividends
M/C Problems
Page 698
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(15-3) Residual dividend model
CR
Answer: a MEDIUM
1406. Chicago Brewing has the following data, dollars in thousands. If it follows the residual dividend
model, what will its dividend payout ratio be?
Capital budget
$5,000
% Debt
45%
Net income (NI)
$5,300
a. 48.11%
b. 50.52%
c. 55.57%
d. 61.13%
e. 67.24%
(15-3) Residual dividend model
CR
Answer: a MEDIUM
1407. LA Moving Company has the following data, dollars in thousands. If it follows the residual
dividend model, what will its dividend payout ratio be?
Capital budget
% Debt
$5,000
45%
Net income (NI)
$7,000
a. 60.71%
b. 63.75%
c. 70.13%
d. 77.14%
e. 84.85%
Chapter 15: Dividends
M/C Problems
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(15-3) Residual dividend model
CR
Answer: d MEDIUM
1408. New Orleans Builders Inc. has the following data. If it follows the residual dividend model, what
is its forecasted dividend payout ratio?
Capital budget
$7,500
% Debt
35%
Net income (NI)
$6,500
a. 18.23%
b. 20.25%
c. 22.50%
d. 25.00%
e. 27.50%
(15-6) Stock split
CR
Answer: c MEDIUM
1409. Ross-Jordan Financial has suffered losses in recent years, and its stock currently sells for only
$0.50 per share. Management wants to use a reverse split to get the price up to a more
“reasonable” level, which it thinks is $25 per share. How many of the old shares must be given
up for one new share to achieve the $25 price, assuming this transaction has no effect on total
market value?
a. 47.50
b. 49.88
c. 50.00
d. 52.50
e. 55.13
(15-6) Stock split
CR
Answer: b MEDIUM
1410. Keys Financial has done extremely well in recent years, and its stock now sells for $175 per
share. Management wants to get the price down to a more typical level, which it thinks is $25
per share. What stock split would be required to get to this price, assuming the transaction has
Chapter 15: Dividends
M/C Problems
Page 700
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no effect on the total market value? Put another way, how many new shares should be given
per one old share?
a. 6.98
b. 7.00
c. 7.35
d. 7.72
e. 8.10
(15-6) Stock split
CR
Answer: b MEDIUM
1411. Whited Products recently completed a 4-for-1 stock split. Prior to the split, its stock sold for
$120 per share. If the firm's total market value increased by 5% as a result of increased liquidity
and favorable signaling effects, what was the stock price following the split?
a. $29.93
b. $31.50
c. $33.08
d. $34.73
e. $36.47
(15-3) Residual dividend model
CR
Answer: c MEDIUM/HARD
1412. Clark Farms Inc. has the following data, and it follows the residual dividend model. Currently, it
finances with 15% debt. Some Clark family members would like for the dividends to be
increased. If Clark increased its debt ratio, which the firm's treasurer thinks is feasible, by how
much could the dividend be increased, holding other things constant?
Chapter 15: Dividends
Capital budget
$3,000,000
Net income (NI)
$3,500,000
% Debt now
15%
% Debt after change
60%
M/C Problems
Page 701
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a. $1,093,500
b. $1,215,000
c. $1,350,000
d. $1,485,000
e. $1,633,500
Chapter 15: Dividends
M/C Problems
Page 702
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(15-3) Residual dividend model
CR
Answer: a MEDIUM/HARD
1413. Purcell Farms Inc. has the following data, and it follows the residual dividend model. Currently,
it finances with 15% debt. Some Purcell family members would like for the dividend payout
ratio to be increased. If Purcell increased its debt ratio, which the firm's treasurer thinks is
feasible, by how much could the dividend payout ratio be increased, holding other things
constant?
Capital budget
$3,000,000
Net income (NI)
$3,500,000
% Debt now
15%
% Debt after change
60%
a. 38.6%
b. 40.5%
c. 42.5%
d. 44.7%
e. 46.9%
(15-3) Residual dividend model
CR
Answer: c MEDIUM/HARD
1414. Whitman Antique Cars Inc. has the following data, and it follows the residual dividend model.
Some Whitman family members would like more dividends, and they also think that the firm's
capital budget includes too many projects whose NPVs are close to zero. If Whitman reduced its
capital budget to the indicated level, by how much could dividends be increased, holding other
things constant?
Original capital budget
$3,000,000
New capital budget
$2,000,000
Net income
$3,500,000
% Debt
40%
a. $486,000
Chapter 15: Dividends
M/C Problems
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b. $540,000
c. $600,000
d. $660,000
e. $726,000
(15-3) Residual dividend model
CR
Answer: e MEDIUM/HARD
1415. Pavlin Corp.'s projected capital budget is $2,000,000, its target capital structure is 40% debt and
60% equity, and its forecasted net income is $900,000. If the company follows the residual
dividend model, how much dividends will it pay or, alternatively, how much new stock must it
issue?
a. $462,983; $244,352
b. $487,350; $257,213
c. $513,000; $270,750
d. $540,000; $285,000
e. $
0; $300,000
Chapter 15: Dividends
M/C Problems
Page 704
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(15-6) Stock split
CR
Answer: b MEDIUM/HARD
1416. Grullon Co. is considering a 7-for-3 stock split. The current stock price is $75.00 per share, and
the firm believes that its total market value would increase by 5% as a result of the improved
liquidity that should follow the split. What is the stock's expected price following the split?
a. $32.06
b. $33.75
c. $35.44
d. $37.21
e. $39.07
(15-3) Residual dividend model
CR
Answer: c HARD
1417. Walter Industries is a family owned concern. It has been using the residual dividend model, but
family members who hold a majority of the stock want more cash dividends, even if that means
a slower future growth rate. Neither the net income nor the capital structure will change during
the coming year as a result of a dividend policy change to the indicated target payout ratio. By
how much would the capital budget have to be cut to enable the firm to achieve the new target
dividend payout ratio?
% Debt
35%
% Equity = 1.0 – % Debt
65%
Capital budget under the residual dividend model
$5,000,000
Net income; it will not change this year even if
dividends increase
$3,500,000
Equity to support the capital budget
= % Equity × Capital budget
$3,250,000
Dividends paid = NI − Equity needed
$250,000
Currently projected dividend payout ratio
7.1%
Target dividend payout ratio
70.0%
a. -$2,741,538
Chapter 15: Dividends
M/C Problems
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b. -$3,046,154
c. -$3,384,615
d. -$3,723,077
e. -$4,095,385
(15-3) Residual dividend model
CR
Answer: e HARD
1418. Sheehan Corp. is forecasting an EPS of $3.00 for the coming year on its 500,000 outstanding
shares of stock. Its capital budget is forecasted at $800,000, and it is committed to maintaining
a $2.00 dividend per share. It finances with debt and common equity, but it wants to avoid
issuing any new common stock during the coming year. Given these constraints, what
percentage of the capital budget must be financed with debt?
a. 30.54%
b. 32.15%
c. 33.84%
d. 35.63%
e. 37.50%
Chapter 15: Dividends
M/C Problems
Page 706
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(15-3) Residual dividend model
CR
Answer: e HARD
1419. Del Grasso Fruit Company has more positive NPV projects than it can finance under its current
policies without issuing new stock, but its board of directors had decreed that it cannot issue
any new shares in the foreseeable future. Your boss, the CFO, wants to know how the capital
budget would be affected by changes in capital structure policy and/or the target dividend
payout policy. You obtained the following data, which shows the firm's projected net income
(NI), its current capital structure and dividend payout policies, and three possible new policies.
Projected net income for the coming year will not be affected by a policy change. How much
larger could the capital budget be if (1) the target debt ratio were raised to the indicated
amount, other things held constant, (2) the target payout ratio were lowered to the indicated
amount, other things held constant, or (3) the debt ratio and dividend payout were both
changed by the indicated amounts?
Current
Projected NI
Policy Changes
Policy
Increase Debt
Lower Payout
Do Both
$175.0
$175.0
$175.0
$175.0
% Debt
25.0%
75.0%
25.0%
75.0%
% Equity
75.0%
25.0%
75.0%
25.0%
% Payout
65.0%
65.0%
20.0%
20.0%
a. $133.0; $ 85.5; $389.6
b. $140.0; $ 90.0; $410.1
c. $147.4; $ 94.8; $431.7
d. $155.2; $ 99.8; $454.4
e. $163.3; $105.0; $478.3
Chapter 15: Dividends
M/C Problems
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