MGMT 134 Sample Midterm Questions #1

Sample Questions Chapter 18 Answers at end of questions

True-False
Optimal dividend policy
i

The optimal dividend policy for a firm strikes a balance between payment of current
dividends and retention of earnings for future growth, and results in the maximization of
stock price.
a. True
b. False

Dividend irrelevance
ii

The dividend irrelevance theory, proposed by Miller and Modigliani, says that as long as
a firm pays a dividend, how much it pays does not affect either its cost of capital or its
stock price.
a. True
b. False

Dividend irrelevance
iii

MM's dividend irrelevance theory says that dividend policy does not affect a firm's value
but can affect its cost of capital.
a. True
b. False

Investor's dividend preference

iv

If investors do, in fact, prefer that firms retain most of their earnings, then firms that want
to maximize stock price should hold dividend payments to low levels.
a. True
b. False

Dividends and stock prices

v

The announcement of an increase in the cash dividend always causes an increase in the
price of the firm's common stock.
a. True
b. False

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MGMT 134 Sample Midterm Questions #1

Residual dividend policy
vi

If a firm adopts a residual dividend policy, dividends are determined as a residual item.
Therefore, the better the firm's investment opportunities, the lower its dividend payments
should be.
a. True
b. False

Stock dividends and splits

vii

A stock dividend and a stock split should, at least conceptually, have the same effect on
shareholders wealth.
a. True
b. False

Reverse split
viii

A reverse split reduces the number of shares outstanding.

a. True
b. False

Medium:
Dividend irrelevance
ix

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

Dividend irrelevance
x

A firm that follows a residual dividend policy must believe that the dividend irrelevance
theory is correct.
a. True
b. False

Earnings, dividends, and growth

xi

How a firm splits its income between retained earnings and dividends does not affect its
rate of growth, which is determined by the firm's basic earning power.
a. True
b. False

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MGMT 134 Sample Midterm Questions #1

Dividend-growth tradeoff
xii

One implication of the bird-in-the-hand theory of dividends is that a 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

WACC and dividend policy

xiii

If the shape of the curve depicting a firm's WACC versus its debt ratio is more like a
sharp "V", as opposed to a shallow "U", the easier it will be for the firm to maintain a
steady dividend in the face of varying investment opportunities from year to year.
a. True
b. False

Empirical tests
xiv

While the DCF-based empirical tests of dividend theory have generated inconclusive
results, CAPM-based tests have demonstrated that low payout ratio stocks have lower
required returns because of tax considerations.
a. True
b. False

Stock split
xv

Even if a stock split has no information content, and even if the dividend per share
adjusted for the split does not increase, there can still be a real benefit (i.e., a higher value
for shareholders) from such a split, but any such benefit is probably small.
a. True
b. False

Signaling hypothesis
xvi

If the information content, or signaling, hypothesis is correct, then changes in dividend

policy can be important with respect to firm value and capital costs.
a. True
b. False

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MGMT 134 Sample Midterm Questions #1

Multiple Choice: Conceptual
Easy:
Dividends versus capital gains
xvii

Myron Gordon and John Lintner believe that the required return on equity increases as
the dividend payout ratio is decreased. Their argument is based on the assumption that
a.
b.
c.
d.
e.

Investors are indifferent between dividends and capital gains.

Investors require that the dividend yield and capital gains yield equal a constant.
Capital gains are taxed at a higher rate than dividends.
Investors view dividends as being less risky than potential future capital gains.
Investors value a dollar of expected capital gains more highly than a dollar of
expected dividends because of the lower tax rate on capital gains.

Dividends, DRIPs, and repurchases

xviii

Which of the following statements is most correct?

a. In general, stock repurchases are taxed the same way as dividends.
b. One nice feature of dividend reinvestment plans is that they enable investors to
reduce the taxes paid on their dividends.
c. On average, companies send a negative signal to the marketplace when they
announce an increase in their dividend.
d. If a company is interested in issuing new equity capital, a new stock dividend
reinvestment plan probably makes more sense than an open market dividend
reinvestment plan.
e. Statements b and d are correct.

Dividend payout
xix

In the real world, we find that dividends

a.
b.
c.
d.
e.

Usually exhibit greater stability 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.
Are usually set as a fixed percentage of earnings.

Dividend payout
xx

A decrease in a firm's willingness to pay dividends is likely to result from an increase in

its
a.
b.
c.
d.
e.

Earnings stability.
Access to capital markets.
Profitable investment opportunities.
Collection of accounts receivable.
Stock price.

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MGMT 134 Sample Midterm Questions #1

Dividend theories
xxi

Which of the following statements best describes the theories of investors preferences
for dividends?
a. Modigliani and Miller argue that investors prefer dividends to capital gains.
b. The bird-in-hand theory suggests that a company can reduce its cost of equity capital
by reducing its dividend payout ratio.
c. The tax preference theory suggests that a company can increase its stock price by
increasing its dividend payout ratio.
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.

Dividend theory and policy

xxii

Which of the following statements is most correct?

a. The bird-in-the-hand theory implies that a company can reduce its WACC by
reducing its dividend payout.
b. The bird-in-the-hand theory implies that a company can increase its stock price by
reducing its dividend payout.
c. One problem with following a residual dividend policy is that it can lead to erratic
dividend payouts which may prevent the firm from establishing a reliable clientele of
investors who prefer a particular dividend policy.
d. Statements a and c are correct.
e. All of the statements above are correct.

Optimal dividend policy

xxiii

Which of the following would not have an influence on the optimal dividend policy?
a.
b.
c.
d.
e.

The possibility of accelerating or delaying investment projects.

A strong shareholders' preference for current income versus capital gains.
Bond indenture constraints.
The costs associated with selling new common stock.
All of the statements above can have an effect on dividend policy.

Stock split
xxiv

A stock split will cause a change in the total dollar amounts shown in which of the
following balance sheet accounts?
a.
b.
c.
d.
e.

Cash.
Common stock.
Paid-in capital.
Retained earnings.
None of the above.

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MGMT 134 Sample Midterm Questions #1

Stock split
xxv

You currently own 100 shares of stock in Beverly Brothers Inc. The stock currently
trades at $120 a share. The company is contemplating a 2-for-1 stock split. Which of the
following best describes your position after the proposed stock split takes place?
a.
b.
c.
d.
e.

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.

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i
.

Optimal dividend policy

ii

Answer: a

Diff: E

Dividend

irrelevance

Answer: b
iii

Diff: E

Dividend

irrelevance

Answer: b
iv

Investor's

dividend
Answer: a

Dividends

and

vii

viii

Residual

Stock

and

Answer: a

Diff: E

irrelevance

irrelevance

dividends,

WACC

and

growth

Diff: M
tradeoff
Diff: M
policy

Diff: M

Empirical
Answer: b

xv

and

dividend

Answer: b
xiv

Diff: M

Dividend-growth
Answer: a

xiii

Diff: M

Dividend

Earnings,

split

Diff: E

Dividend

splits

Reverse

Answer: b
xii

policy

dividends

Diff: E

Diff: E

Answer: b
xi

prices

Answer: a

Answer: a
x

Diff: E

dividend

Answer: a
ix

preference

stock

Answer: b
vi

Diff: E

Diff: M

Stock
Answer: a

tests

Diff: M

split

xvi

Signaling

hypothesis

Answer: a
xvii

Dividends

versus

Diff: M

capital

Answer: d
xviii.
Answer: d

Dividends,
Diff: E

DRIPs,

gains

Diff: E

and

repurchases

Statement a is false; repurchases are taxed as capital gains. Statement b is

false; investors still have to pay income taxes on reinvested dividends.
Statement c is false; an increase in dividends is usually a positive signal.
Statement d is true.
xix

Dividend
Answer: a

payout

xx

Diff: E

Dividend
Answer: c

payout
Diff: E

xxi

Dividend theories

Answer: e

Diff: E

Statement e is true; the others are false. MM developed the dividend

irrelevance theory. Reducing the payout would have the effect of increasing
the cost of equity if the bird-in-the-hand theory holds. The tax preference
theory suggests that a company can increase its stock price by reducing its
payout ratio. The residual dividend policy should be followed to determine
the long-run target payout ratio. If followed year to year, dividends would
fluctuate.
xxii. Dividend theory and policy

Answer: c

Diff: E

Statement c is correct; the others are false.

The bird-in-the-hand theory
implies that a company can reduce its WACC and increase its stock price by
increasing its dividend payout.
xxiii .

Optimal

dividend

Answer: e
xxiv

xxv.

Stock split

policy

Diff: E

Stock
Answer: e

Diff: E

Answer: b

Diff: E

split

With a 2-for-1 stock split, the price is (roughly) halved and the number of
shares doubles.