Sie sind auf Seite 1von 30

14GitmanPrinciplesofFinance,EleventhEdition

Chapter13
DividendPolicy

.1 Learning Goals
1. Understandcashdividendpaymentprocedures,thetaxtreatmentofdividends,andtheroleof
dividendreinvestmentplans.

2. Describetheresidualtheoryofdividendsandthekeyargumentswithregardtodividendirrelevance
andrelevance.

3. Discussthekeyfactorsinvolvedinestablishingadividendpolicy.

4. Reviewandevaluatethethreebasictypesofdividendpolicies.

5. Evaluatestockdividendsfromaccounting,shareholder,andcompanypointsofview.

6. Explainstocksplitsandstockrepurchasesandthefirmsmotivationforundertakingeachofthem.

.2 True/False
1. Holdersofrecordarestockholderswhosenamesarerecordedonthedateofrecord.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:RelevantDividendDates

2. Purchasersofastocksellingexdividendreceivethecurrentdividend.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:RelevantDividendDates

3. Dateofrecord(dividends)istheactualdateonwhichthecompanywillmailthedividendpayment
totheholdersofrecord.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:RelevantDividendDates
15GitmanPrinciplesofFinance,EleventhEdition
4. Thepaymentdateisfivedaysafterthedateofrecord,onwhichthecompanywillmailthedividend
totheholdersofrecord.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:RelevantDividendDates

5. Theexdividendperiodbeginsfourbusinessdayspriortothepaymentdateduringwhichastock
willbesoldwithoutpayingthecurrentdividend.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:RelevantDividendDates

6. Thepaymentofcashdividendstocorporatestockholdersisdecidedbythefirmschieffinancial
officer.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:DividendPaymentProcedures

7. Dividendreinvestmentplans(DRPs)enablestockholderstousedividendsreceivedonthefirms
stocktoacquireadditionalsharesorfractionalsharesatlittleornotransaction(brokerage)cost.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:DividendReinvestmentPlans

8. Becauseretainedearningsareaformofinternalfinancing,thedividenddecisioncansignificantly
affectthefirmsexternalfinancingrequirements.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:DividendPolicyandFinancingPolicy

9. Ignoringgeneralmarketfluctuations,thestockspricewouldbeexpectedtodropbytheamountof
thedeclareddividendontheexdividenddate.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:RelevantDividendDates

10. Thedividenddecisionscansignificantlyaffectthefirmssharepriceandexternalfinancing
requirements.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:DividendPolicyandFinancingPolicy
Chapter13DividendPolicy16
11. AccordingtoModiglianiandMiller,afirmsvalueisdeterminedsolelybytheearningpowerand
riskofitsassetsandthatthemannerinwhichitsplitsitsearningsstreambetweendividendsand
internallyretainedfundsdoesnotaffectthisvalue.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:DividendIrrelevanceArguments

12. Duetoclienteleeffect,ModiglianiandMillerarguethattheshareholdersgetwhattheyexpectand,
thus,thevalueofthefirmsstockisunaffectedbydividendpolicy.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:DividendIrrelevanceArguments

13. Theresidualtheoryofdividendstendstosuggestthattherequiredreturnofinvestorsisnot
influencedbythefirmsdividendpolicyand,thus,dividendpolicyisirrelevant.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:ResidualTheoryofDividends

14. Theclienteleeffectistheargumentthatafirmattractsshareholderswhosepreferenceswithrespect
tothepaymentandstabilityofdividendscorrespondstothepaymentpatternandstabilityofthefirm
itself.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:ClienteleEffects

15. Accordingtothebirdinthehandargument,currentdividendpaymentsreduceinvestoruncertainty
andresultinahighervalueforthefirmsstock.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:BirdintheHandArgument

16. Theresidualtheoryofdividendsimpliesthatifthefirmcannotearnareturn(IRR)frominvestment
ofitsearningsthatisinexcessofcost(WMCC),itshoulddistributetheearningsbypaying
dividendstostockholders.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:ResidualTheoryofDividends
17GitmanPrinciplesofFinance,EleventhEdition
17. Inthedividendrelevancearguments,currentdividendpaymentsarebelievedtoreduceinvestors
uncertainty,therebyallelsebeingequalplacingahighervalueonthefirmsstock.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:2
Topic:DividendRelevanceArguments

18. Whileanearningsrequirementlimitingtheamountofdividendspaidissometimesimposed,the
firmisnotprohibitedfrompayingmoreindividendsthanitscurrentearnings.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:InternalConstraintsonDividendPayments

19. Generally,legalconstraintsprohibitthepaymentofcashdividendsuntilacertainlevelofearnings
hasbeenachievedorlimittheamountofdividendspaidtoacertaindollaramountorpercentageof
earnings.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:InternalConstraintsonDividendPayments

20. Sincelendersaregenerallyreluctanttomakeloanstoafirmtopaydividends,thefirmsabilityto
paycashdividendsisgenerallyconstrainedbytheamountofexcesscashavailable.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:ContractualConstraintsonDividendPayments

21. Inestablishingadividendpolicy,afirmshouldretainfundsforinvestmentinprojectsyielding
higherreturnsthantheownerscouldobtainfromexternalinvestmentsofequalrisk.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:ShareholderWealthConsiderations

22. Ifafirmpaysoutahigherpercentageofearnings,newequitycapitalwillhavetoberaisedwith
commonstock,whichwillresultinhighercontrolandearningsfortheexistingowners.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:ShareholderWealthConsiderations

23. Regulardividendpolicyisadividendpolicybasedonthepaymentofacertainpercentageof
earningstoownersineachdividendperiod.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:4
Topic:RegularDividendPolicy
Chapter13DividendPolicy18
24. Aconstantpayoutratiodividendpolicyisadividendpolicybasedonthepaymenttoexisting
ownersofadividendintheformofstockasacertainpercentageofthefirmstotalnumberofstocks
outstandingineachdividendperiod.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:4
Topic:ConstantPayoutRatioDividendPolicy

25. Theregulardividendpolicyprovidestheownerswithgenerallypositiveinformation,indicatingthat
thefirmisokayandtherebyminimizingtheiruncertainty.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:RegularDividendPolicy

26. Sinceregularlypayingafixedorincreasingdividendeliminatesuncertaintyaboutthefrequencyand
magnitudeofdividends,itincreasestheownerswealth.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:RegularDividendPolicy

27. Thepaymentofastockdividendisashiftingoffundsbetweencapitalaccountsratherthanauseof
funds.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:5
Topic:StockDividends

28. Incaseofstockdividend,theshareholdersproportionofownershipinthefirmremainsthesame,
andaslongasthefirmsearningsremainunchanged,sodoeshisorhershareoftotalearnings.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:StockDividends

29. Ifthefirmsearningsremainconstantandtotalcashdividendsdonotincrease,astockdividend
resultsinalowerpersharemarketvalueforthefirmsstock.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:StockDividends

30. Theshareholderreceivingastockdividendreceivesashareofcommonstockofequalvaluetotheir
existingsharesofcommonstock.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:StockDividends
19GitmanPrinciplesofFinance,EleventhEdition
31. Afterthestockdividendispaid,thepersharevalueofthestockholdersstockwillremainthesame
asthevaluebeforethestockdividendand,thus,themarketvalueofhisorhertotalholdingsinthe
firmwillremainunchanged.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:5
Topic:StockDividends

32. Ifthestockdividendispaidsothatcashcanberetainedtosatisfypastduebills,adeclineinmarket
valuemayresult.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:5
Topic:StockDividends

33. Thestockrepurchasecanbeviewedasacashdividend.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:6
Topic:StockRepurchases

34. Astocksplitcommonlyincreasesthenumberofsharesoutstandingandthestockspersharepar
value.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:StockSplits

35. Ina2for1stocksplit,thenumberofsharesoutstandingdecreasesbyfiftypercentandthestocks
pershareparvaluewilldouble.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:StockSplits

36. Reversestocksplitsareinitiatedwhenastockissellingattoolowapricetoappearrespectable.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
Topic:StockSplits

37. Thetreasurystockisanaccountingentryonthefirmsbalancesheettodesignatethefirmstotal
investmentingovernmentsecurities.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:TreasuryStock
Chapter13DividendPolicy20
38. Therepurchaseofcommonstockresultsinatypeofreversedilution,sincetheearningspershare
andthemarketpriceofstockareincreasedbyreducingthenumberofsharesoutstanding.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:StockRepurchases

39. Generallyaslongasearningsremainconstant,therepurchaseofsharesreducesthenumberof
outstandingshares,raisingtheearningspershareandthereforethemarketpricepershare.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:StockRepurchases

40. Dividendsprovideinformationaboutthefirmscurrentandfutureperformance.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:DividendFundamentals

41. Dividendsprovideinformationaboutthefirmscurrentperformancebutlittleornoinformation
aboutthefirmsfutureperformance.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:1
Topic:DividendFundamentals

42. Thedividendpaymentdateissetbythefirmsboardofdirectorsandrepresentstheactualdateon
whichthefirmmailsthedividendpaymenttotheholdersofrecord.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:DividendPaymentDate

43. Thedividendpaymentdateissetbythefirmschiefexecutiveofficerandrepresentstheactualdate
onwhichthefirmmailsthedividendpaymenttotheholdersofrecord.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:1
Topic:DividendPaymentDate

44. Bypurchasingsharesthroughafirmsdividendreinvestmentplan(orDRIP),shareholderstypically
canacquiresharesatabout5percentbelowtheprevailingmarketprice.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:DividendReinvestmentPlans
21GitmanPrinciplesofFinance,EleventhEdition
45. Bypurchasingsharesthroughafirmsdividendreinvestmentplan(orDRIP),shareholderstypically
canacquiresharesatabout25percentbelowtheprevailingmarketprice.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:DividendReinvestmentPlans

46. TheJobsGrowthTaxReliefReconciliationActof2003significantlychangedthetaxtreatmentof
corporatedividendsformosttaxpayersbydroppingthetaxratetotherateapplicableoncapital
gains,whichisamaximumrateof15percent.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:TaxTreatmentofDividends

47. TheJobsGrowthTaxReliefReconciliationActof2003significantlychangedthetaxtreatmentof
corporatedividendsformosttaxpayersbydroppingthetaxratetotherateapplicableoncapital
gains,whichisamaximumrateof25percent.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:TaxTreatmentofDividends

48. Theresidualtheoryofdividends,asespousedbyModiglianiandMiller,suggeststhatdividends
representanearningsresidualratherthananactivedecisionvariablethataffectsfirmvalue;this
meansthatafirmsdecisiontopaydividendsornotwillnothaveanyimpactonafirmsshareprice.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:2
Topic:DividendIrrelevanceArguments

49. Therepresentativetheoryofdividends,asespousedbyModiglianiandMiller,suggeststhat
dividendsrepresentasignificant,activedecisionvariablethataffectsfirmvalue;thismeansthata
firmsdecisiontopaydividendscanhaveasignificantimpactonafirmsshareprice.
Answer: FALSE
LevelofDifficulty:4
LearningGoal:2
Topic:DividendIrrelevanceArguments

50. Thebirdinthehandargumentespousingtheimportanceofdividendsordividendrelevance
suggeststhatinvestorsviewacurrent(certain)dividendaslessriskythanfuture(uncertain)
dividendsorcapitalgains;thissuggeststhatwhetherafirmpaysadividendornotcanhavea
significantimpactonshareprice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:2
Topic:BirdintheHandArgument
Chapter13DividendPolicy22
51. Thebirdinthehandargumentespousingtheimportanceofdividendsordividendrelevance
suggeststhatinvestorsviewacurrent(certain)dividendaslessriskythanfuture(uncertain)
dividendsorcapitalgains;nevertheless,proponentsofthistheoryarguethatthiswillhaveno
significantimpactonshareprice.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:2
Topic:BirdintheHandArgument

52. Inmoststates,legalcapitalismeasuredeitherbytheparvalueofcommonstock;otherstates,
however,definelegalcapitaltoincludenotonlytheparvalueofthestock,butalsoanypaidin
capitalinexcessofpar.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:LegalCapital

53. Inmoststates,legalcapitalismeasurednotonlybytheparvalueandpaidincapitalofthestock,but
alsobyanyaccumulatedretainedearnings.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:LegalCapital

54. Ifafirmhasoverdueliabilitiesorislegallyinsolventorbankrupt,moststatesprohibititspayment
ofcashdividends.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:LegalConstraintsonDividendPayments

55. Thelevelofdividendsafirmexpectstopayisoftendirectlyrelatedtohowrapidlyitexpectsto
growaswellasthelevelofassetinvestmentsrequired.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:GrowthConstraintsonDividendPayments

56. Thelevelofdividendsafirmexpectstopayisgenerallyunrelatedtohowrapidlyitexpectstogrow
aswellasthelevelofassetinvestmentsrequired.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:GrowthConstraintsonDividendPayments
23GitmanPrinciplesofFinance,EleventhEdition
57. Becausedividendsaretaxedatthesamerateascapitalgainsunderthe2003TaxAct,afirms
strategyofpayinglowornodividendsprimarilyofferstaxadvantagestowealthystockholders
throughtaxdeferralratherthanasaresultofalowertaxrateoncurrentincome.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:ShareholderWealthConstraintsonDividendPayments

58. Ingeneral,themarketrewardsfirmsthatadoptaconstantdividendpayoutpolicyratherthanafixed
orincreasinglevelofdividendsthroughhighershareprices.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:MarketConstraintsonDividendPayments

59. Ingeneral,themarketrewardsfirmsthatadoptafixedorincreasinglevelofdividendsratherthana
fixeddividendpayoutpolicythroughhighershareprices.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:MarketConstraintsonDividendPayments

60. Ashareholderreceivingastockdividendtypicallyreceivesnothingofvalue.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:StockDividends

.3 Multiple Choice Questions


1. AtafirmsquarterlydividendmeetingheldApril9,thedirectorsdeclareda$0.50persharecash
dividendfortheholdersofrecordonMonday,May1.Thefirmsstockwillsellexdividendson
(a) April9.
(b) May5.
(c) April25.
(d) April27.
Answer: D
LevelofDifficulty:1
LearningGoal:1
Topic:RelevantDividendDates
Chapter13DividendPolicy24
2. Stockholdersdislikedividendsthat
(a) arefixed.
(b) fluctuatewithearnings.
(c) arecontinuous.
(d) increase.
Answer: B
LevelofDifficulty:1
LearningGoal:1
Topic:DividendFundamentals

3. Thepaymentofcashdividendstocorporatestockholdersisdecidedbythe
(a) management.
(b) stockholders.
(c) SEC.
(d) boardofdirectors.
Answer: D
LevelofDifficulty:2
LearningGoal:1
Topic:DividendPaymentProcedures

4. Payingastockdividend_________theretainedearningsaccount.
(a) decreases
(b) hasnoeffecton
(c) increases
(d) reorganizes
Answer: A
LevelofDifficulty:2
LearningGoal:1
Topic:StockDividends

5. Adividendreinvestmentplan_________onthesecurity.
(a) decreasesthereturn
(b) hasnoeffectonthereturn
(c) increasesthereturn
(d) hasanundeterminedeffect
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:DividendReinvestmentPlans
25GitmanPrinciplesofFinance,EleventhEdition
6. Adividendreinvestmentplanenablesstockholdersto
(a) reinvestthedividendsinmoneymarketinstrumentswhichareriskfree.
(b) reinvestalldividendsinthefirmwithnoaccompanyingincreaseinequity.
(c) acquireadditionaldividendsthroughredemptionofstock.
(d) acquiresharesatlittleornotransactioncosts.
Answer: D
LevelofDifficulty:2
LearningGoal:1
Topic:DividendReinvestmentPlans

7. Theresidualtheoryofdividendssuggeststhatdividendsare_________tothevalueofthefirm.
(a) residual
(b) relevant
(c) irrelevant
(d) integral
Answer: C
LevelofDifficulty:2
LearningGoal:2
Topic:ResidualTheoryofDividends

8. Theinformationcontentofdividendsrefersto
(a) nonpaymentofdividendsbycorporations.
(b) dividendchangesasindicatorsofafirmsfuture.
(c) astableandcontinuousdividend.
(d) adividendpaidasapercentofcurrentearnings.
Answer: B
LevelofDifficulty:2
LearningGoal:2
Topic:InformationalContentofDividends

9. Accordingtotheresidualtheoryofdividends,ifthefirmsequityneedexceedstheamountof
retainedearnings,thefirmwould
(a) borrowtopaythecashdividend.
(b) selladditionalstocktopaythecashdividend.
(c) paynocashdividends.
(d) notneedtoconsideritsdividendpolicy.
Answer: C
LevelofDifficulty:3
LearningGoal:2
Topic:ResidualTheoryofDividends
Chapter13DividendPolicy26
10. Accordingtotheresidualtheoryofdividends,ifthefirmsequityneedislessthantheamountof
retainedearnings,thefirmwould
(a) borrowtopaythecashdividend.
(b) declareadividendequaltotheremainingbalance.
(c) paynocashdividends.
(d) notneedtoconsideritsdividendpolicy.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:ResidualTheoryofDividends

11. Dividendpolicyisaformof
(a) capitalbudgetingpolicy.
(b) financingpolicy.
(c) workingcapitalpolicy.
(d) dividendreinvestmentpolicy.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:DividendPolicyandFinancingPolicy

12. Theclienteleeffectrefersto
(a) therelevanceofdividendpolicyonsharevalue.
(b) thefirmsabilitytoattractstockholderswhosedividendpreferencesaresimilartothefirms
dividendpolicy.
(c) theinformationalcontentofdividends.
(d) thebirdinthehandargument.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:ClienteleEffect

13. ModiglianiandMillersuggestthatthevalueofthefirmisnotaffectedbythefirmsdividendpolicy,
dueto
(a) therelevanceofdividends.
(b) theclienteleeffect.
(c) theinformationalcontent.
(d) theoptimalcapitalstructure.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:DividendIrrelevanceArguments
27GitmanPrinciplesofFinance,EleventhEdition
14. ModiglianiandMiller,recognizingthatdividendsdosomehowaffectstockprices,suggestthat
positiveeffectsofdividendincreasesareattributable
(a) directlytothedividendpolicy.
(b) directlytotheoptimalcapitalstructure.
(c) nottotheinformationalcontentbuttotheconsistencyinthepaymentofdividends.
(d) nottothedividenditselfbuttotheinformationalcontentofthedividendswithrespecttofuture
earnings.
Answer: D
LevelofDifficulty:3
LearningGoal:2
Topic:InformationalContentofDividends

15. ModiglianiandMillerarguethatwhenthefirmhasnoacceptableinvestmentopportunities,it
should
(a) closeitsdoors.
(b) distributetheunneededfundstotheowners.
(c) loweritscostofcapital.
(d) retainthefundsuntilanacceptableprojectarises.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:ResidualTheoryofDividends
16. Gordonsbirdinthehandargumentsuggeststhat
(a) dividendsareirrelevant.
(b) firmsshouldhavea100percentpayoutpolicy.
(c) shareholdersaregenerallyriskaverseandattachlessrisktocurrentdividends.
(d) themarketvalueofthefirmisunaffectedbydividendpolicy.
Answer: C
LevelofDifficulty:3
LearningGoal:2
Topic:BirdintheHandTheory
17. Proponentsofthedividendirrelevancetheoryarguethat,allelsebeingequal,aninvestorsrequired
returnandthevalueofthefirmareunaffectedbydividendpolicy,forallofthefollowingreasons,
EXCEPT
(a) thefirmsvalueisdeterminedsolelybytheearningpowerandriskofitsassets.
(b) investorsaregenerallyriskaverseandattachlessrisktocurrentasopposedtofuturedividends
orcapitalgains.
(c) ifdividendsdoaffectvalue,theydososolelybecauseoftheirinformationcontent,which
signalsmanagementsearningsexpectations.
(d) aclienteleeffectexistswhichcausesafirmsshareholderstoreceivethedividendsthatthey
expect.
Answer: B
LevelofDifficulty:4
LearningGoal:2
Topic:DividendIrrelevanceArguments
Chapter13DividendPolicy28
18. Ingeneral,withregardtodividendpayments,thecontractualconstraintsimposedbyloan
agreementscanincludeallofthefollowingEXCEPT
(a) prohibitthepaymentofcashdividendsuntilacertainlevelofearningshasbeenachieved.
(b) limitthepercentageofearningsthatcanbepaidoutindividends.
(c) limittheactualdollaramountofdividendsthatcanbepaidout.
(d) requirethepaymentofacommonstockdividend.
Answer: D
LevelofDifficulty:2
LearningGoal:3
Topic:ContractualConstraintsonDividendPayments

19. Firmsareusuallyprohibitedbystatelawfromdistributing
(a) retainedearningsasdividends.
(b) paidincapitalasdividends.
(c) dividendsinayearthefirmhasanetloss.
(d) assetsasdividends.
Answer: B
LevelofDifficulty:2
LearningGoal:3
Topic:LegalConstraintsonDividendPayments

20. ThefactorsinvolvedinsettingadividendpolicyincludeallofthefollowingEXCEPT
(a) restrictivecovenantsinabondindenture.
(b) growthprospects.
(c) thelegalprohibitiononpayingdividendswhichexceedcurrentearnings.
(d) capitalimpairmentrestrictions.
Answer: C
LevelofDifficulty:3
LearningGoal:3
Topic:ConstraintsonDividendPayments

21. ThefactorsinvolvedinsettingadividendpolicyincludeallofthefollowingEXCEPT
(a) operatingconstraints.
(b) legalconstraints.
(c) contractualconstraints.
(d) internalconstraints.
Answer: A
LevelofDifficulty:3
LearningGoal:3
Topic:ConstraintsonDividendPayments
29GitmanPrinciplesofFinance,EleventhEdition
22. Afirmhasthefollowingstockholdersequitybalances:

Commonstockatpar $400,000
Paidincapitalinexcessofpar 1,200,000
Retainedearnings 2,000,000

Instateswherethefirmslegalcapitalisdefinedastheparvalueofitscommonstock,themaximum
cashdividendthefirmcouldpayis
(a) $3,600,000.
(b) $400,000.
(c) $3,200,000.
(d) $1,600,000.
Answer: C
LevelofDifficulty:3
LearningGoal:3
Topic:LegalConstraintsonDividendPayments

23. Anexcessearningsaccumulationtaxisleviedwhen
(a) shareholdersreceivedividendswhichexceedthefirmsearnings.
(b) firmsdonotpaydividendsinordertodelaytheownerstaxliability.
(c) firmsdonotpaydividendstoreinvestinthefirm.
(d) earningsexceeddividends.
Answer: B
LevelofDifficulty:3
LearningGoal:3
Topic:LegalConstraintsonDividendPayments

24. Afirmthathasalargepercentageof_________investorsmaypayoutalowerpercentageofits
earningsasdividends.
(a) wealthy
(b) pensionfund
(c) middleincome
(d) business
Answer: A
LevelofDifficulty:3
LearningGoal:3
Topic:ShareholderWealthConstraintsonDividendPayments
Chapter13DividendPolicy30
25. Amongownerconsiderationsintheestablishmentofdividendpolicy,anyofthefollowingmay
enterintothedecisionEXCEPT
(a) thetaxstatusoftheowners.
(b) theownersinvestmentopportunities.
(c) thepotentialdilutionofownership.
(d) restrictiveconstraintsonthepreferredstock.
Answer: D
LevelofDifficulty:3
LearningGoal:3
Topic:ShareholderWealthConstraintsonDividendPayments

26. Thedividendpolicymustbeformulatedconsideringtwobasicobjectives,namely
(a) delayingthetaxliabilityofthestockholderandinformationcontent.
(b) maximizingshareholderwealthanddelayingthetaxliabilityofthestockholder.
(c) maximizingshareholderwealthandprovidingforsufficientfinancing.
(d) maintainingliquidityandminimizingtheweightedaveragecostofcapital.
Answer: C
LevelofDifficulty:3
LearningGoal:3
Topic:ShareholderWealthConstraintsonDividendPayments

27. Thecapitalimpairmentrestrictionsareestablishedto
(a) reducedividendsequaltoorbelowthecurrentearningslevel.
(b) constrainthefirmtopayingdividendswhichdonotrequireadditionalborrowing.
(c) protecttheshareholder.
(d) provideasufficientbasetoprotectcreditorsclaims.
Answer: D
LevelofDifficulty:4
LearningGoal:3
Topic:LegalConstraintsonDividendPayments

28. Afirmhascurrentaftertaxearningsof$1,000,000andhasdeclaredacashdividendof$400,000.
Thefirmsdividendpayoutratiois
(a) 2.5percent.
(b) 2.0percent.
(c) 4.0percent.
(d) 40percent.
Answer: D
LevelofDifficulty:1
LearningGoal:4
Topic:DividendPayoutRatio
31GitmanPrinciplesofFinance,EleventhEdition
29. ThemostcommonlyuseddividendpoliciesareallofthefollowingEXCEPT
(a) constantpayoutratio.
(b) regular.
(c) inkind.
(d) lowregularandextra.
Answer: C
LevelofDifficulty:1
LearningGoal:4
Topic:TypesofDividendPolicies

30. Theproblemwithaconstantpayoutratiodividendpolicyfromtheshareholdersperspectiveisthat
(a) itborestheshareholders.
(b) ifthefirmsearningsdrop,sodoesthedividendpayment.
(c) evenwhenearningsarelow,thecompanymustpayafixeddividend.
(d) thereisnoinformationalcontent.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:ConstantPayoutRatioDividendPolicy

31. Theproblemwiththeregulardividendpolicyfromthefirmsperspectiveisthat
(a) itborestheshareholders.
(b) ifthefirmsearningsdrop,sodoesthedividendpayment.
(c) evenwhenearningsarelow,thecompanymustpayafixeddividend.
(d) itincreasestheshareholdersuncertainty.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:RegularDividendPolicy

32. Whenafirmpaysastateddollardividendandadjuststhepaymentasearningsincrease,itsdividend
policycanbecalled
(a) alowregularandextradividendpolicy.
(b) aregulardividendpolicy.
(c) atargetdividendpayoutratiopolicy.
(d) aconstantpayoutratiodividendpolicy.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:RegularDividendPolicy
Chapter13DividendPolicy32
33. Theadvantageofusingthelowregularandextradividendpolicyisthat
(a) thefirmavoidsgivingtheshareholdersfalsehopes.
(b) ifthefirmsearningsdrop,sodoesthedividendpayment.
(c) theextradividendmaybecomearegularevent.
(d) cyclicalshiftsinearningsmaybeavoided.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:LowRegularandExtraDividendPolicy

34. AtafirmsquarterlydividendmeetingheldonDecember5,thedirectorsdeclareda$1.50pershare
cashdividendtobepaidtotheholdersofrecordonMonday,January1.Beforethedividendwas
declared,thefirmsaccumulatedretainedearningsbalanceandcashbalancewere$1,280,000and
$30,000respectively.Thefirmhas10,000sharesofcommonstockoutstanding.OnJanuary2,the
cash,dividendspayable,andretainedearningsaccountshadbalancesof
(a) $15,000,$0,and$1,265,000,respectively.
(b) $30,000,$15,000,and$1,280,000,respectively.
(c) $30,000,$0,and$1,265,000,respectively.
(d) $15,000,$0,and$1,280,000,respectively.
Answer: A
LevelofDifficulty:3
LearningGoal:4
Topic:AccountingforDividends

35. Afirmhashadthefollowingearningshistoryoverthelastfiveyears:

Year EarningsperShare
2003 $2.50
2002 2.00
2001 1.75
2000 1.25
1999 1.00

Ifthefirmsdividendpolicyisbasedona$0.50payoutpershare,increasingby$0.05pershare
wheneverearningsexceed$1.50pershare,theannualdividendsfor2000and2003were
(a) $1.25and$2.50,respectively.
(b) $0.50and$0.50,respectively.
(c) $0and$0.50,respectively.
(d) $0.50and$0.55,respectively.
Answer: D
LevelofDifficulty:3
LearningGoal:4
Topic:LowRegularandExtraDividendPolicy
33GitmanPrinciplesofFinance,EleventhEdition
36. Afirmhashadthefollowingearningshistoryoverthelastfiveyears:

Year EarningsperShare
2003 $2.50
2002 2.00
2001 1.75
2000 1.25
1999 1.00

Ifthefirmsdividendpolicywasbasedonaconstantpayoutratioof50percentforalloftheyears
withearningsover$1.50pershareandazeropayoutotherwise,theannualdividendsfor1999and
2003were
(a) $0.50and$1.25,respectively.
(b) $0and$2.00,respectively.
(c) $0and$1.25,respectively.
(d) $0and$0.88,respectively.
Answer: C
LevelofDifficulty:3
LearningGoal:4
Topic:ConstantDividendPayoutRatioDividendPolicy

37. Afirmhashadthefollowingearningshistoryoverthelastfiveyears:

Year EarningsperShare
2003 $2.50
2002 2.00
2001 1.75
2000 1.25
1999 1.00

Ifthefirmsdividendpolicywastopay$0.25pershareeachperiodexceptwhenearningsexceed
$1.50,whenanextradividendequalto50percentoftheearningsabove$1.50wouldbepaid,the
annualdividendsfor2000and2003were
(a) $0.25and$1.25,respectively.
(b) $0.25and$0.75,respectively.
(c) $0and$0.25,respectively.
(d) $0.25and$0.25,respectively.
Answer: B
LevelofDifficulty:3
LearningGoal:4
Topic:LowRegularandExtraDividendPolicy
Chapter13DividendPolicy34
38. Theshareholderreceivingastockdividendreceives
(a) ashareofcommonstockofequalvaluetotheirexistingsharesofcommonstock.
(b) cash.
(c) additionalsharesofcommonstockandcash.
(d) nothingofvalue.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:StockDividends

39. Stockdividendsare_________costlytoissuethancashdividends.
(a) less
(b) equally
(c) more
(d) occasionallyless
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:StockDividends

40. Mr.R.owns20,000sharesofABCCorporationstock.Thecompanyisplanningtoissueastock
dividend.BeforethedividendMr.R.owned10percentoftheoutstandingstock,whichhadamarket
valueof$200,000,or$10pershare.Uponreceivingthe10percentstockdividendthevalueofhis
sharesis
(a) $220,000.
(b) $210,000.
(c) $200,000.
(d) greater,butcannotbedetermined.
Answer: C
LevelofDifficulty:4
LearningGoal:5
Topic:StockDividends

41. A_________hasaneffectonthefirmssharepricesimilartothatofa_________.
(a) stockrepurchase;stocksplit
(b) stockdividend;stocksplit
(c) cashdividend;stockdividend
(d) cashdividend;stocksplit
Answer: B
LevelofDifficulty:3
LearningGoal:6
Topic:StockDividendsandStockSplits
35GitmanPrinciplesofFinance,EleventhEdition
42. Thepurposeofastocksplitisto
(a) affectthefirmscapitalstructure.
(b) decreasethedividend.
(c) enhancethetradingactivityofthestockbyloweringthemarketprice.
(d) increasethemarketpriceofthestock.
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:StockSplits

43. Astocksplithas_________effectonthefirmscapitalstructure.
(a) little
(b) no
(c) ameasurable
(d) adetrimental
Answer: B
LevelofDifficulty:3
LearningGoal:6
Topic:StockSplits

44. Thepurposeofareversestocksplitisto
(a) issueadditionalshares.
(b) increasethedividend.
(c) increasethepriceofstock.
(d) reducetradingactivity.
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:StockSplits

45. Theaccountinginastocksplitwilltransferfunds
(a) fromtheCommonStockandPaidinCapitalaccountstotheRetainedEarningsaccount.
(b) fromtheRetainedEarningsaccounttothePaidinCapitalaccount.
(c) fromthePaidinCapitalaccounttotheRetainedEarningsaccount.
(d) fromtheRetainedEarningsaccounttothePreferredStockaccount.
(e) Noneoftheabove.
Answer: E
LevelofDifficulty:3
LearningGoal:6
Topic:StockSplits
Chapter13DividendPolicy36
46. StockrepurchasesaremadeforallofthefollowingreasonsEXCEPT
(a) toobtainsharestobeusedinacquisition.
(b) toretireoutstandingissues.
(c) tohavesharesavailableforstockoptionplans.
(d) todecreasethebookvalueofequity.
Answer: D
LevelofDifficulty:3
LearningGoal:6
Topic:StockRepurchases

47. Whencommonstockisrepurchasedandretired,theunderlyingmotiveisto
(a) delaytaxes.
(b) boostthestocksdividends.
(c) distributetheexcesscashtotheowners.
(d) reducetheretainedearningsbalance.
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:StockRepurchases

48. Therepurchaseofstock_________theearningspershareand_________themarketpriceofstock.
(a) increases;increases
(b) decreases;decreases
(c) increases;decreases
(d) decreases;increases
Answer: A
LevelofDifficulty:3
LearningGoal:6
Topic:StockRepurchases

49. StockrepurchasesmaybemadeforallofthefollowingreasonsEXCEPT
(a) toenhanceshareholdervaluebyreducingthenumberofsharesoutstandingandtherebyraising
earningspershare.
(b) tohelpdiscourageanunfriendlytakeoverbyreducingthenumberofpubliclytradedshares.
(c) tomakesharesavailableforstockoptionplans.
(d) tomakesharesavailableforstockdividends.
Answer: D
LevelofDifficulty:3
LearningGoal:6
Topic:StockRepurchases
37GitmanPrinciplesofFinance,EleventhEdition
50. Whenpurchasingoutstandingsharesofcommonstockafirmcanutilizeallofthefollowing
methodsEXCEPT
(a) purchaseontheopenmarketatmarketprices.
(b) withatenderofferatvaryingprices.
(c) withatenderofferataspecifiedprice.
(d) bypurchasingalargeblockonanegotiatedbasis.
Answer: B
LevelofDifficulty:3
LearningGoal:6
Topic:StockRepurchases

51. Thepurposeofastocksplitisto
(a) issueadditionalshares.
(b) increasethedividend.
(c) reducethepriceofstock.
(d) reducetradingactivity.
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:StockSplits

52. Theneteffectofastockrepurchaseis
(a) similartothepaymentofastockdividend.
(b) similartoacashdividend.
(c) similartoastocksplit.
(d) similartoareversestocksplit.
Answer: B
LevelofDifficulty:4
LearningGoal:6
Topic:StockRepurchases

53. Enhancementofshareholdervaluethroughstockrepurchaseisachievedby
(a) reducingthenumberofsharesoutstandingandtherebyraisingearningspershare.
(b) sendingapositivesignaltoinvestorsinthemarketplacethatmanagementbelievesthatthestock
isundervalued.
(c) providingatemporaryfloorforthestockprice,whichmayhavebeendeclining.
(d) alloftheabove.
Answer: D
LevelofDifficulty:4
LearningGoal:6
Topic:StockRepurchases
Chapter13DividendPolicy38
54. AtthequarterlymeetingofTangshanMiningCorporation,heldonSeptember10th,thedirectors
declareda$1.00persharedividendforthefirms100,000sharesofcommonstockoutstanding.The
neteffectofdeclaringandpayingthisdividendwouldbeto
(a) decreasetotalassetsby$100,000andincreasestockholdersequityby$100,000.
(b) decreasetotalassetsby$100,000anddecreasestockholdersequityby$100,000.
(c) increasetotalassetsby$100,000andincreasestockholdersequityby$100,000.
(d) increasetotalassetsby$100,000anddecreasestockholdersequityby$100,000.
Answer: B
LevelofDifficulty:3
LearningGoal:1
Topic:AccountforDividendPayments

55. UndertheJobsandGrowthTaxReliefReconciliationActof2003,themaximumrateoftaxationon
dividendsreceivedbyshareholderswassetat
(a) 18%.
(b) 20%.
(c) 25%.
(d) noneoftheabove.
Answer: D
LevelofDifficulty:2
LearningGoal:1
Topic:TaxRateonDividendIncome

56. AsaresultoftheJobsandGrowthTaxReliefReconciliationActof2003,earlystudiesshowedthat
thepercentageoffirmspayingquarterlydividends
(a) increased.
(b) decreased.
(c) didnotchange.
(d) noneoftheabove.
Answer: A
LevelofDifficulty:2
LearningGoal:1
Topic:TaxRateonDividendIncome

57. TangshanMininghascommonstockatparof$200,000,paidincapitalinexcessofparof$400,000,
andretainedearningsof$280,000.Instateswherethefirmslegalcapitalisdefinedastheparvalue
ofcommonstock,thefirmcouldpayout_________incashdividendswithoutimpairingitscapital.
(a) $200,000.
(b) $480,000.
(c) $600,000.
(d) $880,000.
Answer: B
LevelofDifficulty:3
LearningGoal:1
Topic:LegalConstraintsonDividendPayments
39GitmanPrinciplesofFinance,EleventhEdition
58. TangshanMininghascommonstockatparof$200,000,paidincapitalinexcessofparof$400,000,
andretainedearningsof$280,000.Instateswherethefirmslegalcapitalisdefinedasthetotalof
parvalueandpaidincapitalofcommonstock,thefirmcouldpayout_________incashdividends
withoutimpairingitscapital.
(a) $280,000.
(b) $400,000.
(c) $480,000.
(d) $600,000.
Answer: A
LevelofDifficulty:3
LearningGoal:1
Topic:LegalConstraintsonDividendPayments

59. Shareholderwealthconsiderationsinthepaymentofdividendsincludeallofthefollowingexcept
(a) thetaxstatusofthefirmsowners.
(b) thecriminalstatusofthefirmsowners.
(c) theinvestmentopportunitiesofthefirmsowners.
(d) thepotentialdilutionofownershiponbehalfofthefirmsowners.
Answer: B
LevelofDifficulty:2
LearningGoal:1
Topic:ShareholderWealthConstraintsonDividendPayments

60. Whichtypeofdividendpaymentpolicyhasthedisadvantagethatifthefirmsearningsdroporifa
lossoccursinagivenperiod,dividendsmaybelowornonexistent?
(a) Constantpayoutratiopolicy.
(b) Regulardividendpolicy.
(c) Lowregularandextradividendpolicy.
(d) noneoftheabove.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:ConstantPayoutRatioDividendPolicy

61. Whichtypeofdividendpaymentpolicyhastheadvantagethatifthefirmsearningsdrop,dividends
willstillbemaintainedatarelativelyconstantlevel?
(a) Constantpayoutratiopolicy.
(b) Regulardividendpolicy.
(c) Lowregularandextradividendpolicy.
(d) noneoftheabove.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:RegularDividendPolicy
Chapter13DividendPolicy40
62. Thegreatadvantageofa_________isthatthispolicyavoidsgivingshareholdersfalsehopes.
(a) constantpayoutratiopolicy
(b) regulardividendpolicy
(c) lowregularandextradividendpolicy
(d) noneoftheabove.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:LowRegularandExtraDividendPolicy

63. TangshanMininghas100,000sharesoutstandingandjustdeclareda20percentstockdividend.
Beforetheannouncement,thefirmssharesweretradingat$50.00pershare.Afterthestock
dividend,thefirmssharesshouldtradeat_________pershare.
(a) $40.00
(b) $41.66
(c) $46.33
(d) remainunchanged
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:StockDividend

64. TangshanMininghas100,000sharesoutstandingandjustdeclareda2for1stocksplit.Beforethe
announcement,thefirmssharesweretradingat$50.00pershare.Afterthestockdividend,the
firmssharesshouldtradeat_________pershare.
(a) $100.00
(b) $25.00
(c) $50.00
(d) noneoftheabove.
Answer: B
LevelofDifficulty:3
LearningGoal:6
Topic:StockSplit

65. TangshanMininghas100,000sharesoutstandingandjustdeclareda3for2stocksplit.Beforethe
announcement,thefirmssharesweretradingat$50.00pershare.Afterthestockdividend,the
firmssharesshouldtradeat_________pershare.
(a) $33.33
(b) $50.00
(c) $75.00
(d) noneoftheabove.
Answer: A
LevelofDifficulty:3
LearningGoal:6
Topic:StockSplit
41GitmanPrinciplesofFinance,EleventhEdition

.4 Essay Questions
1. Afirmhashadtheindicatedearningspershareoverthelastthreeyears:

Year EPS
2003 $3.00
2002 2.00
2001 1.00

(a) Ifthefirmsdividendpolicywasbasedonaconstantpayoutratioof50percent,determinethe
annualdividendforeachyear.
(b) Ifthefirmsdividendpolicywasbasedonafixeddollarpayoutpolicyof50centspershareplus
anextradividendequalto75percentofearningspershareabove$1.00,determinetheannual
dividendforeachyear.
Answers:
(a)

Year EPS DividendperShare


2003 $3.00 $1.50
2002 2.00 1.00
2001 1.00 0.50

(b)

Year EPS DividendperShare


2003 $3.00 $2.00
2002 2.00 1.25
2001 1.00 0.50

LevelofDifficulty:2
LearningGoal:4
Topic:AlternativeTypesofDividendsPolicies

2. CaswellCasseyPharmaceuticalhasastockholdersequityaccountasshownbelow.Thefirms
commonstockcurrentlysellsfor$20pershare.

Preferredstock $500,000
Commonstock(2,000,000shares@$1par) 2,000,000
Paidincapitalinexcessofpar 10,000,000
Retainedearnings 11,600,000
Totalstockholdersequity $24,100,000
Chapter13DividendPolicy42
(a) WhatisthemaximumdividendpershareCaswellCaseycanpay?(Assumecapitalincludesall
paidincapital.)
(b) Recastthepartialbalancesheet(thestockholdersequityaccounts)toshowindependently
(1) a2for1stocksplitofthecommonstock.
(2) acashdividendof$1.50pershare.
(3) astockdividendof5percentonthecommonstock.

(c) AtwhatpricewouldyouexpecttheCaswellCasseystocktosellafter
(1) thestocksplit?
(2) thestockdividend?
Answers:
(a) Themaximumdividendpersharethefirmcanpayis:
$11,600,000/2,000,000shares$5.80/share
(b)
Preferredstock $500,000 $500,000 $500,000
Commonstock 2,000,000* 2,000,000 2,100,000**
Paidincapital 10,000,000 10,000,000 11,900,000
Retainedearnings 11,600,000 8,600,000 9,600,000
TotalS.E. $24,100,000 $21,100,000 $24,100,000
*(4,000,000sharesat$0.50par)
**(2,100,000sharesat$1par)
(c) (1)$10/share
(2)$19.05;2,000,000shares$20/share$40,000,000marketvalue
2,100,000shares?/share$40,000,000marketvalue
LevelofDifficulty:4
LearningGoal:6
Topic:(a)LegalConstraintsonDividendPayments;(b)CashDividends,StockDividends,and
StockSplits;(c)StockDividendsandStockSplits

3. TangshanMiningCompanyhasreleasedthefollowinginformation.

Earningsavailabletocommonstockholders $5,000,000
Numberofsharesofcommonstockoutstanding 1,000,000
Marketpricepershare $50
Retainedearnings 11,600,000

(a) WhatareTangshanMiningscurrentearningspershare?
(b) WhatisTangshanMiningscurrentP/Eratio?
(c) TangshanMiningwantstousehalfofitsearningseithertopayshareholdersdividendsorto
repurchasesharesforinclusioninthefirmsemployeestockownershipplan.Ifthefirmpaysa
cashdividend,whatwillbethedividendpersharereceivedbyexistingshareholders?
(d) Insteadofpayingthecashdividend,whatifthefirmuseshalfofitsearningstopay$55per
sharetorepurchasetheshares,whatwillbethefirmsnewEPS?Whatshouldbethefirmsnew
shareprice?
(e) Comparetheimpactofastockdividendandstockrepurchaseonshareholderwealth.
43GitmanPrinciplesofFinance,EleventhEdition
Answers:

(a) EPS$5,000,000/1,000,000$5.00pershare
(b) P/ERatio$50.00/$5.0010
(c) Dividends/Share$2,500,000/1,000,000$2.50/share
(d) Ifthefirmpaid$55torepurchasestock,itcouldrepurchaseapproximately45,455
shares($2,500,000$55pershare).Asaresult,thefirmwouldnowhave954,545
sharesoutstanding(1,000,000shares45,455shares).Asaresult,EPSwouldrise
from$5.00persharetoapproximately$5.24pershare($5,000,000954,545shares).
Ifweassumethestockstillsellsat10timesearnings,thenewmarketpricecouldbe
estimatedbymultiplyingthenewEPSbythePEratio.Thenewpricewouldthusbe
$52.40pershare,againofapproximately$2.40inshareprice.Notethatthisamount
wouldhavebeenprecisely$2.50centspershareifnotduetorounding.
(e) Theneteffectofastockdividendandastockrepurchaseisthesame.Inthisexample,
inbothcases,shareholderswouldhavereceivedanetgainofapproximately$2.50per
share.
LevelofDifficulty:4
LearningGoal:6
Topic:CashDividends,StockDividends,andShareRepurchases