LOS a: Review cash dividends, stock dividends, stock splits, and reverse stock splits and calculate and discuss their impact on a shareholder's wealth.

Q1. Which justification for repurchasing stock is the least valid?

A)   Shareholders prefer capital gains to cash dividends.

B)   Repurchases offer shareholders more choices than cash dividends.

C)   A cash dividend increase, in response to short-term excess cash flows, may confuse investors.

Q2. Which of the following statements about dividend policy and capital structure is most accurate?

A)   Investors view a stock repurchase as a positive signal and a stock issue as a negative signal.

B)   A person who believes in the clientele effect and a proponent of the "bird-in-hand" theory would have similar views on dividend payout policy.

C)   Monte Carlo simulation is used to estimate market risks; scenario analysis measures stand-alone risk.

Q3. A periodic payment to shareholders in the form of additional shares of stock instead of cash is a:

A)   dividend reinvestment plan

B)   stock repurchase

C)   stock dividend

Q4. Stock splits:

A)   are less common than stock dividends.

B)   increase firm value.

C)   do not in and of themselves affect firm value

Q5. Financial managers utilize stock splits and stock dividends because they perceive that:

A)   investors will double the share price if there is a 20% stock dividend.

B)   brokerage fees paid by shareholders will be reduced.

C)   an optimal trading range exists.

Q6. Which of the following statements about a stock repurchase is least accurate?

A)   Disgruntled stockholders are forced to sell their shares, improving management's position.

B)   A stock repurchase occurs when a large block of stock is removed from the marketplace.

C)   Management can distribute cash to shareholders without signaling about future earnings.

LOS a: Review cash dividends, stock dividends, stock splits, and reverse stock splits and calculate and discuss their impact on a shareholder's wealth. fficeffice" />

Q1. Which justification for repurchasing stock is the least valid?

A)   Shareholders prefer capital gains to cash dividends.

B)   Repurchases offer shareholders more choices than cash dividends.

C)   A cash dividend increase, in response to short-term excess cash flows, may confuse investors.

Correct answer is A)

Some shareholders prefer capital gains, while others prefer dividends. Repurchases offer shareholders the choice of tendering or not tendering their stock, while cash dividends represent a payment they cannot refuse. Raising dividends is often seen as a positive signal, but an increase funded by short-term cash flows may not be sustainable, forcing the company to reduce the dividend later.

Q2. Which of the following statements about dividend policy and capital structure is most accurate?

A)   Investors view a stock repurchase as a positive signal and a stock issue as a negative signal.

B)   A person who believes in the clientele effect and a proponent of the "bird-in-hand" theory would have similar views on dividend payout policy.

C)   ffice:smarttags" />Monte Carlo simulation is used to estimate market risks; scenario analysis measures stand-alone risk.

Correct answer is A)

Investors view a stock repurchase as a positive signal and a stock issue as a negative signal. A repurchase may mean that management believes the stock is undervalued. To understand why a stock issue is viewed negatively, consider the following circumstances: A biotech company has a new blockbuster drug that will increase its profitability, but to produce and market the drug, the company needs to raise capital. If the company sells new stock, then as sales (and thus profits) occur, the price of the stock will rise. The current shareholders will do well but not as well as they would have had the company not sold more stock before the share price increased. Thus, it is assumed that management will prefer to finance growth with non-stock sources.

The other statements are false. A person who believes in the clientele effect and a proponent of the “bird-in-hand” theory would not have similar views on dividend policy. The clientele effect suggests that different groups of investors want different dividend levels (often based on tax status), and through the law of supply and demand, investors will select companies that meet their needs. Thus, dividend payout policy does not matter. According to the “bird-in-hand” theory, investors prefer dividends to capital appreciation because they view the former (D₁ / P₀) as less risky than the latter (g, or growth rate).

Q3. A periodic payment to shareholders in the form of additional shares of stock instead of cash is a:

A)   dividend reinvestment plan

B)   stock repurchase

C)   stock dividend

Correct answer is C)

Stock dividends are dividends paid out in new shares of stock instead of cash. Unlike stock dividends, dividend reinvestment plans are at the discretion of individual shareholders. In the case of stock repurchases, the company is buying back shares so the number of shares in the investment public’s hands is declining.

Q4. Stock splits:

A)   are less common than stock dividends.

B)   increase firm value.

C)   do not in and of themselves affect firm value

Correct answer is C)

Stock splits divide up each existing share into multiple shares. The price of each share will drop correspondingly to the number of shares created, so there is no change in the owner’s wealth. Empirical research has shown that in the absence of a dividend yield increase, the stock price falls to the stock split ratio of the original price (i.e., to 25% of the original price in a 4-for-1 stock split). This makes sense, given that the investor’s percentage ownership of the company has not changed.

Q5. Financial managers utilize stock splits and stock dividends because they perceive that:

A)   investors will double the share price if there is a 20% stock dividend.

B)   brokerage fees paid by shareholders will be reduced.

C)   an optimal trading range exists.

Correct answer is C)

Although there is little empirical evidence to support the contention, there is nevertheless a widespread belief in financial circles that an optimal price range exists for stocks. “Optimal” means that if the price is within this range, the price/earnings ratio, price/sales and other relevant ratios will be maximized. Hence, the value of the firm will be maximized.

Q6. Which of the following statements about a stock repurchase is least accurate?

A)   Disgruntled stockholders are forced to sell their shares, improving management's position.

B)   A stock repurchase occurs when a large block of stock is removed from the marketplace.

C)   Management can distribute cash to shareholders without signaling about future earnings.

Correct answer is A)

A repurchase gives stockholders a choice. They can sell or not sell.

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