Question 1

Which of the following acts as a constraint on dividend payments?

Accepted Answer

Debt contract restrictions limit a company's ability to pay dividends. Lenders may include covenants that prevent the borrower from making dividend payments if they have not met certain financial ratios or if they are in violation of certain conditions.

Question 2

The distribution of earnings by a firm to stockholders by buying shares of its stock in the financial markets is known as a _____.

Accepted Answer

The distribution of earnings by buying back shares of its own stock in the financial markets is known as a stock repurchase or share buyback. The other options (stock dividend, stock split, stock ratio, and stock effect) refer to different actions related to the company's shares, but not specifically related to distributing earnings to stockholders through repurchasing shares.

Question 3

Dividend payments cannot exceed the balance sheet item "Retained earnings." This is known as the _____.

Accepted Answer

The impairment of capital rule prevents a company from making dividend payments that exceed its retained earnings, ensuring that dividends do not impair the capital of the company.

Question 4

If the stockholders of a firm prefer current income to future income, then the:

Accepted Answer

If the stockholders prefer current income, then they would want a higher dividend payout, which would lead to a decrease in the cost of equity. The cost of equity is the return that shareholders require for their investment, and if they prefer current income, the company must offer higher dividend payments to satisfy their preference. Therefore, as the dividend payout increases, the cost of equity decreases.

Question 5

Sunshine Corp. announces a 2-for-1 stock split for its shares trading at $100. If the current number of shares outstanding is 200,000, then the new market price of the share will be _____.

Accepted Answer

A 2-for-1 stock split means that the number of outstanding shares will double while the price per share will be halved. Therefore, after the split, there will be 400,000 shares outstanding, and the new market price per share will be $50 ($100/2).

Question 6

Amber Corp. has 3 million shares outstanding, each selling at $30. If Amber announces a 20% stock dividend, then the transfer from retained earnings is equal to _____.

Accepted Answer

A 20% stock dividend means that Amber Corp. will be issuing 20% more shares to its shareholders. In this case, 20% of 3 million shares is 0.6 million shares. At a price of $30 per share, the total value of the stock dividend is 0.6 million shares x $30 per share = $18,000,000.

The transfer from retained earnings is equal to the value of the stock dividend, which is $18,000,000. Therefore, the correct choice is B.

Question 7

All else equal, a normal stock split or a stock dividend:

Accepted Answer

A stock split or stock dividend increases the number of shares outstanding, but does not change the overall value of the company. Therefore, all else equal, the per share price of the stock should decrease, not increase (option A is incorrect). A stock split or stock dividend also does not directly impact a firm's profits or earnings, so option B is incorrect. The increase in share count resulting from a stock split or stock dividend should be recognized on the balance sheet (option D is incorrect). Finally, while a stock dividend may increase the dividend per share, this is not always the case and not guaranteed, so option E is also incorrect.

Question 8

A_____ is an action taken by a firm to decrease the per-share price of its stock.

Accepted Answer

A stock split is when a company increases the number of outstanding shares by issuing more shares to current shareholders. This results in a decrease in the per-share price of the stock without affecting the total market value of the company.

Question 9

Which of the following factors leads to a high dividend-payout ratio?

Accepted Answer

When a company has excess cash even after investing in profitable projects, it may choose to distribute the surplus to shareholders in the form of dividends, leading to a high dividend-payout ratio. The other options do not necessarily lead to a high dividend-payout ratio; option A and E may even limit the amount of dividends a company can pay. Option B suggests that shareholders prefer future income, which would lead to a lower dividend-payout ratio since the company would retain earnings for future investments. Option C implies a preference for limited ownership control, which would not necessarily relate to dividend payments.

Question 10

One of the disadvantages of stock repurchases is that:

Accepted Answer

Stock repurchases can lead to the company paying too much for its own shares if the market price is overvalued, which can be a disadvantage.

Question 11

Which of the following is an advantage of stock repurchases?

Accepted Answer

Stock repurchases provide a form of defense against a potential takeover attempt, as they reduce the number of shares outstanding and make it more expensive for an acquiring company to obtain a controlling interest. Additionally, it can also increase the earnings per share for remaining shareholders. Option A is incorrect as stock repurchases may indicate that the company has excess cash and believes that buying back shares is a good investment decision. Option B is incorrect as companies can distribute excess cash through stock repurchases. Option C is incorrect since a company may repurchase shares on a regular basis as part of its capital management strategy. Option E is also incorrect because employee stock options can be adjusted to reflect the stock repurchase.

Question 12

Which of the following is an important factor that affects dividend policies of companies around the world?

Accepted Answer

Tax structures are an important factor that affects dividend policies of companies around the world. Companies consider the tax implications of dividends on both the company and its shareholders when deciding on dividend policies. Different countries have different tax policies affecting dividends, and these policies can either encourage or discourage companies from paying dividends. For example, if dividend income is taxed at a higher rate than capital gains, companies may choose to retain earnings rather than pay dividends.

Quiz 13: Distribution of Retained Earnings: Dividends and Stock Repurchases