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Dividends & Payout Policy Fundamentals of Corporate Finance Questions

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Practice Questions for Dividend Policy
Reference: Chapter 17 Dividends and Payout Policy, Fundamentals of Corporate Finance, any
edition, Ross, Westerfield and Jordan.
Multiple Choices:
1. The common stock of Pierson Enterprises has historically had a high dividend yield and is
expected to continue to do so. As a result, the majority of its shareholders are individuals and
entities that are seeking a regular source of cash income. Most of these shareholders pay
either no taxes or a relatively low amount of taxes. The fact that most of these shareholders
have similar characteristics is referred to by which one of the following terms?
A. information content effect
B. clientele effect
C. efficient markets hypothesis
D. distribution effect
2. HJ Corporation has excess cash and has opted to buy some of its shares of outstanding
common stock. What is this process of buying called?
A. stock dividend
B. stock split
C. stock repurchase
D. stock recap
3. Which one of the following statements related to dividend policy is correct?
A. The primary question related to dividend policy is whether or not a firm should ever pay
a dividend.
B. Both dividends and dividend policy are irrelevant.
C. Dividend policy focuses on the timing of dividend payments.
D. Whether or not a firm ever pays a dividend is irrelevant to equity valuation.
4. The information content of a dividend increase generally signals that:
A. the firm has a one-time surplus of cash.
B. the firm has few, if any, net present value projects to pursue.
C. management believes earnings growth will be strong going forward.
D. the firm has more cash than it needs due to a decline in future orders.
5. An investor is more likely to prefer a high dividend payout if a firm:
A. has few, if any, positive net present value projects.
B. has lower tax rates than the investor.
C. has a stock price that is increasing rapidly.
D. offers substantial gains on its equities, which are taxed at a favorable rate.

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Show-your-work Questions:
1. Galles Corporation is evaluating an extra dividend versus a share repurchase. In either case,
$14,500 would be spent. Current earnings are $1.65 per share, and stock currently sells for
$58 per share. There are 2,000 shares outstanding. Ignore taxes and other imperfections in
answering the first two questions.
a. Evaluate the two alternatives in terms of the effect on the price per share of the stock and
shareholder wealth.
b. What will be the effect on the company’s EPS and PE ratio under the two different
scenarios?
c. In the real world, which of these actions would you recommend? Why?
a. If the company makes a dividend payment, we can calculate the wealth of a shareholder
as:
Dividend per share = $14,500 / 2,000 shares = $7.25
The stock price after the dividend payment will be:
P
X
= $58 7.25 = $50.75 per share
The shareholder will have a stock worth $50.75 and a $7.25 dividend for a total wealth
of $58. If the company makes a repurchase, it will repurchase:
Shares repurchased = $14,500 / $58 = 250 shares
If the shareholder lets their shares be repurchased, they will have $58 in cash. If the
shareholder keeps their shares, they’re still worth $58.
b. If the company pays dividends, the current EPS is $1.65, and the P/E ratio is:
P/E = $50.75 / $1.65 = 30.76
If the company repurchases stock, the number of shares will decrease. The total net
income is the EPS times the current number of shares outstanding. Dividing net income
by the new number of shares outstanding, we find the EPS under the repurchase is:
EPS = $1.65(2,000) / (2,000 250) = $1.89
The stock price will remain at $58 per share, so the P/E ratio is:
P/E = $58 / $1.89 = 30.76

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Practice Questions for Dividend Policy Reference: Chapter 17 – Dividends and Payout Policy, Fundamentals of Corporate Finance, any edition, Ross, Westerfield and Jordan. Multiple Choices: 1. The common stock of Pierson Enterprises has historically had a high dividend yield and is expected to continue to do so. As a result, the majority of its shareholders are individuals and entities that are seeking a regular source of cash income. Most of these shareholders pay either no taxes or a relatively low amount of taxes. The fact that most of these shareholders have similar characteristics is referred to by which one of the following terms? A. information content effect B. clientele effect C. efficient markets hypothesis D. distribution effect 2. HJ Corporation has excess cash and has opted to buy some of its shares of outstanding common stock. What is this process of buying called? A. stock ...
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