Strayer FIN534 Week 9 Quiz 8

FIN 534 Week 9 Quiz 8
Question 1

Trenton Publishing follows a strict residual dividend policy. All
else equal, which of the following factors would be most likely to lead to an
increase
in the firm’s dividend per share?

The firm’s net income increases.

The company increases the percentage of equity in its target
capital structure.

The number of profitable potential projects increases.

Congress lowers the tax rate on capital gains. The remainder of
the tax code is not changed.

Earnings are unchanged, but the firm issues new shares of common
stock

Question 2

Which of the following statements is correct?

Firms with a lot of good investment opportunities and a relatively
small amount of cash tend to have above average payout ratios.

One advantage of the residual dividend policy is that it leads to
a stable dividend payout, which investors like.

An increase in the stock price when a company decreases its
dividend is consistent with signaling theory as postulated by MM.

If the “clientele effect” is correct, then for a company whose
earnings fluctuate, a policy of paying a constant percentage of net income will
probably maximize the stock price.

Stock repurchases make the most sense at times when a company
believes its stock is undervalued

Question 3

Which of the following statements is CORRECT?

When firms are deciding on the size of stock splits—say whether to
declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller
one, in this case the 2-for-1 split, because then the after-split price will be
higher than if the 3-for-1 split had been used.

Back before the SEC was created in the 1930s, companies would
declare reverse splits in order to boost their stock prices. However, this was
determined to be a deceptive practice, and it is illegal today.

Stock splits create more administrative problems for investors
than stock dividends, especially determining the tax basis of their shares when
they decide to sell them, so today stock dividends are used far more often than
stock splits.

When a company declares a stock split, the price of the stock
typically declines—by about 50% after a 2-for-1 split—and this necessarily
reduces the total market value of the equity.

If a firm’s stock price is quite high relative to most stocks—say
$500 per share—then it can declare a stock split of say 10-for-1 so as to bring
the price down to something close to $50. Moreover, if the price is relatively
low—say $2 per share—then it can declare a “reverse split” of say 1-for-25 so
as to bring the price up to somewhere around $50 per share.

Question 4

If a firm adheres strictly to the residual dividend policy, then
if its optimal capital budget requires the use of all earnings for a given year
(along with new debt according to the optimal debt/total assets ratio), then
the firm should pay

no dividends except out of past retained earnings.

no dividends to common stockholders.

dividends only out of funds raised by the sale of new common
stock.

dividends only out of funds raised by borrowing money (i.e., issue
debt).

dividends only out of funds raised by selling off fixed assets

Question 5

Firm M is a mature firm in a mature industry. Its annual net
income and net cash flows are both consistently high and stable. However, M’s
growth prospects are quite limited, so its capital budget is small relative to
its net income. Firm N is a relatively new firm in a new and growing industry.
Its markets and products have not stabilized, so its annual operating income
fluctuates considerably. However, N has substantial growth opportunities, and
its capital budget is expected to be large relative to its net income for the
foreseeable future. Which of the following statements is correct?

Firm M probably has a lower debt ratio than Firm N.

Firm M probably has a higher dividend payout ratio than Firm N.

If the corporate tax rate increases, the debt ratio of both firms
is likely to decline.

The two firms are equally likely to pay high dividends.

Firm N is likely to have a clientele of shareholders who want to
receive consistent, stable dividend income

Question 6

Which of the following statements is correct?

One disadvantage of dividend reinvestment plans is that they
increase transactions costs for investors who want to increase their ownership
in the company.

One advantage of dividend reinvestment plans is that they enable
investors to postpone paying taxes on the dividends credited to their account.

Stock repurchases can be used by a firm that wants to increase its
debt ratio.

Stock repurchases make sense if a company expects to have a lot of
profitable new projects to fund over the next few years, provided investors are
aware of these investment opportunities.

One advantage of an open market dividend reinvestment plan is that
it provides new equity capital and increases the shares outstanding.

Question 7

Which of the following statements about dividend policies is correct?

Modigliani and Miller argue that investors prefer dividends to
capital gains because dividends are more certain than capital gains. They call
this the “bird-in-the hand” effect.

One reason that companies tend to avoid stock repurchases is that
dividend payments are taxed at a lower rate than gains on stock repurchases.

One advantage of dividend reinvestment plans is that they allow
shareholders to avoid paying taxes on the dividends that they choose to
reinvest.

One key advantage of a residual dividend policy is that it enables
a company to follow a stable dividend policy.

The clientele effect suggests that companies should follow a
stable dividend policy.

Question 8

If a firm adheres strictly to the residual dividend policy, the
issuance of new common stock would suggest that

the dividend payout ratio has remained constant.

the dividend payout ratio is increasing.

no dividends were paid during the year.

the dividend payout ratio is decreasing.

the dollar amount of investments has decreased

Question 9

Which of the following should not
influence a firm’s dividend policy decision?

The firm’s ability to accelerate or delay investment projects.

A strong preference by most shareholders for current cash income
versus capital gains.

Constraints imposed by the firm’s bond indenture.

The fact that much of the firm’s equipment has been leased rather
than bought and owned.

The fact that Congress is considering changes in the tax law
regarding the taxation of dividends versus capital gains.

Question 10

Which of the following actions will best enable a company to raise
additional equity capital?

Refund long-term debt with lower cost short-term debt.

Declare a stock split.

Begin an open-market purchase dividend reinvestment plan.

Initiate a stock repurchase program.

Begin a new-stock dividend reinvestment plan.
Question 11

Which of the following statements is correct?

If a company has a 2-for-1 stock split, its stock price should
roughly double.

Capital gains earned in a share repurchase are taxed less
favorably than dividends; this explains why companies typically pay dividends
and avoid share repurchases.

Very often, a company’s stock price will rise when it announces
that it plans to commence a share repurchase program. Such an announcement
could lead to a stock price decline, but this does not normally happen.

Stock repurchases increase the number of outstanding shares.

The clientele effect is the best explanation for why companies
tend to vary their dividend payments from quarter to quarter.
Question 12

You own 100 shares of Troll Brothers’ stock, which currently sells
for $120 a share. The company is contemplating a 2-for-1 stock split. Which of
the following best describes what your position will be after such a split
takes place?

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

Question 13

In the real world, dividends

are usually more stable 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, and
these changes are randomly higher or lower, depending on whether earnings
increased or decreased.

are usually set as a fixed percentage of earnings, e.g., at 40% of
earnings, so if EPS = $2.00, then DPS will equal $0.80. Once the percentage is
set, then dividend policy is on “automatic pilot” and the actual dividend
depends strictly on earnings.
Question 14

Which of the following statements is correct?

One advantage of dividend reinvestment plans is that they enable
investors to avoid paying taxes on the dividends they receive.

If a company has an established clientele of investors who prefer
a high dividend payout, and if management wants to keep stockholders happy, it
should not
follow the strict residual dividend policy.

If a firm follows a strict residual dividend policy, then, holding
all else constant, its dividend payout ratio will tend to rise whenever the
firm’s investment opportunities improve.

If Congress eliminates taxes on capital gains but leaves the
personal tax rate on dividends unchanged, this would motivate companies to
increase their dividend payout ratios.

Despite its drawbacks, following the residual dividend policy will
tend to stabilize actual cash dividends, and this will make it easier for firms
to attract a clientele that prefers high dividends, such as retirees.
Question 15

Which of the following statements is correct?

The tax code encourages companies to pay dividends rather than
retain earnings.

If a company uses the residual dividend model to determine its
dividend payments, dividends payout will tend to increase whenever its
profitable investment opportunities increase.

The stronger management thinks the clientele effect is, the more
likely the firm is to adopt a strict version of the residual dividend model.

Large stock repurchases financed by debt tend to increase earnings
per share, but they also increase the firm’s financial risk.

A dollar paid out to repurchase stock is taxed at the same rate as
a dollar paid out in dividends. Thus, both companies and investors are
indifferent between distributing cash through dividends and stock repurchase
programs.
Question 16

Blemker Corporation has $500 million of total assets, its basic
earning power is 15%, and it currently has no debt in its capital structure.
The CFO is contemplating a recapitalization where it will issue debt at a cost
of 10% and use the proceeds to buy back shares of the company’s common stock,
paying book value. If the company proceeds with the recapitalization, its
operating income, total assets, and tax rate will remain unchanged. Which of
the following is most likely to occur as a result of the recapitalization?

The ROA would increase.

The ROA would remain unchanged.

The basic earning power ratio would decline.

The basic earning power ratio would increase.

The ROE would increase.
Question 17

Which of the following statements is CORRECT?

As a rule, the optimal capital structure is found by determining
the debt-equity mix that maximizes expected EPS.

The optimal capital structure simultaneously maximizes EPS and
minimizes the WACC.

The optimal capital structure minimizes the cost of equity, which
is a necessary condition for maximizing the stock price.

The optimal capital structure simultaneously minimizes the cost of
debt, the cost of equity, and the WACC.

The optimal capital structure simultaneously maximizes stock price
and minimizes the WACC.
Question 18

The firm’s target capital structure should be consistent with
which of the following statements?

Maximize the earnings per share (EPS).

Minimize the cost of debt (rd).

Obtain the highest possible bond rating.

Minimize the cost of equity (rs).

Minimize the weighted average cost of capital (WACC).
Question 19

Which of the following statements is CORRECT? As a firm increases
the operating leverage used to produce a given quantity of output, this will

normally lead to an increase in its fixed assets turnover ratio.

normally lead to a decrease in its business risk.

normally lead to a decrease in the standard deviation of its
expected EBIT.

normally lead to a decrease in the variability of its expected
EPS.

normally lead to a reduction in its fixed assets turnover ratio.
Question 20

Firms U and L each have the same amount of assets, and both have a
basic earning power ratio of 20%. Firm U is unleveraged, i.e., it is 100%
equity financed, while Firm L is financed with 50% debt and 50% equity. Firm
L’s debt has a before-tax cost of 8%. Both firms have positive net income.
Which of the following statements is CORRECT?

The two companies have the same times interest earned (TIE) ratio.

Firm L has a lower ROA than Firm U.

Firm L has a lower ROE than Firm U.

Firm L has the higher times interest earned (TIE) ratio.

Firm L has a higher EBIT than Firm U.
Question 21

Firms U and L each have the same amount of assets, and both have a
basic earning power ratio of 20%. Firm U is unleveraged, i.e., it is 100%
equity financed, while Firm L is financed with 50% debt and 50% equity. Firm
L’s debt has a before-tax cost of 8%. Both firms have positive net income.
Which of the following statements is CORRECT?

The two companies have the same times interest earned (TIE) ratio.

Firm L has a lower ROA than Firm U.

Firm L has a lower ROE than Firm U.

Firm L has the higher times interest earned (TIE) ratio.

Firm L has a higher EBIT than Firm U.

Question 22

Which of the following statements is CORRECT?

When a company increases its debt ratio, the costs of equity and
debt both increase. Therefore, the WACC must also increase.

The capital structure that maximizes the stock price is generally
the capital structure that also maximizes earnings per share.

All else equal, an increase in the corporate tax rate would tend
to encourage a company to increase its debt ratio.

Since debt financing raises the firm’s financial risk, increasing
a company’s debt ratio will always increase its WACC.

Since debt is cheaper than equity, increasing a company’s debt ratio
will always reduce its WACC.

Question 23

If debt financing is used, which of the following is CORRECT?

The percentage change in net operating income will be greater than
a given percentage change in net income.

The percentage change in net operating income will be equal to a
given percentage change in net income.

The percentage change in net income relative to the percentage
change in net operating income will depend on the interest rate charged on
debt.

The percentage change in net income will be greater than the
percentage change in net operating income.

The percentage change in sales will be greater than the percentage
change in EBIT, which in turn will be greater than the percentage change in net
income.

Question 24

Companies HD and LD have the same total assets, operating income
(EBIT), tax rate, and business risk. Company HD, however, has a much higher
debt ratio than LD. Also HD’s basic earning power (BEP) exceeds its cost of
debt (rd). Which of the following statements is CORRECT?

HD should have a higher return on assets (ROA) than LD.

HD should have a higher times interest earned (TIE) ratio than LD.

HD should have a higher return on equity (ROE) than LD, but its
risk, as measured by the standard deviation of ROE, should also be higher than
LD’s.

Given that BEP > rd, HD’s stock price must exceed that of LD.

Given that BEP > rd, LD’s stock price must exceed that of HD

Question 25

Volga Publishing is considering a proposed increase in its debt
ratio, which would also increase the company’s interest expense. The plan would
involve issuing new bonds and using the proceeds to buy back shares of its common
stock. The company’s CFO thinks the plan will not change total assets or
operating income, but that it will increase earnings per share (EPS). Assuming
the CFO’s estimates are correct, which of the following statements is CORRECT?

Since the proposed plan increases Volga’s financial risk, the
company’s stock price still might fall even if EPS increases.

If the plan reduces the WACC, the stock price is also likely to
decline.

Since the plan is expected to increase EPS, this implies that net
income is also expected to increase.

If the plan does increase the EPS, the stock price will
automatically increase at the same rate.

Under the plan there will be more bonds outstanding, and that will
increase their liquidity and thus lower the interest rate on the currently
outstanding bonds.

Question 26

Other things held constant, which of the following events is most
likely to encourage a firm to increase the amount of debt in its capital
structure?

Its sales become less stable over time.

The costs that would be incurred in the event of bankruptcy
increase.

Management believes that the firm’s stock has become overvalued.

Its degree of operating leverage increases.

The corporate tax rate increases.

Question 27

Based on the information below, what is Ezzel Enterprises’ optimal
capital structure?

%; %; EPS = $2.95; Stock price = $26.50.

%; %; EPS = $3.05; Stock price = $28.90.

%; %; EPS = $3.18; Stock price = $31.20.

%; %; EPS = $3.42; Stock price = $30.40.

%; %; EPS = $3.31; Stock price = $30.00

Question 28

Which of the following statements is CORRECT?

Increasing financial leverage is one way to increase a firm’s
basic earning power (BEP).

If a firm lowered its fixed costs while increasing its variable
costs, holding total costs at the present level of sales constant, this would
decrease its operating leverage.

The debt ratio that maximizes EPS generally exceeds the debt ratio
that maximizes share price.

If a company were to issue debt and use the money to repurchase
common stock, this action would have no impact on its basic earning power
ratio. (Assume that the repurchase has no impact on the company’s operating
income.)

If changes in the bankruptcy code made bankruptcy less costly to
corporations, this would likely reduce the average corporation’s debt ratio

Question 29

Business risk is affected by a firm’s operations. Which of the
following is NOT associated with (or does not contribute to) business risk?

Demand variability.

Sales price variability.

The extent to which operating costs are fixed.

The extent to which interest rates on the firm’s debt fluctuate.

Input price variability

Question 30

Which of the following statements is CORRECT?

A firm’s business risk is determined solely by the financial
characteristics of its industry.

The factors that affect a firm’s business risk are affected by
industry characteristics and economic conditions. Unfortunately, these factors
are generally beyond the control of the firm’s management.

One of the benefits to a firm of being at or near its target
capital structure is that this eliminates any risk of bankruptcy.

A firm’s financial risk can be minimized by diversification.
The amount of debt in its capital structure can under no
circumstances affect a company’s business risk.