Chapter 15, Distributions to Shareholders: Dividends and Share Repurchases Video Solutions, Fundamentals of Financial Management

Problem 1

Discuss the pros and cons of having the directors formally announce a firm's future dividend policy.

Check back soon!

The cost of retained earnings is less than the cost of new outside equity capital Consequently, it is totally irrational for a firm to sell a new issue of stock and to pay cash dividends during the same year. Discuss the meaning of those statements.

Check back soon!

Problem 3

Would it ever be rational for a firm to borrow money in order to pay cash dividends? Explain.

Check back soon!

03:44

Problem 4

Modigliani and Miller (MM), on the one hand, and Gordon and Lintner (GL), on the other hand, have expressed strong views regarding the effect of dividend policy on a firm's cost of capital and value.
a. In essence, what are MM's and GL's views regarding the effect of dividend policy on the cost of capital and stock prices?
b. How could MM use the information content, or signaling, hypothesis to counter their opponents' arguments? If you were debating MM, how would you counter them?
c. How could MM use the clientele effect concept to counter their opponents' arguments? If you were debating $\mathrm{MM}$, how would you counter them?

Narayan Hari

Numerade Educator

Problem 5

How would each of the following changes tend to affect aggregate (i.e., the average for all corporations) payout ratios, other things held constant? Explain your answers.
a. An increase in the personal income tax rate
b. A liberalization of depreciation for federal income tax purposes - that is, faster tax write-offs
c. An increase in interest rates
d. An increase in corporate profits
e. A decline in investment opportunities
f. Permission for corporations to deduct dividends for tax purposes as they now deduct interest expense
g. A change in the Tax Code so that realized and unrealized long-term capital gains in any year are taxed at the same rate as ordinary income

Check back soon!

Problem 6

One position expressed in the financial literature is that firms set their dividends as a residual after using income to support new investment.
a. Explain what a residual dividend policy implies, illustrating your answer with a table showing how different investment opportunities can lead to different dividend payout ratios.
b. Think back to Chapter 14 where we considered the relationship between capital structure and the cost of capital. If the WACC-versus-debt-ratio plot was shaped like a sharp V, would this have a different implication for the importance of setting dividends according to the residual policy than if the plot was shaped like a shallow bowl (a flattened $\mathrm{U}$ )?

Check back soon!

Problem 7

Executive salaries have been shown to be more closely correlated to the size of the firm than to its profitability. If a firm's board of directors is controlled by management rather than outside directors, this might result in the firm's retaining more earnings than can be justified from the stockholders' point of view. Discuss those statements, being sure (1) to discuss the interrelationships among cost of capital, investment opportunities, and new investment and (2) to explain the implied relationship between dividend policy and stock prices.

Check back soon!

Problem 8

What is the difference between a stock dividend and a stock split? As a stockholder, would you prefer to see your company declare a $100 \%$ stock dividend or a two-for-one split? Assume that either action is feasible.

Check back soon!

Problem 9

Most firms like to have their stock selling at a high P/E ratio, and they also like to have extensive public ownership (many different shareholders). Explain how stock dividends or stock splits may help achieve those goals.

Check back soon!

07:20

Problem 10

Indicate whether the following statements are true or false. If the statement is false, explain why.
a. If a firm repurchases its stock in the open market, the shareholders who tender the stock are subject to capital gains taxes.
b. If you own 100 shares in a company's stock and the company's stock splits two-forone, you will own 200 shares in the company following the split.
c. Some dividend reinvestment plans increase the amount of equity capital available to the firm.
d. The Tax Code encourages companies to pay a large percentage of their net income in the form of dividends.
e. If your company has established a clientele of investors who prefer large dividends, the company is unlikely to adopt a residual dividend policy.
f. If a firm follows a residual dividend policy, holding all else constant, its dividend payout will tend to rise whenever the firm's investment opportunities improve.