Managerial Finance

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Managerial Finance – Problem Review Set – Dividends Policy

If a firm adopts a residual distribution policy, distributions are determined as a residual after funding the capital budget. Therefore, the better the firm's investment opportunities, the lower its payout ratio should be.


Even if a stock split has no information content, and even if the dividend per share adjusted for the split is not increased, there can still be a real benefit (i.e., a higher value for shareholders) from such a split, but any such benefit is probably small.


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

a.The firm’s ability to accelerate or delay investment projects. b.A strong preference by most shareholders for current cash income versus capital gains. c.Constraints imposed by the firm’s bond indenture.

d.The fact that much of the firm’s equipment has been leased rather than bought and owned. e.The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains.

Which of the following would be most likely to lead to a decrease in a firm’s dividend payout ratio?

a.Its earnings become more stable.
b.Its access to the capital markets increases.
c.Its R&D efforts pay off, and it now has more high-return investment opportunities. d.Its accounts receivable decrease due to a change in its credit policy. e.Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.

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 dividends except out of past retained earnings. dividends to common stockholders.
c.dividends only out of funds raised by the sale of new common stock. d.dividends only out of funds raised by borrowing money (i.e., issue debt). e.dividends only out of funds raised by selling off fixed assets.

Which of the following statements is CORRECT?

a.The tax code encourages companies to pay dividends rather than retain earnings. b.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. c.The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model. d.Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm’s financial risk. e.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.

P&D Co. has a capital budget of $1,000,000. The company wants to maintain a target capital structure which is 30% debt and 70% equity. The company forecasts that its net income this year will be $800,000. If the company follows a residual dividend policy, what will be its total dividend payment?


Residual dividend policy--nonalgorithmicAnswer: a
The amount of new investment which must be financed with equity is: $1,000,000  70% = $700,000.

Since the firm has $800,000 of net income only $100,000 will be left for dividends.

Ting Technology has a capital budget of $850,000, it wants to maintain a target capital structure of 35% debt and 65% equity, and it also wants to pay a dividend of $400,000. If the company follows a residual dividend policy, how much net income must it earn to meet its capital budgeting requirements and pay the...
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