Dividend Reinvestment Plans

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1. Which of the following statements about dividend policies is CORRECT?

a. 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. b. One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than gains on stock repurchases. c. One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest. d. One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy. e. The clientele effect suggests that companies should follow a stable dividend policy. *E*

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

2. Which of the following statements is CORRECT?

a. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company. b. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account. c. Stock repurchases can be used by a firm that wants to increase its debt ratio. d. 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. e. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding. *C*

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

3. Which of the following statements is CORRECT?

a. 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...
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