4.3 Dividends Flashcards
(17 cards)
When determining the amount of dividends to be declared, the most important factor to consider is the
A. Expectations of the shareholders
B. Future planned uses of retained earnings
C. Impact of inflation on replacement costs
D. Future planned uses of cash
D. Future planned uses of cash
When determining the amount of dividends to be declared, the most important factor to consider is the future planned uses of cash. If the monies that would have been paid out in the form of excess dividends could provide the equity holders a higher return if employed in some productive capacity, a rational investor should not expect the excess payout.
A company has issued 25,000 shares of its authorized 50,000 shares of common stock. There are 5,000 shares of common stock that have been purchased and are classified as treasury stock. The company has 10,000 shares of preferred stock. If a $0.60 per share dividend has been authorized on its common stock, what will be the total common stock dividend payment?
A. $12,000
B. $15,000
C. $21,000
D. $30,000
A. $12,000
Shares outstanding = shares issued - shares repurchased
= 25,000 - 5,000 = 20,000
Common stock dividend
= shares outstanding x Dividend per share
= 20,000 x 0.6 = 12,000
The purchase of treasury stock with a firm’s surplus cash
A. Increases a firm’s assets.
B. Increases a firm’s financial leverage.
C. Increases a firm’s interest coverage ratio.
D. Dilutes a firm’s earnings per share.
B. Increases a firm’s financial leverage.
A purchase of treasury stock involves a decrease in assets (usually cash) and a corresponding decrease in equity. Thus, equity is reduced and the debt-to-equity ratio and financial leverage increase.
A corporation has 6,000 shares of 5% cumulative, $100 par value preferred stock outstanding and 200,000 shares of common stock outstanding. The corporation’s board of directors last declared dividends for the year ended May 31, Year 1, and there were no dividends in arrears. For the year ended May 31, Year 3, the corporation had net income of $1,750,000. The board of directors is declaring a dividend for common shareholders equivalent to 20% of net income. The total amount of dividends to be paid at May 31, Year 3, is
A. $350,000
B. $380,000
C. $206,000
D. $410,000
D. $410,000
If a company has cumulative preferred stock, all preferred dividends for the current and any unpaid prior years must be paid before any dividends can be paid on common stock. The total preferred dividends that must be paid equal $60,000 (6,000 shares × $100 par × 5% × 2 years), and the common dividend is $350,000 ($1,750,000 × 20%), for a total of $410,000.
A stock dividend
A. Increases the debt-to-equity ratio of a firm.
B. Decreases future earnings per share.
C. Decreases the size of the firm.
D. Increases stockholders’ wealth.
B. Decreases future earnings per share.
A stock dividend is a transfer of equity from retained earnings to paid-in capital. The transaction decreases retained earnings and increases common stock and additional paid-in capital. Additional shares are outstanding following the stock dividend, but every stockholder maintains the same percentage of ownership. In effect, a stock dividend divides the pie (the corporation) into more pieces, but the pie is still the same size. Thus, a corporation has a lower EPS and a lower book value per share following a stock dividend, but every stockholder is just as well off as previously. A stock dividend has no effect except on the composition of the stockholders’ equity section of the balance sheet.
In practice, dividends
A. Usually exhibit greater stability than earnings.
B. Fluctuate more widely than earnings.
C. Tend to be a lower percentage of earnings for mature firms.
D. Are usually changed every year to reflect earnings changes.
A. Usually exhibit greater stability than earnings.
Dividend policy determines the portion of net income distributed to stockholders. Corporations normally try to maintain a stable level of dividends, even though profits may fluctuate considerably, because many stockholders buy stock with the expectation of receiving a certain dividend every year. Thus, management tends not to raise dividends if the payout cannot be sustained. The desire for stability has led theorists to propound the information content or signaling hypothesis: A change in dividend policy is a signal to the market regarding management’s forecast of future earnings. This stability often results in a stock that sells at a higher market price because stockholders perceive less risk in receiving their dividends.
When a company desires to increase the market value per share of common stock, the company will implement
A. The sale of treasury stock.
B. A reverse stock split.
C. The sale of preferred stock.
D. A stock split.
B. A reverse stock split.
A reverse stock split decreases the number of shares outstanding, thereby increasing the market price per share. A reverse stock split may be desirable when a stock is selling at such a low price that management is concerned that investors will avoid the stock because it has an undesirable image.
A 10% stock dividend most likely
A. Increases the size of the firm
B. Decreases net income
C. Increases shareholders’ wealth
D. Decreases future earnings per share
D. Decreases future earnings per share
A stock dividend is a transfer of equity from retained earnings to paid-in-capital. The transaction decreases retained earnings and increases common stock and additional paid-in capital. Additional shares are outstanding following the stock dividend, but every shareholder maintains the same percentage of ownership. In effect, a stock dividend divides the pie (the corporation) into more pieces, but the pie is still the same size. Hence, a corporation will have a lower EPS and a lower book value per share following a stock dividend, but every shareholder will be just as well off as previously. A stock dividend has no effect except on the composition of the shareholders’ equity section of the balance sheet.
A firm has 1,000 shares outstanding and retained earnings of $25,000. Theoretically, what would you expect to happen to the price of the firm’s stock, currently selling for $50 per share, if a 20% stock dividend is declared?
A. Price should increase to $60 per share.
B. Nothing; price should remain at $50.
C. Price should decrease to $41.67 per share.
D. Price should decrease to $40 per share.
C. Price should decrease to $41.67 per share.
The total market capitalization of 1,000 shares is $50,000. That should remain about the same following the issuance of the 200 shares of stock dividend. Thus, dividing $50,000 by 1,200 shares equals $41.67 share.
The chief financial officer of a Midwestern machine parts manufacturer is considering splitting the company’s stock, which is currently selling at $80 per share. The stock currently pays a $1 per share dividend. If the split is two-for-one, the post-split price will be
A. Greater than $40, if the dividend is changed to $0.45 per new share.
B. Greater than $40, if the dividend is changed to $0.55 per new share.
C. Less than $40, regardless of dividend policy.
D. Exactly $40, regardless of dividend policy.
B. Greater than $40, if the dividend is changed to $0.55 per new share.
If the pre-stock dividend payout rate were maintained, the post-split dividend would be $0.50 per share ($1 ÷ 2). Thus, if the dividend post-split is raised to $0.55, investors will bid up the price of the stock from its immediate post-split price of $40 per share ($80 ÷ 2).
A corporation has 200,000 shares of common stock outstanding. Net income for the recently ended fiscal year was $500,000, and the stock has a price-earning ratio of eight. The board of directors has just declared a three-for-two stock split. For an investor who owns 100 shares of stock before the split, the approximate value (rounded to the nearest dollar) of the investment in the corporation’s stock immediately after the split is
A. $2,000
B. $3,000
C. $1,333
D. $250
A. $2,000
EPS equals $2.50 ($500,000 NI / 200,000 pre split shares). Thus, 100 shares had a value of $2,000 (100 shares x 2.50 EPS x 8 P/E Ratio) before the split. This value is unchanged by the stock split. Although the stockholder has more shares, the total value of the investment is the same.
The date when the right to a dividend expires is called the
A. Payment date.
B. Ex-dividend date.
C. Declaration date.
D. Holder-of-record date.
B. Ex-dividend date.
The ex-dividend date is typically set before the date of record. Unlike the other relevant dates, it is not established by the corporate board of directors but by the stock exchanges. The period between the ex-dividend date and the date of record gives the stock exchange members time to process any transactions in time for the new shareholders to receive the dividend to which they are entitled. An investor who buys a share of stock before the ex-dividend date will receive the dividend that has been previously declared. An investor who buys on or after the ex-dividend date (but before the date of record or payment date) will not receive the declared dividend.
Stock dividends and stock splits differ in that
A. A stock dividend results in a decline in the par value per share.
B. In a stock split, a larger number of new shares replaces the outstanding shares.
C. Stock splits are paid in additional shares of common stock, whereas a stock dividend results in replacement of all outstanding shares with a new issue of shares.
D. Stock splits involves a bookkeeping transfer from retained earnings to the capital stock account.
B. In a stock split, a larger number of new shares replaces the outstanding shares.
A stock split does not involve any accounting entries. Instead, a larger number of new shares are issued to replace and retire all outstanding shares.
Which one of the following best describes the record date as it pertains to common stock?
A. Four business days prior to the payment of a dividend.
B. The date on which a prospectus is declared effective by the Securities and Exchange Commission.
C. The date that is chosen to determine the ownership of shares.
D. The 52-week high for a stock published in The Wall Street Journal.
C. The date that is chosen to determine the ownership of shares.
Three dates are important in the declaration and distribution of dividends: the date of declaration, the date of record, and the date of distribution. The date of record is the date as of which the corporation determines the shareholders who will receive the declared dividend. Essentially, the corporation closes its shareholder records on this date. Only those shareholders who own the stock on the date of record will receive the dividend.
The policy decision that by itself is least likely to affect the value of the firm is the
A. Sale of a risky division that will now increase the credit rating of the entire company.
B. Distribution of stock dividends to shareholders.
C. Investment in a project with a large net present value.
D. Use of a more highly leveraged capital structure that resulted in a lower cost of capital.
B. Distribution of stock dividends to shareholders.
A stock dividend does not significantly affect the value of the firm. It simply divides ownership interests into smaller pieces without changing any shareholder’s proportionate share of ownership.
Jensen Corporation’s board of directors met on June 3 and declared a regular quarterly cash dividend of $.40 per share for a total value of $200,000. The dividend is payable on June 24 to all stockholders of record as of June 17. Excerpts from the statement of financial position for Jensen Corporation as of May 31 are presented as follows.
Cash $ 400,000
Accounts receivable (net) 800,000
Inventories 1,200,000
Total current assets $2,400,000
Total current liabilities $1,000,000
Assume that the only transactions to affect Jensen Corporation during June are the dividend transactions.
Jensen’s total stockholders’ equity would be
A. Unchanged by the dividend declaration and decreased by the dividend payment.
B. Decreased by the dividend declaration and increased by the dividend payment.
C. Unchanged by either the dividend declaration or the dividend payment.
D. Decreased by the dividend declaration and unchanged by the dividend payment.
D. Decreased by the dividend declaration and unchanged by the dividend payment.
A dividend declaration reduces retained earnings and thus total stockholders’ equity. The subsequent payment will have no effect on stockholders’ equity since only cash and dividends payable are reduced.
A firm’s dividend policy may treat dividends either as the residual part of a financing decision or as an active policy strategy.
Treating dividends as an active policy strategy assumes that
A. Dividends are irrelevant.
B. Dividends are costly, and the firm should retain earnings and issue stock dividends.
C. Dividends provide information to the market.
D. The firm should pay dividends only after investing in all investment opportunities having an expected return greater than the cost of capital.
C. Dividends provide information to the market.
Stock prices often move in the same direction as dividends. Moreover, companies dislike cutting dividends. They tend not to raise dividends unless anticipated future earnings will be sufficient to sustain the higher payout. Thus, some theorists have proposed the information content or signaling hypothesis. According to this view, a change in dividend policy is a signal to the market regarding management’s forecast of future earnings. Consequently, the relation of stock price changes to changes in dividends reflects not an investor preference for dividends over capital gains but rather the effect of the information conveyed.
