Unit 8

Question 1

Cash dividends types

Answer 1

Regular
Special
Extra cash
Liquidating

Question 2

Factors for high dividends payout

Answer 2

1. Desire for current income
2. Resolution of uncertainty

Question 3

Clientele effect

Answer 3

Stocks attract particular groups based on dividend yield and resulting tax effects

Question 4

Clientele effect

Answer 4

Stocks attract particular groups based on dividend yield and resulting tax effects

Question 5

Advantage of paying dividends

Answer 5

1. Underscore good results and supports the stock price
2. Allows investors to raise capital at a lower cost because of a mixture of institutional and individual investors
3. Stock price usually increases when dividends are new or increased
4. Absorb excess CF and reduce agency costs

Question 6

Disadvantages of paying dividends

Answer 6

1. Taxed to recipients
2. Reduce internal sources of financing
3. Dividend cuts are hard to make without affecting the stock price

Question 7

Stock dividend

Answer 7

Payment made by firm to its owner in form of stock

Question 8

Stock split

Answer 8

Increase in firm’s share outstanding without change in owner’s equity

Question 9

Reverse split

Answer 9

Stock split which firm’s number of shares outstanding is reduced

Question 10

Current payout methods

Answer 10

1. Constant dividend (% of earnings)
2. Stable dividend (increases when earnings increase sustainably for long term)
3. Residual dividend policy

Question 11

Residual dividend policy

Answer 11

1. Earnings used to invest in projects with positive NPV
2. Remaining earnings declared as dividends
3. Where no retained earnings left, no dividends are paid

Question 12

Pros of Residual dividend policy

Answer 12

1. Ensures cash is efficiently distributed towards investments
2. Requires FEWER new stocks and LOWER flotation costs

Question 13

Cons of residual dividend policy

Answer 13

1. Results in unstable dividends as the dividends are only paid out when the company has paid all its capital expenditures.
2. Not suitable for all investors as they want regular returns and not capital appreciation
3. -Amounts not distributed is invested is different growth opportunities, which subsequently increases overall risk exposure of the company as such risk can result in a loss if the expected returns are not realized.
4. -Gives constantly changing signals regarding management expectations