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CHAPTER 18 DISTRIBUTIONS TO SHARHOLDERS: DIVIDENDS AND REPURCHASES (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: Optimal distribution policy Answer: a Diff: E 1 . The optimal distribution policy for a firm strikes a balance between current dividends and capital gains, and results in the maximization of stock price. a. True b. False Dividend irrelevance Answer: b Diff: E 2 . The dividend irrelevance theory, proposed by Miller and Modigliani, says that as long as a firm pays a dividend, how much it pays does not affect either its cost of capital or its stock price. a. True b. False Dividend irrelevance Answer: b Diff: E 3 . MM's dividend irrelevance theory says that dividend policy does not affect a firm's value but can affect its cost of capital. a. True b. False Investor's dividend preference Answer: a Diff: E 4 . If investors do, in fact, prefer that firms retain most of their earnings, then firms that want to maximize stock price should hold dividend payments to low levels. a. True b. False Dividends and stock prices Answer: b Diff: E 5 . The announcement of an increase in the cash dividend always causes an increase in the price of the firm's common stock. a. True b. False Chapter 18 - Page 1
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Residual distribution policy Answer: a Diff: E 6 . If a firm adopts a residual distribution policy, distributions are determined as a residual item. Therefore, the better the firm's investment opportunities, the lower its distributions should be. a. True b. False Stock dividends and splits Answer: a Diff: E 7 . A stock dividend and a stock split should, at least conceptually, have the same effect on shareholders’ wealth. a. True b. False Reverse split Answer: a Diff: E 8 . A reverse split reduces the number of shares outstanding. a. True b. False Medium: Dividend irrelevance Answer: a Diff: M 9 . Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk. a. True b. False Dividend irrelevance Answer: b Diff: M 10 . A firm that follows a residual distribution policy must believe that the dividend irrelevance theory is correct. a. True b. False Chapter 18 - Page 2
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Dividend-growth tradeoff Answer: a Diff: M 11 . One implication of the bird-in-the-hand theory of dividends is that a reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm's required return constant, other things held constant. a. True b. False WACC and dividend policy Answer: b Diff: M 12 . If the shape of the curve depicting a firm's WACC versus its debt ratio is more like a sharp "V", as opposed to a shallow "U", the easier it will be for the firm to maintain a steady dividend in the face of varying investment opportunities from year to year. a. True
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