Chapter 15 - EOC Solutions

Chapter 15 - EOC Solutions - 151 uncertainty,...

Info icon This preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Answers to End-of-Chapter Questions 15-1 The biggest advantage of having an announced dividend policy is that it would reduce investor  uncertainty, and reductions in uncertainty are generally associated with lower capital costs and  higher stock prices, other things being equal. The disadvantage is that such a policy might  decrease corporate flexibility. However, the announced policy would possibly include elements of  flexibility.  On balance, it would appear desirable for directors to announce their policies. 15-2 While it is true that the cost of outside equity is higher than that of retained earnings, it is not  necessarily irrational for a firm to pay dividends and sell stock in the same year.  The reason is  that if the firm has been paying a regular dividend, and then cuts it in order to obtain equity capital  from retained earnings, there might be an unfavorable effect on the firm’s stock price.  If investors  lived in the world of certainty and rationality postulated by Miller and Modigliani, then the  statement would be true, but it is not necessarily true in an uncertain world. 15-3 Logic suggests that stockholders like stable dividends—many of them depend on dividend  income, and if dividends were cut, this might cause serious hardship.  If a firm’s earnings are  temporarily depressed or if it needs a substantial amount of funds for investment, then it might  well maintain its regular dividend using borrowed funds to tide it over until things returned to  normal.  Of course, this could not be done on a sustained basis—it would be appropriate only on  relatively rare occasions. 15-4 a. MM argue that dividend policy has no effect on r s , thus no effect on firm value and cost of  capital.  On the other hand, GL argue that investors view current dividends as being less risky  than potential future capital gains.  Thus, GL claim that r s  is inversely related to dividend  payout. b. MM could claim that tests which show that increased dividends lead to increased stock prices  demonstrate that dividend increases are causing investors to revise earnings forecasts  upward, rather than cause investors to lower r s .  MM’s claim could be countered by invoking  the efficient market hypothesis.  That is, dividend increases are built into expectations and  dividend announcements could lower stock price, as well as raise it, depending on how well  the dividend increase matches expectations.  Thus, a bias towards price increases with  dividend increases supports GL.
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern