div1 - Chapter 20: Solutions Problem 1 a. True b. True c....

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Chapter 20: Solutions Problem 1 a. True b. True c. False Problem 2 Firms usually do not change their dividends very frequently. This is what is meant by "sticky" dividends. Part of the reason for "sticky" dividends is that firms are reluctant to cut dividends, because of the fear that markets will punish them. Consequently, they do not increase dividends unless they believe that they can maintain these higher dividends. Problem 3 Cutting dividends may send a very negative signal to markets. When firms announce that they will be cutting dividends, markets assume the worst, i.e, that the firm is in serious financial trouble, and the company's stock price usually drops sharply. Problems 3a and 3b See contributed problems and solutions Problem 4 If there are no tax differences in the treatment of dividends and capital gains, and firms can raise external financing at little or no cost, it can be argued that dividends are irrelevant. Large, financially strong firms with primarily tax-exempt or low-tax rate investors may fit this description best. Problem 5 No. This tax disadvantage was particularly applicable in the United States prior to 1986 for high-tax rate individual investors. It does not apply to tax exempt investors or to corporations. Problem 6 It should reduce the amount it pays in dividends. The problem it might run into is communicating this intent to the market. Since its existing stockholders like dividends, the announcement is likely to lead to some of them selling the stock, causing the stock price to drop. Problem 7 An increase in dividends suggests to markets that the firm has the confidence that its future cash flows will be high enough to continue making these dividend payments. This confidence is the positive signal that might lead markets to increase their assessment of the firm's value. The empirical evidence is supportive, with stock prices increasing on dividend increases. Problem 8 Page 1
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Chapter 20: Solutions Yes. If a firm that is believed to have great projects/high growth prospects increases dividends, it may send the signal that its project choice is narrowing. There seems to be no empiricial evidence to support this hypothesis, though. Problem 9 (Price before - Price After) = (1- t(ordinary)) / (1-.4 t (ordinary)) Solving for the ordinary tax rate, 3.5/5 = (1-t o )/(1-.4t o ) Ordinary tax rate = 0.30/0.72 = 41.67% Problem 9a See contributed problems and solutions Problem 10 Company Price change Dividend Price change/Dividend NE Gas 2 4 0.5 SE Bell 3 4 0.75 Western Elec 5 5 1
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This note was uploaded on 01/29/2012 for the course ECONOMICS 3400 taught by Professor Kroger during the Spring '11 term at Georgia State University, Atlanta.

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div1 - Chapter 20: Solutions Problem 1 a. True b. True c....

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