Managerial Finance Problem Review Set Dividends Policy

1)
If a firm adopts a residual distribution policy, distributions are determined
as a residual after funding the capital budget. Therefore, the better
the firm's investment opportunities, the lower its payout ratio should
be.
a. True
b. False

2)
Even if a stock split has no information content, and even if the dividend per
share adjusted for the split is not increased, there can still be a real
benefit (i.e., a higher value for shareholders) from such a split, but
any such benefit is probably small.
a. True
b. False

3)
Which of the following should NOT influence a firms dividend policy decision?
a. The firms ability to accelerate or delay investment projects.
b. A strong preference by most shareholders for current cash income
versus capital gains.
c. Constraints imposed by the firms bond indenture.
d. The fact that much of the firms equipment has been leased rather
than bought and owned.
e. The fact that Congress is considering changes in the tax law
regarding the taxation of dividends versus capital gains.

4)
Which of the following would be most likely to lead to a decrease in a firms
dividend payout ratio?
a. Its earnings become more stable.
b. Its access to the capital markets increases.
c. Its R&D efforts pay off, and it now has more high-return investment
opportunities.
d. Its accounts receivable decrease due to a change in its credit
policy.
e. Its stock price has increased over the last year by a greater
percentage than the increase in the broad stock market averages.

5)
If a firm adheres strictly to the residual dividend policy, then if its
optimal capital budget requires the use of all earnings for a given year
(along with new debt according to the optimal debt/total assets ratio),
then the firm should pay
a.
b.
c.
d.

no dividends except out of past retained earnings.

no dividends to common stockholders.
dividends only out of funds raised by the sale of new common stock.
dividends only out of funds raised by borrowing money (i.e., issue
debt).
e. dividends only out of funds raised by selling off fixed assets.

6)
Which of the following statements is CORRECT?
a. The tax code encourages companies to pay dividends rather than retain
earnings.
b. If a company uses the residual dividend model to determine its
dividend payments, dividends payout will tend to increase whenever
its profitable investment opportunities increase.
c. The stronger management thinks the clientele effect is, the more likely
the firm is to adopt a strict version of the residual dividend model.
d. Large stock repurchases financed by debt tend to increase earnings
per share, but they also increase the firms financial risk.
e. A dollar paid out to repurchase stock is taxed at the same rate as a
dollar paid out in dividends. Thus, both companies and investors are
indifferent between distributing cash through dividends and stock
repurchase programs.

7)
P&D Co. has a capital budget of $1,000,000. The company wants to maintain a
target capital structure which is 30% debt and 70% equity. The company
forecasts that its net income this year will be $800,000. If the company
follows a residual dividend policy, what will be its total dividend payment?
a.
b.
c.
d.
e.

$100,000
$200,000
$300,000
$400,000
$500,000

Residual dividend policy--nonalgorithmic

The amount of new investment which must be financed with equity is:
$1,000,000 70% = $700,000.
Since the firm has $800,000 of net income only $100,000 will be left for dividends.

8)

Answer: a

Ting Technology has a capital budget of $850,000, it wants to maintain a

target capital structure of 35% debt and 65% equity, and it also wants to pay
a dividend of $400,000. If the company follows a residual dividend policy,
how much net income must it earn to meet its capital budgeting requirements
and pay the dividend, all while keeping its capital structure in balance?
a.
b.
c.
d.
e.

$904,875
$952,500
$1,000,125
$1,050,131
$1,102,638

Residual dividend model--find net income

Capital budget
Equity ratio
Dividends to be paid
Required net income = Dividends + (Capital budget % Equity)

Answer: b

DIUM

$850,000
65%
$400,000
$952,500

9)
Brooks Corp.'s projected capital budget is $2,000,000, its target
capital structure is 60% debt and 40% equity, and its forecasted net
income is $600,000. If the company follows a residual dividend policy,
what total dividends, if any, will it pay out?
a.
b.
c.
d.
e.

$240,000
$228,000
$216,600
$205,770
$0

Residual model--divs paid, divs are zero

Capital budget
% Equity
Net income (NI)
Dividends paid = NI [% Equity(Capital Budget)]

10)

Answer: e
$2,000,000
40%
$600,000
$0

D. Paul Inc. forecasts a capital budget of $725,000. The CFO wants to

maintain a target capital structure of 45% debt and 55% equity, and it also
wants to pay dividends of $500,000. If the company follows the residual
dividend policy, how much income must it earn, and what will its dividend
payout ratio be?
a.
b.
c.
d.
e.

Net Income
$898,750
$943,688
$990,872
$1,040,415
$1,092,436

Payout
55.63%
58.41%
61.34%
64.40%
67.62%

Residual model--find NI, then divs and payout

Capital budget
Equity ratio
Dividends paid
NI=Divs + (Eq % Cap Bud)
Payout = Dividends/NI

Answer: a

$725,000
55%
$500,000
$898,750
55.63%

11)
Dentaltech Inc. projects the following data for the coming year. If the firm
follows the residual dividend policy and also maintains its target capital
structure, what will its payout ratio be?
EBIT
Interest rate
Debt outstanding
Shares outstanding
a.
b.
c.
d.
e.

$2,000,000
10%
$5,000,000
$5,000,000

Capital budget
% Debt
% Equity
Tax rate

37.2%
39.1%
41.2%
43.3%
45.5%

Residual dividend policy

EBIT
Interest rate
Debt outstanding
Shares outstanding

$2,000,000
10%
$5,000,000
$5,000,000

Answer: d
Capital budget
% Debt
% Equity
Tax rate

EBIT
Interest expense = interest rate debt
Taxable income
Taxes = Tax rate income
Net income (NI)
Equity needed for capital budget = % Equity(capital budget) =
Dividends = NI Equity needed
Payout ratio = Dividends/NI

12)

$850,000
40%
60%
40%

$850,000
40%
60%
40%
$2,000,000
500,000
$1,500,000
600,000
$900,000
510,000
$390,000
43.33%

Keys Financial has done extremely well in recent years, and its stock now
sells for $175 per share. Management wants to get the price down to a more
typical level, which it thinks is $25 per share. What stock split would be
required to get to this price, assuming the transaction has no effect on the
total market value? Put another way, how many new shares should be given per
one old share?
a.
b.
c.
d.
e.

6.65
6.98
7.00
7.35
7.72

Stock splits--optimal stock split

Current price
Target price
No. of new shares per 1 old share = Current price/Target price

Answer Key

Answer: c
$175.00
$25.00
7.00

1)
2)
3)
4)
5)
6)
7)
8)
9)
10)
11)
12)

a
a
d
c
b
d
a
b
e
a
d
c