Dividend Policy, Hybrid and Derivative Securities

Quiz # 4

Multiple Choice

1. A dividend reinvestment plan enables stockholders to

(a) reinvest the dividends in money market instruments which are risk free.
(b) reinvest all dividends in the firm with no accompanying increase in equity.
(c) acquire additional dividends through redemption of stock.
(d) acquire shares at little or no transaction costs.

2. The residual theory of dividends suggests that dividends are _________ to the
value of the firm.
(a) residual
(b) relevant
(c) irrelevant
(d) integral

3. The information content of dividends refers to

(a) nonpayment of dividends by corporations.
(b) dividend changes as indicators of a firm’s future.
(c) a stable and continuous dividend.
(d) a dividend paid as a percent of current earnings.

4. According to the residual theory of dividends, if the firm’s equity need exceeds
the amount of retained earnings, the firm would
(a) borrow to pay the cash dividend.
(b) sell additional stock to pay the cash dividend.
(c) pay no cash dividends.
(d) not need to consider its dividend policy.
5. Dividend policy is a form of
 (a) capital budgeting policy.
(b) financing policy.
(c) working capital policy.
(d) dividend reinvestment policy.

6. IFRS/PFRS requires explicit disclosure of _________ obligation on the firm’s

balance sheet. For this type of lease, the present value for all of its payments is
shown as an asset and the total lease payment obligation is included as a
liability on the firm’s balance sheet.
(a) an operating lease
(b) a leveraged lease
(c) a sale-leaseback
(d) a finance (capital) lease

7. A security that is neither debt nor equity but derives its value from an underlying
asset that is often another security is called
(a) hybrid security.
(b) convertible security.
(c) derivative security.
(d) None of the above.

8. A _________ is an option included as part of a bond or preferred stock that

permits the holder to convert the security into a specified number of shares of
common stock.
(a) put option
(b) stock-purchase warrant
(c) conversion feature
(d) repurchase agreement
9. Convertible bonds normally have _________ to permit the issuer to retire or
encourage conversion.
(a) a put option
(b) a call feature
(c) a stock purchase warrant
(d) a striking price
Answer: B
Level of Difficulty: 1

Learning Goal: 3

Topic: Convertible Bonds

10. Convertible preferred stock is normally converted into

(a) secured bonds.
(b) debentures.
(c) shares of common stock.
(d) warrants.
Answer: C
Level of Difficulty: 1

Learning Goal: 3

Topic: Convertible Preferred Stocks

11. A firm has the following stockholders’ equity balances:

Ordinary (Common) stock at P400,000

par
Share Premiumn (APIC) 1,200,000
Retained earnings 2,000,000
 In states where the firm’s legal capital is defined as the par value of its common
stock, the maximum cash dividend the firm could pay is
(a) P3,600,000.
(b) P400,000.
(c) P3,200,000.
(d) P1,600,000.
Answer: C

12. A firm has had the following earnings history over the last five years:

Year Earnings per Share

2019 P2.50
2018 2.00
2017 1.75
2016 1.25
2015 –1.00
 If the firm’s dividend policy is based on a P0.50 payout per share, increasing by
P0.05 per share whenever earnings exceed P1.50 per share, the annual
dividends for 2016 and 2019 were
(a) P1.25 and P2.50, respectively.
(b) P0.50 and P0.50, respectively.
(c) P0 and P0.50, respectively.
(d) P0.50 and P0.55, respectively.

13. Tangshan Mining has common stock at par of P200,000, paid in capital in
excess of par of P400,000, and retained earnings of P280,000. In states where
the firm’s legal capital is defined as the par value of common stock, the firm
could pay out _________ in cash dividends without impairing its capital.
(a) P200,000.
(b) P480,000.
(c) P600,000.
(d) P880,000.

14. KOBID Mining has 100,000 shares outstanding and just declared a 20 percent
stock dividend. Before the announcement, the firm’s shares were trading at
P50.00 per share. After the stock dividend, the firm’s shares should trade at
_________ per share.
(a) P40.00
(b) P41.66
(c) P46.33
(d) remain unchanged

15. Bettis Bus Co. uses the residual dividend model to determine its common dividend
payout. This year the company expects its net income to be
P2 million, and it expects to have a 25 percent common dividend payout ratio. The
company’s target common equity ratio is 40 percent, and the firm is financed with
only common equity and debt. What is the company’s forecasted total capital
budget for the year?

a. P1.25 million

b. P2.25 million

c. P2.50 million
d. P3.75 million
16. A firm has outstanding convertible preferred stock with a P50 par value which is
convertible into three shares of common stock. The conversion value is P45.
What is the current market price of a share of common stock?
(a) P15.00
(b) P16.67
(c) P17.33
(d) P20.00

17. A firm has an outstanding bond with a P1,000 par value that is convertible at
P40 per share of common stock. If the current market value of common stock
per share is P45, the conversion value of the bond is
(a) P880.
(b) P1,000.
(c) P1,125.
(d) P1,200.

18. A firm needs P2 million of new long-term financing. The firm is considering the
sale of common stock or a convertible bond. The current market price of the
common stock is P42 per share. To sell this new issue, the stock would have to
be underpriced by P2 and sold for P40 per share. The firm currently has
300,000 shares of common stock outstanding. The alternative is to issue 20-
year,
10 percent, and P1,000 par-value convertible bonds. The conversion price
would be set at P50 per share, and the bond could be sold at par. The earnings
for the firm are expected to be P500,000 in the coming year. Assuming the firm
chooses the sale of common stock, the earnings per share in the coming year
will be _________.
(a) P1.43
(b) P1.44
(c) P1.45
(d) P1.47

19. A firm needs P5 million of new long-term financing. The firm is considering the
sale of common stock or a convertible bond. The current market price of the
common stock is P65 per share. To sell this new issue, the stock would have to
be underpriced by P2 and sold for P63 per share. The firm currently has
600,000 shares of common stock outstanding. The alternative is to issue 20-
year,
10 percent, and P1,000 par-value convertible bonds. The conversion price
would be set at P73 per share, and the bond could be sold at par. The earnings
for the firm are expected to be P4,000,000 in the coming year. Assuming the
firm chooses the convertible bond, the earnings per share after all bonds are
converted will be _________.
(a) P6.67
(b) P5.98
 (c) P5.91
(d) P5.88

20. A firm needs P1.5 million of new long-term financing. The firm is considering
the sale of common stock or a convertible bond. The current market price of the
common stock is P16 per share. To sell this new issue, the stock would have to
be underpriced by P1 and sold for P15 per share. The firm currently has
600,000 shares of common stock outstanding. The alternative is to issue 30-
year, 8 percent, and P1,000 par-value convertible bonds. The conversion price
would be set at P20 per share, and the bond could be sold at par. The earnings
for the firm are expected to be P700,000 in the coming year. Which plan results
in less dilution of the earnings per share?
(a) The common stock with an EPS of P1.17.
(b) The convertible bond with an EPS of P1.04.
(c) The common stock with an EPS of P1.00.
(d) The convertible bond with an EPS of P1.00.

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