FINANCIAL MANAGEMENT II EXAM

• Maximum group size NOT more than 5 members

• Submission date May 27
Questions (select only 10 question)
1. Contrast a passive dividend policy with an active one.
2. How does an investor manufacture “homemade” dividends? What is the effect of the actions
of a number of investors doing so, all other things held constant?
3. How do taxes affect the return to different investors? Are taxes a consideration in the dividend
policy decision?
4. Why do companies with high growth rates tend to have low dividend-payout ratios and
companies with low growth rates tend to have high dividend-payout ratios?
5. What is financial signaling as it relates to cash dividends, stock dividends/splits, and stock
repurchase?
6. From a managerial standpoint, how do a firm’s liquidity and ability to borrow affect its
dividend-payout ratio?
7. As the firm’s financial manager, would you recommend to the board of directors that the firm
adopt as policy a stable dividend payment per share or a stable dividend-payout ratio? What
are the disadvantages of each? Would the firm’s industry influence your decision? Why?
8. What is a target dividend-payout ratio? An extra cash dividend?
9. Define a stock dividend and a stock split. What is the impact of each on share value?
10. Are stock dividends valuable to investors? Why or why not?
11. If we wish to raise share price, is it a good idea to have a reverse stock split? Explain.
12. As an investor, would you prefer the firm to repurchase its common stock by means of a self-
tender offer or through open-market operations? Why?
13. If repurchase of stock has a favorable tax effect, why would a company ever want to pay a cash
dividend?
14. When earnings falter, why are boards of directors of companies reluctant to reduce the
dividend?
15. Why do lenders frequently place a formal restriction in the debt contract on the amount of
dividends that can be paid?
16. What is a dividend reinvestment plan (DRIP) and how might it help shareholders?
17. Is dividend policy a type of financing decision or is it a type of investment decision? Explain.
18. What does working capital management encompass? What functional decisions are involved,
and what underlying principle or trade-off influences the decision process?
19. A firm is currently employing an “aggressive” working capital policy with regard to the level
of current assets it maintains (relatively low levels of current assets for each possible level of
output). The firm has decided to switch to a more “conservative” working capital policy. What
effect will this decision probably have on the firm’s profitability and risk?
20. Utilities hold 10 percent of total assets in current assets; retail trade industries hold 60 percent
of total assets in current assets. Explain how industry characteristics account for this difference.
21. Distinguish between “temporary” and “permanent” working capital.
22. If the firm adopts a hedging (maturity matching) approach to financing, how would it finance
its current assets?
23. Some firms finance their permanent working capital with short-term liabilities (commercial
paper and short-term notes). Explain the impact of this decision on the profitability and risk of
these firms.

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 24. Suppose that a firm finances its seasonal (temporary) current assets with long-term funds. What
is the impact of this decision on the profitability and risk of this firm?
25. Risk associated with the amount of current assets is generally assumed to decrease with
increased levels of current assets. Is this assumption always correct for all levels of current
assets – in particular, for an excessively high level of current assets relative to the firm’s needs?
Explain.
26. At times, long-term interest rates are lower than short-term rates, yet the discussion in the
chapter suggests that long-term financing is more expensive. If long-term rates are lower,
should the firm finance itself entirely with long-term debt?
27. How does shortening the maturity composition of outstanding debt increase the firm’s risk?
Why does increasing the liquidity of the firm’s assets reduce the risk?
28. What are the costs of maintaining too large a level of working capital? Too small a level of
working capital?
29. How is a margin of safety provided for in working capital management?

Problems (select only 2 question)

1. The DeWitt Company’s shareholders’ equity account (book value) as of December 31, 20X1,
is as follows:
Common stock ($5 par value; 1,000,000 shares) $ 5,000,000
Additional paid-in capital 5,000,000
Retained earnings 15,000,000
Total shareholders’ equity $25,000,000
Currently, DeWitt is under pressure from shareholders to pay some dividends. DeWitt’s cash
balance is $500,000, all of which is needed for transactions purposes. The stock is trading for $7
a share.
a. Reformulate the shareholders’ equity account if the company pays a 15 percent stock
dividend.
b. Reformulate the shareholders’ equity account if the company pays a 25 percent stock
dividend.
c. Reformulate the shareholders’ equity account if the company declares a 5-for-4 stock split.
2. Tijuana Brass Instruments Company treats dividends as a residual decision. It expects to
generate $2 million in net earnings after taxes in the coming year. The company has an all-
equity capital structure, and its cost of equity capital is 15 percent. The company treats this
cost as the opportunity cost of “internal” equity financing (retained earnings). Because of
flotation costs and underpricing, “external” equity financing (new common stock) is not relied
on until internal equity financing is exhausted.
a. How much in dividends (out of the $2 million in earnings) should be paid if the company
has $1.5 million in projects whose expected returns exceed 15 percent?
b. How much in dividends should be paid if it has $2 million in projects whose expected
returns exceed 15 percent?
c. How much in dividends should be paid if it has $3 million in projects whose expected
returns exceed 16 percent? What else should be done?
3. For each of the companies described here, would you expect it to have a low, medium, or high
dividend-payout ratio? Explain why.

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 a. A company with a large proportion of inside ownership, all of whom are high-income
individuals
b. A growth company with an abundance of good investment opportunities
c. A company that has high liquidity and much unused borrowing capacity and is
experiencing ordinary growth
d. A dividend-paying company that experiences an unexpected drop in earnings from an
upward-sloping trend line
e. A company with volatile earnings and high business risk

4. The Anderson Corporation (an all-equity-financed firm) has a sales level of $280,000 with a
10 percent profit margin before interest and taxes. To generate this sales volume, the firm
maintains a fixed-asset investment of $100,000. Currently, the firm maintains $50,000 in
current assets.
a. Determine the total asset turnover for the firm and compute the rate of return on total assets
before taxes.
b. Compute the before-tax rate of return on assets at different levels of current assets starting
with $10,000 and increasing in $15,000 increments to $100,000.
c. What implicit assumption is being made about sales in Part (b)? Appraise the significance
of this assumption along with the policy to choose the level of current assets that will
maximize the return on total assets as computed in Part (b).

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