Basic Finance An Introduction to

Financial Institutions Investments and

Management 11th Edition Mayo Test
Bank
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 Chapter 10
THE FEATURES OF STOCK

TRUE/FALSE

T 1. The owners of a corporation elect the board of

directors.

F 2. Cumulative voting concentrates voting power in the

hands of a majority of corporate voters.

T 3. Pre-emptive rights mean that current stockholders

have the right to maintain their proportionate ownership
before new shares may be sold to the general public.

F 4. A 5% stock dividend reduces a firm's total equity.

T 5. A cash dividend reduces the firm's assets.

T 6. A constant payout ratio implies dividends vary with

earnings.

T 7. Once a firm has earnings, management has essentially

two choices: distribute or retain them.

T 8. Federal income taxes favor the retention of earnings

over the distribution of earnings.

F 9. A stock dividend has no impact on a firm's

liabilities or the price of its stock.

T 10. If a stock is selling for $90 and is split 3 for 1,

the new price of the stock should be $30.

T 11. A stock dividend decreases retained earnings.

F 12. A reverse split (e.g., 1 for 2) increases the number

of shares the firm has outstanding.

T 13. Dividend reinvestment plans permit the stockholder to

reinvest dividends as they are received.

F 14. Dividends reinvested are not subject to federal

income tax.

T 15. A cash dividend reduces a firm's equity.

F 16. Corporations are obligated to pay cash dividends if
they generate earnings.

T 17. If a firm does not pay cash dividends, it may reinvest

the earnings and grow.

T 18. Stockholders who seek to defer taxes prefer capital

gains to dividends.

T 19. Most publicly held American firms that pay dividends

tend to pay a regular quarterly cash dividend.

T 20. When a stock goes ex-dividend, its price tends to

decline by the amount of the cash dividend.

F 21. Stock dividends increase the wealth of stockholders

who receive additional shares.

T 22. A reserve split (e.g., 1 for 10) should raise the per
share price of a stock but not it total value.

F 23. Dividend reinvestment plans permit stockholders to

defer income taxes on dividends.

T 24. Dividend reinvestment plans are a convenient means to

encourage individuals to save.

F 25. Persons owning stock on the day a dividend is declared

receive the dividend.
MULTIPLE CHOICE

c 1. Which of the following is equity?

1. investments
2. additional paid-in capital
3. retained earnings
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. 1, 2, and 3

d 2. A company may pay

1. a regular quarterly cash dividend
2. stock dividends
3. no dividends
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. 1, 2, and 3

b 3. Dividends come at the expense of

a. interest
b. retained earnings
c. liabilities
d. stock

c 4. A stock dividend causes the firm's

a. assets to increase
b. equity to increase
c. liabilities to remain unchanged
d. assets to decrease

d 5. The paying of a cash dividend causes the firm's

a. assets and equity to increase
b. assets to decrease and equity to increase
c. assets and liabilities to increase
d. assets and equity to decrease

a 6. The retention of earnings instead of paying dividends

a. may result in greater growth and higher stock
prices
b. is advantageous for all stockholders
c. is favored by stockholders in lower income tax
brackets
d. leads to lower future dividends
d 7. A stock split
a. increases equity
b. generates capital gains
c. increases retained earnings
d. does not affect liabilities

c 8. Which of the following are true concerning dividend

reinvestment plans?
1. taxes are deferred
2. they offer stockholders a convenient means to save
3. the firm may pay the brokerage and other fees
associated with the plans
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. 1, 2, and 3

d 9. Dividends are paid on the

a. declaration date
b. ex dividend date
c. date of record
d. distribution date

a 10. Stock repurchases reduce

1. total equity
2. total assets
3. corporate taxes
4. total liabilities
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. 3 and 4

b 11. Management may prefer not paying dividends to

a. reduce corporate income taxes
b. finance growth and increase the value of their
shares
c. use the money to reduce investments in assets
d. increase the firm's liabilities
a 12. Dividends may be paid in
1. cash
2. stock
3. retained earnings
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. 1, 2, and 3

c 17. A stock dividend

a. reduces the firm's cash
b. increases the firm's total equity
c. decreases the firm's stock price
d. increases the firm's assets

d 18. If a stock's price is $90 and the stock is split three

for one, the price becomes
a. $90
b. $60
c. $45
d. $30

a 19. Dividend reinvestment plans are

a. a convenient means to accumulate shares
b. a means to defer federal income taxes on
the dividends
c. available only if the corporation distributes
stock dividends
d. more expensive than buying the stock through
brokers

a 20. Stock repurchases

a. increase per share earnings
b. decrease per share earnings
c. increase liabilities
d. decrease liabilities
PROBLEMS

1. Currently the price of a stock is $58 a share. The

firm's balance sheet is as follows:

Assets Liabilities and Equity

Cash $10,000,000 Accounts payable $20,000,000
Accounts 250,000,000 Long-term debt 400,000,000
receivable Common stock ($10 par; 10,000,000
Inventory 120,000,000 1,000,000 shares outstanding)
Plant and 325,000,000 Paid-in capital 90,000,000
equipment Retained earnings 185,000,000
$705,000,000 $705,000,000

Construct a new balance sheet showing the impact of a two-

for-one stock split. What will be the new price of the
stock?

Answer:
The new balance sheet after the two-for-one stock split:

Assets Liabilities and Equity

Cash $10,000,000 Accounts payable $20,000,000
Accounts 250,000,000 Long-term debt 400,000,000
receivable Common stock ($5 par; 10,000,000
Inventory 120,000,000 2,000,000 shares outstanding)
Plant and 325,000,000 Add. paid-in capital 90,000,000
equipment Retained earnings 185,000,000
$705,000,000 $705,000,000

The only changes are the entries under common stock since
there are now 2,000,000 shares of $5 par stock outstanding.

The new price of the stock is $58/2 = $29.

2. Construct a new balance sheet showing the impact of a 5
percent stock dividend. What will be the new price of the
stock?

Answer:
The new balance sheet after the 5 percent stock dividend:

Assets Liabilities and Equity

Cash $10,000,000 Accounts payable $20,000,000
Accounts 250,000,000 Long-term debt 400,000,000
receivable Common stock ($10 par; 10,500,000
Inventory 120,000,000 1,050,000 shares outstanding)
Plant and 325,000,000 Add. paid-in capital 92,400,000
equipment Retained earnings 182,100,000
$705,000,000 $705,000,000

The firm issues (.05)(1,000,000) = 50,000 shares with a $10

par value. The common stock entry is increased by $500,000
to $10,500,000.

The market value of the stock is $58 x 50,000 = $2,900,000.

Retained earnings are reduced by $2,900,000 to
$182,100,000.

Since retained earnings are reduced by $2,900,000 and

common stock is increased only by $500,000, $2,400,000 is
unaccounted for. In order to balance the balance sheet,
additional paid-in capital is increased by $2,400,000.

The new price of the stock is $58/1.05 = $55.24. This price

adjustment is necessary to adjust for the dilution of the
old stock that results from the stock dividend.

Be certain to point out that in both the stock split and

the stock dividend (1) assets are not changed, (2)
liabilities are not changed, and (3) total equity is not
changed. All that occurs is (1) a reduction in the price of
the stock resulting from the increase in the number of
shares, and (2) some changes in the individual entries in
the equity section of the balance sheet.
3. A company whose stock is selling for $45 has the
following balance sheet:
Assets $32,000 Liabilities $10,000
Common stock 6,000
($6 par; 1,000
shares issued)
Additional paid-in 2,000
capital
Retained earnings 14,000

a. Construct a new balance sheet showing a 3 for 1 stock

split. What is the new price for the stock?

Answer: Three for one split:

Assets $32,000 Liabilities $10,000
Common stock 6,000
($2 par; 3,000
shares issued)
Additional paid-in 2,000
capital
Retained earnings 14,000

The firm now has 3,000 shares outstanding with a $2 par

value. The price of the stock adjusts to $45/3 = $15.

b. What would be the balance sheet if the firm paid a 10

percent stock dividend (instead of the stock split)?

Answer: 10 percent stock dividend:

Assets $32,000 Liabilities $10,000
Common stock 6,600
($6 par; 1,100
shares issued)
Additional paid-in 5,900
capital
Retained earnings 9,500

The 10 percent stock dividend results in the firm issuing

100 new shares. $4,500 ($45 x 100) is subtracted from
retained earnings and added to the other equity accounts.
$600 (100 x $6 par) is added to stock outstanding. The
residual ($3,900) additional paid-in capital.