Complete Problems 1, 2, 3, 4, and 5 in Chapter 14 of the Textbook

Complete problems 1, 2, 3, 4, and 5 in chapter 14 of the textbook.

Please show all work for each problem.

1.

Define each of the following terms:

1. Optimal distribution policy

A dividend policy in which company wants to pay surplus as dividend and pays dividend in a manner which maximizes the present value of future dividend until bankruptcy.

1. Dividend irrelevance theory;

As the retained earnings belong to shareholders therefore the payment of dividend is irrelevant to determine the value of stock under this theory.

bird-in-the-hand theory;

It is based on the theory that whatever is in your hand has worth; therefore the investor is concern about payment of dividend not whatever is earned.

tax effect theory

As the dividends are taxes more than the capital gain, therefore under this theory the investor prefers capital gain instead of dividends.

1. Information content, or signaling, hypothesis; clientele effect

No idea

1. Residual distribution model;

A dividend policy under which the dividend is declared from retained earnings if anything is left after meeting the investment requirement from equity financing.

extra dividend

A dividend which is paid in addition to regular payment of dividend at different date or for sale an asset in the form of cash which is of non recurring nature.

1. Declaration date;

A date at which the dividend is declared by the company.

holder-of-record date;

A date which is the deadline for stockholders that whose name will appear in the book of shareholders on this data will receive dividend.

ex-dividend date;

A date after which the buyer will not be able to receive dividend.

payment date

A date when the dividend is paid in cash to shareholders.

1. Dividend reinvestment plan (DRIP)

A plan under which the investor does not receive cash for dividend declared, rather the amount is reinvested in the underlying company equity.

1. Stock split;

Where the number of shares issued is increased and par value is decreased with the same proportion without change in dollar value of stocks.

stock dividend;

When dividend is not paid in cash, rather the new common stock are issued instead of cash, it is called stock dividend.

stock repurchase

When company buys back its own stocks from market, it is also called treasury stock.

2.

How would each of the following changes tend to affect aggregate payout ratios

(that is, the average for all corporations), other things held constant? Explain youranswers.

1. An increase in the personal income tax rate

Will have no affect on the company payout ratio as it will apply after payment of dividend by company.

1. A liberalization of depreciation for federal income tax purposes— that is, fastertax write-offs
2. AS the more taxes will be paid and less income after taxes will be available and the same amount of dividend is paid which was paid earlier, it will increase the payout ratio.
3. A rise in interest rates

The dividend payout ratio will increase as the more dividend will be expected by the investor.

1. An increase in corporate profits

If the same amount of dividend is paid which was paid last year, the increase in profit will decrease the dividend payout ratio.

1. A decline in investment opportunities

Will decrease the payout ratio as the investor will have less investment opportunities, therefore they will be happy with lower amount of dividend.

1. Permission for corporations to deduct dividends for tax purposes as they now dointerest charges

Will increase the dividend payout ratio as the company will be able to save in cash by paying less amount of tax as the dividend will be an expense, not the distribution of profit.

1. A change in the Tax Code so that both realized and unrealized capital gains inany year were taxed at the same rate as dividends
2. It would have increase the dividend payout ratio as the investor will not be happy with capital gain due to tax indifference.

3.

What is the difference between a stock dividend and a stock split? As a stockholder,would you prefer to see your company declares a 100% stock dividend or a 2-for-1split? Assume that either action is feasible.

Stock Split is just the division of shares in smaller par value and increase in number of shares, while stock dividend is new shares issued. As the stock split will not increase overall wealth of stockholders therefore he or she would like to receive 100% stock dividend.

4.

One position expressed in the financial literature is that firms set their dividends as a residual after using income to support new investments. Explain what a residual policy implies (assuming that all distributions are in the form of dividends), illustrating your answer with a table showing how different investment opportunities could lead to different dividend payout ratios.

Residual dividend policy is based on the theory that certain portion of investment to be invested from earnings to balance the capital structure of the company, which comprised of both debt and equity financing. If the more amount of investment is to be made, the dividend payout ratio will go down as shown in the table.

Earnings / Investment / Dividend / Payout
$ 200,000 / $ 50,000 / $ 150,000 / 75%
$ 200,000 / $ 100,000 / $ 100,000 / 50%
$ 200,000 / $ 125,000 / $ 75,000 / 38%

5.

Indicate whether the following statements are true or false. If the statement is false, explain why.

a. if a firm repurchases its stock in the open market, the shareholders who tenderthe stock are subject to capital gains taxes. True.

b. If you own 100 shares in a company’ s stock and the company’ s stock splits 2- for-1, then you will own 200 shares in the company following the split. True

c. Some dividend reinvestment plans increase the amount of equity capital available to the firm. True

d. The Tax Code encourages companies to pay a large percentage of their net incomein the form of dividends. False as the dividend payment has no impact of company taxation.

e. A company that has established a clientele of investors who prefer large dividends is unlikely to adopt a residual dividend policy. True

f. If a firm follows a residual dividend policy then, holding all else constant, its dividend payout will tend to rise whenever the firm’ s investment opportunitiesimprove. False, as the lower amount of dividend will be paid from earnings.