. Dividends are the active variable in the “marginal principle of retained earnings.”


1. The “marginal principle of retained earnings” holds that corporate investment should provide a return equal to or higher than that a stockholder could earn. 
True    False


2. Dividends are the active variable in the “marginal principle of retained earnings.” 
True    False


3. At maturity (Stage IV) the firm will usually pay out about 15-25% of earnings in dividends. 
True    False


4. Life cycle growth analysis can be helpful in determining a firm’s ability to pay dividends. 
True    False


5. In Stage III growth, stock dividends and stock splits are eliminated. 
True    False


6. The major drawback for viewing dividends as a passive variable is that stockholders likely have some preference related to dividend payments. 
True    False


7. One reason that investors may prefer dividends to reinvestment by the firm is that dividend payments provide information to the investor. 
True    False


8. In Stage I of a firm’s life cycle, the firm will pay high dividends to shareholders in order to attract additional investors. 
True    False


9. In Stage II of a firm’s life cycle, expansion continues, but at a decreasing rate. 
True    False


10. Some researchers feel that stockholders prefer dividends to retained earnings because dividends have information content. 
True    False


11. Generally, dividends should be changed when a corporation reaches a new level of permanent income. 
True    False


12. One of the major influences on dividends is the corporate growth rate in sales and the subsequent return on assets. 
True    False


13. When a firm raises its dividend, the information content is usually positive for investors. 
True    False


14. Dividends may be relevant because they help to resolve uncertainty about the firm and its future. 
True    False


15. Stable dividends may cause a higher discount rate for the firm, thereby raising the value of the firm. 
True    False


16. Stability of dividends is not important to stockholders. 
True    False


17. Regardless of the situation, no well-managed firm would borrow money to pay dividends to stockholders. 
True    False


18. Dividends can only be distributed if the firm has positive income in the year the dividend is paid. 
True    False


19. Retained earnings accurately portray the liquidity position of the firm. 
True    False


20. A firm will pay dividends as long as it has cash available. 
True    False


21. Corporations are partially exempt from taxes on dividends received from other corporations. 
True    False


22. Prior to the Tax Relief Act of 2003, investors in high marginal tax brackets prefer dividends while investors in low marginal tax brackets prefer to have corporate earnings reinvested. 
True    False


23. Stockholders in general prefer large dividends to small dividends. 
True    False


24. If the cash dividend per share remains constant following a stock dividend, the stockholder will receive greater total cash dividends. 
True    False


25. The Tax Relief Act of 2003 created equal taxation of long-term capital gains and dividends at a 15 percent rate. 
True    False


26. Because the capital gains tax is so high, there are no real tax advantages to a stock repurchase option. 
True    False


27. A general rule of thumb would be that firms with a faster growth rate have smaller payout ratios. 
True    False


28. Investors in high marginal tax brackets usually prefer companies that reinvest most of their earnings, thus creating more growth in earnings and stock prices and deferring taxes into the future. 
True    False


29. A firm paying a stock dividend will experience a drop in its earnings per share but its shareholders’ total claim on earnings will increase. 
True    False


30. The 2003 Tax Act created equal taxation of short-term and long-term capital gains. 
True    False


31. A rapid growth firm can often expect a shift in the type of its typical stockholder as the firm moves into maturity. 
True    False


32. Most dividends, like interest, are paid semi-annually. 
True    False


33. Long-term capital gains are taxed at a lower rate than dividends. 
True    False


34. The dividend payout ratio is the dividend divided by the stock price. 
True    False


35. The dividend yield is the dividend divided by the stock price. 
True    False


36. Following the payment of a stock dividend, the firm’s stock price tends to fall. 
True    False


37. To receive a dividend on common stock, an investor must purchase the stock before the ex-dividend date. 
True    False


38. When a firm which previously paid regular dividends ceases to do so, the stock is ex-dividend until the firm resumes regular dividend payments. 
True    False


39. Stock dividends usually enhance the overall wealth of an investor. 
True    False


40. Stock dividends may be utilized to provide information to investors about growing companies. 
True    False


41. A stock split involves a reduction in the firm’s retained earnings account. 
True    False


42. Distributions of 20-25% or greater of outstanding shares are generally to be treated as stock splits. 
True    False


43. Stock splits are usually utilized to place stock in a lower-price trading range. 
True    False


44. Stock dividends and stock splits have the same impact on retained earnings. 
True    False


45. A reverse stock split is normally used by those firms whose stock price has been stable for several years. 
True    False


46. The repurchase of a corporation’s own stock will generally have a negative impact on its price. 
True    False


47. Firms with extra money should always repurchase their own stock, thus increasing the value of the firm. 
True    False


48. Dividend reinvestment plans provide the stockholder an opportunity to buy additional shares of stock with the cash dividend paid by the company. 
True    False


49. Usually with a dividend reinvestment plan an investor may buy fractional shares. 
True    False


50. By employing a dividend reinvestment plan, a company is assured of always increasing cash flow into the company. 
True    False


51. The goal of a company in the growth lifecycle stage should be to maximize dividends to shareholders. 
True    False


52. Investors in the retirement phase of their lifecycle tend to prefer reinvestment of dividends by firms. 
True    False


53. As tax rates on dividends have decreased, the preference for retention of earnings has increased. 
True    False


54. One situation in which a stock dividend may be beneficial to the investor is when the cash dividend per share remains constant. 
True    False


55. A stock dividend is often used when the company has high cash levels, but feels that a stock dividend would be more beneficial to the investors. 
True    False


56. Leveraged stock repurchases often increase the likelihood of leveraged buyouts by other firms. 
True    False


57. One way companies responded to the financial crisis of 2008-2009 was to cut their cash dividends to stockholders. 
True    False


58. For the most part, companies not directly associated with the financial crisis of 2008-2009 did not cut their dividend payments to stockholders. 
True    False


59. Research shows that firms that repurchase their shares exhibit positive stock price returns. 
True    False



Multiple Choice Questions

60. According to the “marginal principle of retained earnings,” dividends are 
A. the active variable.
B. the passive variable.
C. not usually paid.
D. a certain fixed percentage of earnings.


61. The marginal principle of retained earnings means that each potential project to be financed by retained earnings must 
A. provide a higher rate of return than the stockholders can achieve after paying taxes on the distributed dividends.
B. yield a return equal to or greater than the marginal cost of capital.
C. provide enough return to pay the corporation’s marginal tax rate.
D. have an internal rate of return greater than the corporate growth rate of dividends.


62. The major, overall argument against the “marginal principle of retained earnings” is 
A. the uncertainty surrounding capital investment projects.
B. the lack of ability to adequately measure corporate investment returns.
C. the diversity of stockholders and their potential investment returns.
D. its failure to consider stockholder preferences.


63. The residual theory of dividend policy asserts that 
A. sufficient dividends are paid to maintain a stable total dividend payment-any residual is invested internally by the firm.
B. sufficient dividends are paid to maintain a stable dividend payout ratio-any residual is invested internally by the firm.
C. dividends are paid out of the residual remaining after internal investments by the firm.
D. dividend payments are adjusted to maintain dividends at a constant percentage of total cash flows.


64. In which phase of the life cycle would one most likely encounter stock dividends? 
A. Phase II.
B. Phase III.
C. Phase IV.
D. Phase II and Phase III.


65. Which of the following is not true about the life cycle growth and dividend policy? 
A. In the maturity stage, a firm usually pays moderate to high dividends.
B. In the development stage, a firm usually pays stock dividends and some low cash dividends.
C. In the expansion stage, a firm pays low to Intermediate cash dividends and occasionally may have stock splits.
D. In the growth stage, a firm pays stock dividends.


66. In Stage II (growth stage), sales and returns on assets will be growing at increasing rates. Which of the following is true? 
A. Earnings are now available for large dividends.
B. Stock dividends (additional shares) are quite common.
C. Acquisition of new assets will be stable.
D. The payout ratio will be close to 50% by now.


67. In the maturity stage, a firm 
A. is growing about the same rate as the economy as a whole.
B. has returns on assets lower than those of the industry norm.
C. loses market share and suffers a decline in profitability.
D. pays out all earnings in dividends.


68. In the initial stage (Stage I), the corporation 
A. has a product yet to be accepted in the marketplace.
B. anticipates rapid growth in sales and earnings.
C. needs all its earnings for reinvestment in new assets.
D. all of these


69. When a firm enters Stage III of its life cycle, all of the following are likely to be observed except which? 
A. Dividend payout ratios are likely to rise to a moderate level of 20 to 30 percent of earnings.
B. More competition is likely to enter the firm’s market.
C. Sales begin to decrease.
D. Stock splits are common.


70. When a firm enters Stage IV of its life cycle, 
A. Dividend payout ratios are likely to rise to a moderate level of 20 to 30 percent of earnings.
B. The firm has reached maturity.
C. The organization must retain earnings in preparation for cycling back into Stage I of the life cycle.
D. Stock splits are common.


71. Stockholders may prefer dividends to reinvestment by the firm 
A. because dividends resolve some uncertainty.
B. because dividend payments have an information content.
C. because investors may prefer current cash to future cash.
D. all of these


72. A major desire of stockholders regarding dividend policy is 
A. frequent stock dividends.
B. dividend stability.
C. high payouts when earnings are up and lower payouts when earnings are down.
D. payment of dividends at frequent intervals.


73. Which of the following does not affect a company’s dividend policy? 
A. Legal rules concerning capital impairment
B. The efficient market hypothesis
C. Access to capital markets
D. Tax position of shareholders


74. Firm X has declared a stock dividend that pays one share of stock for every 5 shares owned. After the stock dividend, earnings per share will 
A. remain the same.
B. decline 20%.
C. decline 5%.
D. not enough information.


75. The Tax Relief Act of 2003 
A. taxes dividend and long-term capital gains at the same rate.
B. taxes short-term and long-term capital gains at the same rate.
C. eliminated the tax rate on dividends to avoid double taxation.
D. made high dividend paying stock less attractive to high income investors.


76. Which of the following generally does not influence the dividend policy of the firm? 
A. Cash position of the firm
B. Desire for control
C. Seasonal changes in the level of income
D. Investor’s expectations of the future based on dividend policy


77. Lucas, Inc. earned $15 million last year and retained $6 million. Lucas has 5 million shares outstanding, and the current price of Lucas shares is $30 per share. What is the payout ratio? 
A. 2.67%
B. 4%
C. 40%
D. 60%


78. Mirrlees Furniture earned $750,000 last year and had a 30 percent payout ratio. How much did the firm add to its retained earnings? 
A. $225,000
B. $525,000
C. There is not enough information to tell.
D. None of these


79. The ex-dividend date is the date 
A. on which recipients of the dividend are determined.
B. the dividend is paid.
C. the dividend is declared.
D. which no longer includes dividend payments for stock bought on that date.


80. According to the law, dividends may be funded from: 
A. past earnings.
B. current earnings.
C. future earnings.
D. Only a and b.


81. A stock dividend will 
A. increase the value of a share of stock.
B. decrease the capital in excess of par account.
C. decrease the retained earnings account.
D. none of these.


82. A stock dividend will 
A. increase the total value of stockholders’ equity.
B. decrease the total value of stockholders’ equity.
C. not affect the total value of stockholders’ equity.
D. change the total value of stockholders’ equity but the direction cannot be determined unless the market price and par value is known.


83. CBA Inc has 400,000 shares outstanding with a $5 par value. The shares were issued for $12. The stock is currently selling for $34. CBA has $5,000,000 in retained earnings and has declared a stock dividend that will increase the number of outstanding shares by 6%. What will be the capital in excess of par account after the stock dividend? 
A. $7,685,000
B. $2,685,000
C. $3,496,000
D. $2,385,000


84. The primary purpose of a stock split is to 
A. indicate the firm’s desire to retain funds.
B. increase the investor’s overall wealth.
C. reduce the threat of a takeover by creating more shares.
D. bring the stock price to a lower trading range.


85. Which of the following balance sheet accounts will be affected by a stock dividend but not by a stock split? 
A. Retained earnings
B. Cash
C. Common stock
D. Dividends-in-arrears


86. A 2-for-1 stock split is declared. In this case which of following statements is true? 
A. The cash account declines.
B. The common stock account rises.
C. The retained earnings fall.
D. The par value of the common stock is reduced.


87. The stockholders’ equity section of the balance sheet of the XYZ Corp. is as follows:
If the company now splits its stock 3-for-1, which of the following is correct? 
A. The par value per share will remain at $6.
B. The market price per share will probably remain unchanged.
C. The book value per share will decline to $17.60.
D. The par value per share will decline to $2.00.


88. A stock split 
A. is treated by accountants just like a stock dividend.
B. reduces the retained earnings account.
C. does not change the amount in the common stock account.
D. increases corporate wealth.


89. At what payout percentage is a stock dividend considered a stock split? 
A. 10%
B. 15%
C. 25%
D. 33%


90. A reverse stock split 
A. occurs when a company wants to increase the price of its common stock because the market hasn’t recognized the improvements the company has made in achieving profitability.
B. exchanges fewer new shares of common for old shares of common stock.
C. will not change earnings per share.
D. is more popular in bull markets than in bear markets.


91. Reverse stock splits take place in many cases 
A. to avoid delisting by the stock exchanges and NASDAQ.
B. to raise the price of the common stock from the individual investor price range to the institutional investor price range.
C. because there were simply too many shares outstanding from previous stock splits.
D. none of these.


92. A firm with excess cash and few investment alternatives might logically 
A. declare a stock dividend.
B. split its stock two-for-one.
C. repurchase some of its own shares.
D. choose to issue preferred stock.


93. A firm may repurchase stock in the market because 
A. it will increase the stockholder’s wealth.
B. the firm has inadequate capital budgeting alternatives.
C. it provides positive informational content.
D. all of these


94. Management may repurchase shares of stock in the market 
A. to buy stock they feel is considerably underpriced.
B. for employee stock options.
C. to use in a merger.
D. all of these


95. A corporation may wish to repurchase some of its shares for all the following reasons except 
A. the stock may be needed for future mergers.
B. the corporation’s executives will financially benefit if the stock is resold later at a substantial profit.
C. it can stabilize or increase the market price of the stock.
D. the stock may be needed for an employee compensation plan.


96. Some dividend reinvestment plans allow the stockholder to acquire shares of stock 
A. from the company’s unissued shares.
B. in the market through the company’s transfer agent.
C. at a discount from the market price.
D. all of these


97. All of the following uses of annual earnings would contribute toward an increase in shareholder value except: 
A. repurchase shares
B. invest in projects with high profit potential
C. payoff debt
D. all of these increase shareholder value


98. A firm will repurchase their own shares in the market because 
A. it can stabilize their price in the market
B. they believe the shares are selling at a high price
C. it will generally provide a benefit to the shareholders
D. all of these


99. Each of the following are benefits of dividend reinvestment plans to firms except 
A. increased cash flow for reinvestment
B. no underwriting fees required
C. leads to higher earnings per share
D. all of these are benefits



Matching Questions

100. Match the following with the items below: 

1. marginal principle of retained earnings 

     A division of shares by a ratio set by the board of directors. 


2. stock repurchase 

     Dividends paid in additional shares rather than in cash. 


3. stock split 

     Dividends remaining after a portion of earnings have been reinvested. 


4. stock dividends 

     States that the corporation must be able to earn a higher return on retained earnings than stockholders could receive for themselves after paying taxes on the distributed dividends. 


5. residual dividends 

     On this date the purchase of stock no longer carries with it the right to receive the dividend previously declared. 


6. dividend reinvestment plan 

     A method of utilizing excess cash that is occasionally made in lieu of additional dividends. 


7. life cycle curve 

     A curve illustrating growth phases of a firm. 


8. dividend payment date 

     Plans that provide the investor with an opportunity to buy additional shares of stock with cash dividends paid by the company. 


9. ex-dividend date 

     The day a stockholder will receive a dividend. 



101. Match the following with the items below 

1. dividend reinvestment plans 

     Stockholders owning the stock on this date are entitled to receive a dividend. 


2. capital gains taxes 

     The date a stockholder will receive a dividend. 


3. holder-of-record date 

     Dividends per share divided by market price per share. 


4. life cycle 

     The percentage of dividends to earnings after taxes. 


5. dividend payment date 

     Presumes that companies undertake projects which earn more than investors can earn elsewhere, with the remainder distributed as dividends. 


6. marginal principle of retained earnings 

     Assumes that dividends provide valuable data as to economic expectations for the company. 


7. ex-dividend date 

     On this date the purchase of the stock no longer carries with it the right to receive the dividend previously declared. 


8. dividend yield 

     Taxes on increases in value from holding assets. 


9. dividend payout 

     A determinant of dividend policy that changes in a relatively predictable way over time. 


10. dividend information content 

     Plans that provide the investor with an opportunity to buy additional shares of stock with the cash dividends paid by the company. 





Essay Questions

102. Pharma Duece Corporation, which manufactures biotech drugs, has been experiencing a tremendous growth in the price of its common stock. The stock price increased from $3.25 on January 1, 2010 to $18.00 per share on December 31, 2010. Its current net worth statement includes the following:    





103. The stockholders’ equity portion of Brimstone Tire Company follows:
The current market value of Brimstone’s stock is $25. Show what the balance sheet will look like if Brimstone declares a 5% stock dividend. 






104. Maxwell Electronics had net income of $21 million last year, and had 3 million common shares outstanding. They declared a 12% stock dividend. Calculate EPS before and after the stock dividend. 





105. Acme Corporation consists of 250 grocery stores throughout the Midwest. At the beginning of 2010 its statement of net worth showed the following information: Common Stock ($2 par) $800,000; Capital paid in excess of par $1,400,000 and retained earnings $500,000. During the year, net income equaled $160,000. Management was undecided on what to do with the income. Acme paid an annual dividend of $.25 per share last year and the stock price is currently $14.50. Acme has a 6% growth rate in earnings and dividends, and is in the 40% tax bracket.
a) What return on investment would Acme have to earn in order to justify retaining 2010’s earnings? Use the formula:
b) What changes would occur in stockholder’s equity if a $.15 cash dividend was paid? If a 5% stock dividend was given and no cash dividend was paid?
c) What would EPS be before and after the stock dividend?