“Other things being the same, firms with relatively stable sales are able to carry relatively high debt ratios.”

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QUESTION

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

 

(14-4)

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.

 

(14-5)

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 tender the stock are subject to capital gains taxes.

 

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.

 

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

d.The Tax Code encourages companies to pay a large percentage of their net income in the form of dividends.

 

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

 

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 opportunities improve.

Questions

(15-1)

Define each of the following terms:

 

Capital structure; business risk; financial risk

 

Operating leverage; financial leverage; break-even point

 

Reserve borrowing capacity

 

(15-2)

What term refers to the uncertainty inherent in projections of future ROIC?

 

(15-3)

Firms with relatively high nonfinancial fixed costs are said to have a high degree of what?

 

(15-4)

“One type of leverage affects both EBIT and EPS. The other type affects only EPS.” Explain this statement.

 

(15-5)

Why is the following statement true? “Other things being the same, firms with relatively stable sales are able to carry relatively high debt ratios.”

 

Sample Solutions

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