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MGT 5002 Final Exam MCQ (ANSWER 50/50)

1).ÿIf in the opinion of a given investor a stock?s expected return exceeds its required return, this suggests that the investor thinks a.ÿthe stock is experiencing supernormal growth. b.ÿthe stock should be sold. c.ÿthe stock is a good buy. d.ÿmanagement is probably not trying to maximize the price per share. e.ÿdividends are not likely to be declared. 2).ÿThe preemptive right is important to shareholders because it a.ÿallows managers to buy additional shares below the current market price. b.ÿwill result in higher dividends per share. c.ÿis included in every corporate charter. d.ÿprotects the current shareholders against a dilution of their ownership interests. e.ÿprotects bondholders, and thus enables the firm to issue debt with a relatively low interest rate. ÿ3).ÿCompanies can issue different classes of common stock.ÿ Which of the following statements concerning stock classes is CORRECT? a.ÿAll common stocks fall into one of three classes: A, B, and C. b.ÿAll common stocks, regardless of class, must have the same voting rights. c.ÿAll firms have several classes of common stock. d.ÿAll common stock, regardless of class, must pay the same dividend. e.ÿSome class or classes of common stock are entitled to more votes per share than other classes. 4).ÿIf a stock?s dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium. a.ÿThe expected return on the stock is 5% a year. b.ÿThe stock?s dividend yield is 5%. c.ÿThe price of the stock is expected to decline in the future. d.ÿThe stock?s required return must be equal to or less than 5%. e.ÿThe stock?s price one year from now is expected to be 5% above the current price. 5).ÿWhich of the following statements is CORRECT? a.ÿTo implement the corporate valuation model, we discount projected free cash flows at the weighted average cost of capital. b.ÿTo implement the corporate valuation model, we discount net operating profit after taxes (NOPAT) at the weighted average cost of capital. c.ÿTo implement the corporate valuation model, we discount projected net income at the weighted average cost of capital. d.ÿTo implement the corporate valuation model, we discount projected free cash flows at the cost of equity capital. e.ÿThe corporate valuation model requires the assumption of a constant growth rate in all years. 6).ÿWhich of the following statements is CORRECT? a.ÿA major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights. b.ÿPreferred stock is normally expected to provide steadier, more reliable income to investors than the same firm?s common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock. c.ÿThe preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock. d.ÿOne of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free. e.ÿOne of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer. 7).ÿIf D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock?s expected total return for the coming year? a.ÿ7.54% b.ÿ7.73% c.ÿ7.93% d.ÿ8.13% e.ÿ8.34% 8).ÿBankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock.ÿ Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock.ÿ Which of the following actions would REDUCE its need to issue new common stock? a.ÿIncrease the dividend payout ratio for the upcoming year. b.ÿIncrease the percentage of debt in the target capital structure. c.ÿIncrease the proposed capital budget. d.ÿReduce the amount of short-term bank debt in order to increase the current ratio. e.ÿReduce the percentage of debt in the target capital structure. 9).ÿWhen working with the CAPM, which of the following factors can be determined with the most precision? a.ÿThe market risk premium (RPM). b.ÿThe beta coefficient, bi, of a relatively safe stock. c.ÿThe most appropriate risk-free rate, rRF. d.ÿThe expected rate of return on the market, rM. e.ÿThe beta coefficient of ?the market,? which is the same as the beta of an average stock. 10).ÿLaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%.ÿ Which of the following projects (A, B, and C) should the company accept? a.ÿProject B, which is of below-average risk and has a return of 8.5%. b.ÿProject C, which is of above-average risk and has a return of 11%. c.ÿProject A, which is of average risk and has a return of 9%. d.ÿNone of the projects should be accepted. e.ÿAll of the projects should be accepted. 11).ÿO’Brien Inc. has the following data:ÿ rRF = 5.00%; RPM = 6.00%; and b = 1.05.ÿ What is the firm’s cost of equity from retained earnings based on the CAPM? a.ÿ11.30% b.ÿ11.64% c.ÿ11.99% d.ÿ12.35% e.ÿ12.72% 12).ÿScanlon Inc.’s CFO hired you as a consultant to help her estimate the cost of capital.ÿ You have been provided with the following data:ÿ rRF = 4.10%; RPM = 5.25%; and b = 1.30.ÿ Based on the CAPM approach, what is the cost of equity from retained earnings? a.ÿ 9.67% b.ÿ 9.97% c.ÿ10.28% d.ÿ10.60% e.ÿ10.93% 13).ÿA. Butcher Timber Company hired your consulting firm to help them estimate the cost of equity.ÿ The yield on the firm’s bonds is 8.75%, and your firm’s economists believe that the cost of equity can be estimated using a risk premium of 3.85% over a firm’s own cost of debt.ÿ What is an estimate of the firm’s cost of equity from retained earnings? a.ÿ12.60% b.ÿ13.10% c.ÿ13.63% d.ÿ14.17% e.ÿ14.74% 14).ÿYou were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity.ÿ The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 12.75%.ÿ The firm will not be issuing any new stock.ÿ What is its WACC? a.ÿ 8.98% b.ÿ 9.26% c.ÿ 9.54% d.ÿ 9.83% e.ÿ10.12% 15).ÿWhich of the following statements is CORRECT? a.ÿSince debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity. b.ÿThe tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes. c.ÿIf a company assigns the same cost of capital to all of its projects regardless of each project?s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject. d.ÿBecause no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt. e.ÿHigher flotation costs tend to reduce the cost of equity capital. 16).ÿWhich of the following statements is CORRECT? a.ÿThe component cost of preferred stock is expressed as rp(1 – T).ÿ This follows because preferred stock dividends are treated as fixed charges, and as such they can be deducted by the issuer for tax purposes. b.ÿA cost should be assigned to retained earnings due to the opportunity cost principle, which refers to the fact that the firm?s stockholders would themselves expect to earn a return on earnings that were paid out rather than retained and reinvested. c.ÿNo cost should be assigned to retained earnings because the firm does not have to pay anything to raise them.ÿ They are generated as cash flows by operating assets that were raised in the past, hence they are ?free.? d.ÿSuppose a firm has been losing money and thus is not paying taxes, and this situation is expected to persist into the foreseeable future.ÿ In this case, the firm?s before-tax and after-tax costs of debt for purposes of calculating the WACC will both be equal to the interest rate on the firm?s currently outstanding debt, provided that debt was issued during the past 5 years. e.ÿIf a firm has enough retained earnings to fund its capital budget for the coming year, then there is no need to estimate either a cost of equity or a WACC. 17).ÿWhich of the following statements is CORRECT?ÿ Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a.ÿA project?s NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC. b.ÿThe lower the WACC used to calculate it, the lower the calculated NPV will be. c.ÿIf a project?s NPV is less than zero, then its IRR must be less than the WACC. d.ÿIf a project?s NPV is greater than zero, then its IRR must be less than zero. e.ÿThe NPV of a relatively low-risk project should be found using a relatively high WACC. 18).ÿWhich of the following statements is CORRECT? a.ÿOne defect of the IRR method is that it does not take account of cash flows over a project?s full life. b.ÿOne defect of the IRR method is that it does not take account of the time value of money. c.ÿOne defect of the IRR method is that it does not take account of the cost of capital. d.ÿOne defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future. e.ÿOne defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid. 19).ÿWhich of the following statements is CORRECT?ÿ Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a.ÿThe longer a project?s payback period, the more desirable the project is normally considered to be by this criterion. b.ÿOne drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money. c.ÿIf a project?s payback is positive, then the project should be rejected because it must have a negative NPV. d.ÿThe regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. e.ÿIf a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects 20).ÿWhich of the following statements is CORRECT? a.ÿThe NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR. b.ÿThe NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR. c.ÿThe NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate. d.ÿThe NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period. e.ÿThe IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period. 21).ÿWhich of the following statements is CORRECT? a.ÿThe IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount, which the NPV method provides. b.ÿThe discounted payback method eliminates all of the problems associated with the payback method. c.ÿWhen evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project’s acceptability. d.ÿTo find the MIRR, we discount the TV at the IRR. e.ÿA project?s NPV profile must intersect the X-axis at the project?s WACC. 22).ÿWhich of the following statements is CORRECT?ÿ Assume that all projects being considered have normal cash flows and are equally risky. a.ÿIf a project?s IRR is equal to its WACC, then, under all reasonable conditions, the project?s NPV must be negative. b.ÿIf a project?s IRR is equal to its WACC, then under all reasonable conditions, the project?s IRR must be negative. c.ÿIf a project?s IRR is equal to its WACC, then under all reasonable conditions the project?s NPV must be zero. d.ÿThere is no necessary relationship between a project?s IRR, its WACC, and its NPV. e.ÿWhen evaluating mutually exclusive projects, those projects with relatively long lives will tend to have relatively high NPVs when the cost of capital is relatively high. 23).ÿWhich of the following statements is CORRECT? a.ÿA sunk cost is any cost that must be expended in order to complete a project and bring it into operation. b.ÿA sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project. c.ÿA sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project. d.ÿSunk costs were formerly hard to deal with, but once the NPV method came into wide use, it became possible to simply include sunk costs in the cash flows and then calculate the project?s NPV. e.ÿA good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm?s existing stores. 24).ÿWhich of the following factors should be included in the cash flows used to estimate a project?s NPV? a.ÿAll costs associated with the project that have been incurred prior to the time the analysis is being conducted. b.ÿInterest on funds borrowed to help finance the project. c.ÿThe end-of-project recovery of any additional net operating working capital required to operate the project. d.ÿCannibalization effects, but only if those effects increase the project?s projected cash flows. e.ÿExpenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes. 25).ÿWhich one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product? a.ÿA firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. b.ÿA new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm?s current products. c.ÿA firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. d.ÿA firm has spent $2 million on research and development associated with a new product.ÿ These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. e.ÿA firm can produce a new product, and the existence of that product will stimulate sales of some of the firm?s other products. 26).ÿTaussig Technologies is considering two potential projects, X and Y.ÿ In assessing the projects? risks, the company estimated the beta of each project versus both the company?s other assets and the stock market, and it also conducted thorough scenario and simulation analyses.ÿ This research produced the following data: ÿProject XÿÿProject Yÿ Expected NPVÿ$350,000ÿ$350,000 Standard deviation (åNPV)ÿ$100,000ÿ$150,000 Project beta (vs. market)ÿÿÿÿÿ 1.4ÿÿÿÿÿ 0.8 Correlation of the project cash flows with cash flows from currently existing projectsÿCash flows are not correlated with the cash flows from existing projectsÿCash flows are highly correlated with the cash flows from existing projects Which of the following statements is CORRECT? a.ÿProject X has more stand-alone risk than Project Y. b.ÿProject X has more corporate (or within-firm) risk than Project Y. c.ÿProject X has more market risk than Project Y. d.ÿProject X has the same level of corporate risk as Project Y. e.ÿProject X has the same market risk as Project Y since its cash flows are not correlated with the cash flows of existing projects. 27).ÿA firm is considering a new project whose risk is greater than the risk of the firm?s average project, based on all methods for assessing risk.ÿ In evaluating this project, it would be reasonable for management to do which of the following? a.ÿIncrease the estimated IRR of the project to reflect its greater risk. b.ÿIncrease the estimated NPV of the project to reflect its greater risk. c.ÿReject the project, since its acceptance would increase the firm?s risk. d.ÿIgnore the risk differential if the project would amount to only a small fraction of the firm?s total assets. e.ÿIncrease the cost of capital used to evaluate the project to reflect its higher-than-average risk. 28).ÿAs assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with the following data.ÿ What is the Year 1 cash flow? Sales revenuesÿ$13,000 Depreciationÿ$4,000 Other operating costsÿ$6,000 Tax rateÿ35.0% a.ÿ$5,950 b.ÿ$6,099 c.ÿ$6,251 d.ÿ$6,407 e.ÿ$6,568 29).ÿWhich one of the following is an example of a ?flexibility? option? a.ÿA company has an option to invest in a project today or to wait for a year before making the commitment. b.ÿA company has an option to close down an operation if it turns out to be unprofitable. c.ÿA company agrees to pay more to build a plant in order to be able to change the plant’s inputs and/or outputs at a later date if conditions change. d.ÿA company invests in a project today to gain knowledge that may enable it to expand into different markets at a later date. e.ÿA company invests in a jet aircraft so that its CEO, who must travel frequently, can arrive for distant meetings feeling less tired than if he had to fly a commercial airline. 30).ÿLangston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset.ÿ Its assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%.ÿ The company is considering the following projects: ProjectÿRiskÿExpected Return AÿHighÿ15% BÿAverageÿ12% CÿHighÿ11% DÿLowÿ9% EÿLowÿ6% Which set of projects would maximize shareholder wealth? a.ÿA and B. b.ÿA, B, and C. c.ÿA, B, and D. d.ÿA, B, C, and D. e.ÿA, B, C, D, and E. (Comp.) Real optionsÿ 31).ÿWhich one of the following will NOT increase the value of a real option? a.ÿLengthening the time during which a real option must be exercised. b.ÿAn increase in the volatility of the underlying source of risk. c.ÿAn increase in the risk-free rate. d.ÿAn increase in the cost of obtaining the real option. e.ÿA decrease in the probability that a competitor will enter the market of the project in question. 32).ÿGleason Research regularly takes real options into account when evaluating its proposed projects.ÿ Specifically, it considers the option to abandon a project whenever it turns out to be unsuccessful (the abandonment option), and it evaluates whether it is better to invest in a project today or to wait and collect more information (the investment timing option).ÿ Assume the proposed projects can be abandoned at any time without penalty.ÿ Which of the following statements is CORRECT? a.ÿThe abandonment option tends to reduce a project’s NPV. b.ÿThe abandonment option tends to reduce a project’s risk. c.ÿIf there are important first-mover advantages, this tends to increase the value of waiting a year to collect more information before proceeding with a proposed project. d.ÿA project can either have an abandonment option or an investment timing option, but never both. e.ÿInvestment timing options always increase the value of a project. 33).ÿTutor.com is considering a plan to develop an online finance tutoring package that has the cost and revenue projections shown below.ÿ One of Tutor’s larger competitors, Online Professor (OP), is expected to do one of two things in Year 5:ÿ (1) develop its own competing program, which will put Tutor’s program out of business, or (2) offer to buy Tutor’s program if it decides that this would be less expensive than developing its own program.ÿ Tutor thinks there is a 35% probability that its program will be purchased for $6 million and a 65% probability that it won’t be bought, and thus the program will simply be closed down with no salvage value.ÿ What is the estimated net present value of the project (in thousands) at a WACC = 10%, giving consideration to the potential future purchase? WACC = 10.0%ÿÿ0ÿ1ÿ2ÿ3ÿ4ÿ5ÿ Original project:ÿ-$3,000ÿ$500ÿ$500ÿ$500ÿ$500ÿ$500 FutureÿÿProb. Buysÿ35%ÿÿÿÿÿ$6,000 Doesn’t buyÿ65%ÿÿÿÿÿ$0 a.ÿ$161.46 b.ÿ$179.40 c.ÿ$199.33 d.ÿ$219.26 e.ÿ$241.19 34).ÿAn increase in the debt ratio will generally have no effect on which of these items? a.ÿBusiness risk. b.ÿTotal risk. c.ÿFinancial risk. d.ÿMarket risk. e.ÿThe firm’s beta. 35).ÿBased on the information below, what is the firm’s optimal capital structure? a.ÿDebt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50. b.ÿDebt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90. c.ÿDebt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20. d.ÿDebt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. e.ÿDebt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00. 36).ÿWhich of the following events is likely to encourage a company to raise its target debt ratio, other things held constant? a.ÿAn increase in the corporate tax rate. b.ÿAn increase in the personal tax rate. c.ÿAn increase in the company?s operating leverage. d.ÿThe Federal Reserve tightens interest rates in an effort to fight inflation. e.ÿThe company’s stock price hits a new high. 37).ÿThe firm?s target capital structure should do which of the following? a.ÿMaximize the earnings per share (EPS). b.ÿMinimize the cost of debt (rd). c.ÿObtain the highest possible bond rating. d.ÿMinimize the cost of equity (rs). e.ÿMinimize the weighted average cost of capital (WACC). 38).ÿWhich of the following statements is CORRECT, holding other things constant? a.ÿFirms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt. b.ÿAn increase in the personal tax rate is likely to increase the debt ratio of the average corporation. c.ÿIf changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely lead to lower debt ratios for corporations. d.ÿAn increase in the company?s degree of operating leverage would tend to encourage the firm to use more debt in its capital structure so as to keep its total risk unchanged. e.ÿAn increase in the corporate tax rate would in theory encourage companies to use more debt in their capital structures. 39).ÿWhich of the following statements is CORRECT? a.ÿIn general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs. b.ÿThere is no reason to think that changes in the personal tax rate would affect firms? capital structure decisions. c.ÿA firm with a relatively high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal. d.ÿIf a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt. e.ÿSuppose a firm has less than its optimal amount of debt.ÿ Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity. 40).ÿLongstreet Inc. has fixed operating costs of $470,000, variable costs of $2.80 per unit produced, and its product sells for $4.00 per unit.ÿ What is the company’s break-even point, i.e., at what unit sales volume would income equal costs? a.ÿ391,667 b.ÿ411,250 c.ÿ431,813 d.ÿ453,403 e.ÿ476,073 41).ÿSouthwest U’s campus book store sells course packs for $15 each, the variable cost per pack is $9, fixed costs to produce the packs are $200,000, and expected annual sales are 50,000 packs.ÿ What are the pre-tax profits from sales of course packs? a.ÿ$ 72,900 b.ÿ$ 81,000 c.ÿ$ 90,000 d.ÿ$100,000 e.ÿ$110,000 42).ÿYour uncle is considering investing in a new company that will produce high quality stereo speakers.ÿ The sales price would be set at 1.5 times the variable cost per unit; the variable cost per unit is estimated to be $75.00; and fixed costs are estimated at $1,200,000.ÿ What sales volume would be required to break even, i.e., to have EBIT = zero? a.ÿ28,880 b.ÿ30,400 c.ÿ32,000 d.ÿ33,600 e.ÿ35,280 43).ÿIn the real world, dividends a.ÿare usually more stable than earnings. b.ÿfluctuate more widely than earnings. c.ÿtend to be a lower percentage of earnings for mature firms. d.ÿare usually changed every year to reflect earnings changes, and these changes are randomly higher to lower, depending on whether earnings increased or decreased. e.ÿare usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS = $2.00, then DPS would equal $0.80.ÿ Once the percentage is set, then dividend policy is on ?automatic pilot? and the dividend actually paid depends strictly on earnings. 44).ÿYou own 100 shares of Troll Brothers’ stock, which currently sells for $120 a share.ÿ The company is about to declare a 2-for-1 stock split.ÿ Which of the following best describes your likely position after the split? a.ÿYou will have 200 shares of stock, and the stock will trade at or near $120 a share. b.ÿYou will have 200 shares of stock, and the stock will trade at or near $60 a share. c.ÿYou will have 100 shares of stock, and the stock will trade at or near $60 a share. d.ÿYou will have 50 shares of stock, and the stock will trade at or near $120 a share. e.ÿYou will have 50 shares of stock, and the stock will trade at or near $600 a share. 45).ÿMyron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is lowered.ÿ Their argument is based on the assumption that a.ÿinvestors are indifferent between dividends and capital gains. b.ÿinvestors require that the dividend yield plus the capital gains yield equal a constant. c.ÿcapital gains are taxed at a higher rate than dividends. d.ÿinvestors view dividends as being less risky than potential future capital gains. e.ÿinvestors prefer a dollar of expected capital gains to a dollar of expected dividends because of the lower tax rate on capital gains. 46).ÿWhich of the following would be most likely to lead to a decrease in a firm’s dividend payout ratio? a.ÿIts earnings become more stable. b.ÿIts access to the capital markets increases. c.ÿIts research and development efforts pay off, and it now has more high-return investment opportunities. d.ÿIts accounts receivable decrease due to a change in its credit policy. e.ÿIts stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages. 47).ÿWhich of the following statements about dividend policies is CORRECT? a.ÿMiller and Modigliani argued that investors prefer dividends to capital gains because dividends are more certain than capital gains.ÿ They call this the ?bird-in-the-hand? effect. b.ÿOne reason that companies tend to favor distributing excess cash as dividends rather than by repurchasing stock is that dividends are normally taxed at a lower rate than gains on repurchased stock. c.ÿOne advantage of dividend reinvestment plans is that they allow shareholders to delay paying taxes on the dividends that they choose to reinvest. d.ÿOne key advantage of the residual dividend model is that it enables a company to follow a stable dividend policy. e.ÿThe clientele effect suggests that companies should follow a stable dividend policy. 48).ÿWhich of the following statements is CORRECT? a.ÿOne disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their investment in the company. b.ÿOne advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account. c.ÿStock repurchases can be used by a firm that wants to increase its debt ratio. d.ÿStock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities. e.ÿOne advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding. 49).ÿWhich of the following statements is CORRECT? a.ÿHistorically, the tax code has encouraged companies to pay dividends rather than retain earnings. b.ÿIf a company uses the residual dividend model to determine its dividend payments, dividend payout will tend to increase whenever its profitable investment opportunities increase relatively rapidly. c.ÿThe more a firm’s management believes in the clientele effect, the more likely the firm is to adhere strictly to the residual dividend model. d.ÿLarge stock repurchases financed by debt tend to increase expected earnings per share, but they also tend to increase the firm’s financial risk. e.ÿA dollar paid out to repurchase stock has the same tax benefit as a dollar paid out in dividends.ÿ Thus, both companies and investors should be indifferent between distributing cash through dividends and stock repurchase programs. 50).ÿMid-State BankCorp recently declared a 7-for-2 stock split.ÿ Prior to the split, the stock sold for $80 per share.ÿ If the firm’s total market value is unchanged by the split, what will the stock price be following the split? a.ÿ$20.63 b.ÿ$21.71 c.ÿ$22.86 d.ÿ$24.00 e.ÿ$25.20 ÿ