Sample Questions and Answers
Miller and Modigliani proposed that dividend policy does not affect:
A) A firm’s total market value
B) The total earnings of a company
C) The company’s dividend payout ratio
D) The amount of stock issued
Answer: A
The dividend payout ratio is calculated by dividing:
A) Earnings per share by dividends per share
B) Dividends paid by net income
C) Stock price by dividends per share
D) Retained earnings by dividends paid
Answer: B
According to the stable dividend policy, firms should:
A) Adjust dividends only in response to changes in earnings
B) Pay a constant dividend amount regardless of earnings
C) Increase dividends if market conditions improve
D) Never adjust dividends
Answer: A
The bird-in-the-hand theory argues that:
A) Investors prefer the certainty of dividends to the risk of capital gains
B) Capital gains are more valuable than dividends
C) Dividends should be avoided to maximize firm value
D) Investors prefer firms with high capital expenditures
Answer: A
According to the agency theory, high dividends can:
A) Reduce potential conflicts between managers and shareholders
B) Increase the agency cost of equity
C) Lead to higher earnings retention
D) Encourage more long-term investments
Answer: A
If a company’s dividend policy does not affect its stock price, it is an example of the:
A) Dividend irrelevance theory
B) Signaling theory
C) Tax preference theory
D) Clientele effect theory
Answer: A
The signaling effect suggests that:
A) A reduction in dividends can signal poor future prospects
B) Increased dividends indicate that the company is about to reduce its debt
C) High dividends always lead to higher stock prices
D) Investors are indifferent to the size of dividends paid
Answer: A
The stability of dividends policy is best suited for companies that:
A) Have unstable earnings
B) Are in a mature phase with predictable earnings
C) Are in the early growth stages with volatile earnings
D) Are facing financial distress
Answer: B
According to the tax preference hypothesis, investors in high tax brackets prefer:
A) Companies with high dividend payout ratios
B) Firms that do not pay dividends and offer capital gains instead
C) Companies that pay high dividends to increase after-tax returns
D) Firms that provide tax-free dividends
Answer: B
If a company follows a high dividend payout policy, it:
A) May have less capital available for reinvestment
B) Will likely focus more on acquiring new assets
C) Will typically have higher debt levels
D) Will focus on maximizing capital gains
Answer: A
The pecking order theory of dividend policy suggests that:
A) Companies prefer external equity financing over debt
B) Firms prioritize financing first with internal funds, then debt, and finally equity
C) Dividends should always be paid to maintain shareholder satisfaction
D) Firms should always retain earnings and not pay dividends
Answer: B
If a company follows a residual dividend policy, it will:
A) Pay dividends after all profitable investment opportunities are funded
B) Always maintain a fixed dividend payout ratio
C) Pay the same dividend amount every year
D) Pay no dividends if earnings are low
Answer: A
Dividend yield is defined as:
A) Dividends per share divided by stock price per share
B) Stock price per share divided by dividends per share
C) The percentage increase in dividend payout
D) The amount of earnings paid out in dividends
Answer: A
A company is more likely to adopt a high dividend payout ratio if:
A) It has limited growth opportunities
B) It plans to reinvest heavily in new projects
C) It has high retained earnings
D) It wants to attract high-growth investors
Answer: A
According to the dividend preference theory, the value of a firm is determined by:
A) The dividends it pays out rather than the total earnings
B) The capital gains from stock price appreciation
C) Its total market value and growth potential
D) The level of earnings retained and reinvested
Answer: A
The stability of dividends model is typically most relevant for:
A) Growth companies with high volatility
B) Companies in the early stages of development
C) Mature companies with consistent earnings
D) Companies with large debts to pay off
Answer: C
A company with a high dividend payout may find it challenging to:
A) Raise capital through debt
B) Attract long-term investors
C) Retain enough earnings for expansion
D) Reduce its stock price
Answer: C
According to the tax preference theory, investors prefer:
A) High dividends due to lower tax rates on dividends
B) Low dividends because capital gains are taxed at a lower rate
C) Dividends that are tax-exempt
D) Regular dividends from corporations
Answer: B
The signaling effect of dividends refers to the idea that:
A) Companies send signals about their financial health by changing dividends
B) Dividends have no effect on investor perception
C) Companies that reduce dividends are signaling higher earnings in the future
D) Companies should always increase dividends to signal growth
Answer: A
According to Miller and Modigliani’s dividend irrelevance theory, the value of a company is determined by:
A) Dividend payouts and capital structure
B) Earnings and growth prospects
C) Stock price movements and investor perception
D) The level of retained earnings
Answer: B
A company with a high dividend payout ratio may:
A) Reinvest less of its earnings into new projects
B) Be able to fund future expansion without borrowing
C) Have a low debt-to-equity ratio
D) Be focused on retaining earnings for business growth
Answer: A
The clientele effect theory suggests that:
A) Firms should change their dividend policy based on investor preferences
B) Investors prefer firms with the same dividend policies as their past investments
C) Investors are indifferent to dividend policies
D) A company should issue dividends according to tax preferences
Answer: B
According to the bird-in-the-hand theory, the value of a stock is higher when:
A) The company offers high future growth opportunities
B) The company pays dividends now rather than relying on future capital gains
C) Investors receive capital gains instead of dividends
D) The company does not pay dividends
Answer: B
The residual dividend policy is based on the idea that dividends should be paid after:
A) All profitable investment opportunities are funded
B) Stockholders have voted on the amount
C) Management has evaluated the company’s liquidity
D) Creditors are paid
Answer: A
According to agency theory, high dividends can help reduce:
A) The conflict of interest between managers and shareholders
B) The company’s overall tax burden
C) The agency costs of equity
D) The risk of investment in the company
Answer: A
A company may decide to pay a low dividend when:
A) It is in a high-growth phase and needs to reinvest profits
B) It wants to provide immediate returns to shareholders
C) Its stock price is low
D) It has high retained earnings
Answer: A
A high dividend payout ratio might be favored by investors who:
A) Need current income and are not concerned about future growth
B) Are looking for stocks with high capital appreciation
C) Focus on companies with reinvestment strategies
D) Believe in the long-term potential of growth companies
Answer: A
The pecking order theory suggests that companies:
A) Prioritize internal funds, then debt, and issue equity as a last resort
B) Should only use debt financing for expansion
C) Prefer to issue equity before using retained earnings
D) Issue dividends to reduce financing costs
Answer: A
According to the stable dividend policy, firms tend to:
A) Keep dividend payouts stable and only adjust them in response to long-term changes in earnings
B) Adjust dividends frequently to match changes in earnings
C) Eliminate dividends during periods of financial difficulty
D) Pay dividends based on available liquidity
Answer: A
The signaling hypothesis suggests that a firm’s dividend policy will:
A) Not affect its market value
B) Provide information about the firm’s earnings prospects
C) Always cause stock prices to fall
D) Be irrelevant to investors
Answer: B
If a company follows a high dividend payout policy, it may:
A) Have a lower growth rate
B) Raise capital more easily through equity financing
C) Increase retained earnings for expansion
D) Have a higher debt-to-equity ratio
Answer: A
According to the bird-in-the-hand theory, investors prefer:
A) Dividends because they are less risky than future capital gains
B) Stocks with uncertain future dividend payouts
C) Stocks with reinvested earnings over dividend payments
D) Capital gains over dividends
Answer: A
The dividend irrelevance theory was developed by:
A) Miller and Modigliani
B) Gordon and Shapiro
C) Lintner
D) Modigliani and Miller
Answer: A
Under residual dividend policy, a firm will pay dividends from:
A) Excess profits after reinvesting in profitable projects
B) Retained earnings only
C) Loans and external financing
D) Earnings in excess of stockholder expectations
Answer: A
According to tax preference theory, investors in lower tax brackets generally:
A) Prefer low dividends and higher capital gains
B) Prefer high dividends due to favorable tax treatment
C) Are indifferent between dividends and capital gains
D) Prefer companies with no dividends
Answer: B
In signaling theory, an increase in dividends is interpreted by investors as:
A) A signal that the firm’s future prospects are good
B) A sign that the company is facing liquidity issues
C) A sign of financial distress
D) A message to invest more in capital projects
Answer: A
The dividend discount model assumes that:
A) Dividends are the only determinant of stock price
B) Stock prices are determined by future earnings and dividends
C) The stock price depends only on retained earnings
D) Investors do not consider the risk associated with dividends
Answer: B
According to agency theory, one way to reduce agency costs is to:
A) Pay higher dividends to reduce the funds available for discretionary spending
B) Cut dividends to increase retained earnings
C) Use debt financing instead of equity
D) Offer stock options to management
Answer: A
According to tax preference theory, the ideal dividend policy for an investor in a high tax bracket would be:
A) A low dividend payout policy
B) A high dividend payout policy
C) A policy that minimizes capital gains taxes
D) A policy that maximizes dividend payouts
Answer: A
A firm might prefer a residual dividend policy because it:
A) Allows for more flexible dividend payments based on profitability
B) Pays out all its profits as dividends
C) Restricts the firm’s ability to reinvest earnings
D) Makes the firm more attractive to investors seeking high current income
Answer: A
The tax preference hypothesis suggests that:
A) Investors in high tax brackets prefer capital gains over dividends
B) Dividends are always preferred over capital gains
C) Investors in low tax brackets prefer capital gains over dividends
D) Taxes do not affect dividend preferences
Answer: A
According to the bird-in-the-hand theory, the risk-free return from dividends is preferred over the uncertain returns from:
A) Capital gains
B) Debt securities
C) Retained earnings
D) Treasury bonds
Answer: A
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