Question 1: Which of the following statements is CORRECT?
a. The tax code encourages companies to pay dividends.
b. If a company uses the residual dividend model to determine its dividend payments, dividends payout will tend to increase whenever its profitable investment opportunities increase.
c. The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model.
d. Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firmâ??s financial risk.
e. A dollar paid out to repurchase stock is taxed at the same rate as a dollar paid out in dividends. Thus, both companies and investors are indifferent between distributing cash through dividends and stock repurchase programs.
Question 2: Which of the following statements is CORRECT?
a. If a firm repurchases its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes.
b. An open-market dividend reinvestment plan will be most attractive to companies that need new equity and would be looking to issue additional shares of common stock.
c. Stock repurchases tend to reduce financial leverage.
d. If a company declares a 2-for-1 stock split, its stock price should roughly double.
e. One advantage of adopting the residual dividend policy is that this makes it easier for corporations to satisfy their stockholders in the sense of Modigliani and Miller's dividend clientele theory.