Fundamentals of Financial Management
15th Edition
ISBN: 9780357307724
Author: Brigham
Publisher: CENGAGE L
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Chapter 15, Problem 2Q
Summary Introduction
To explain: Whether it is totally irrational for a firm to sell a new issue stock and to pay cash dividends during a year.
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Which of the following statements is NOT CORRECT?
a. The cost of retained earnings is less than the cost of new common stock due to flotation costs. While retained earnings may appear to be free money on the surface, there is an opportunity cost to them as these funds could be invested elsewhere and earning a return for shareholders. Due to the lower cost of retained earnings, companies generally prefer to use retained earnings to finance their projects, and only issue new common stock when they absolutely must.
b. There are two ways to raise common equity. One source is retained earnings that involves bringing in new funds from outside the company, which represents external equity. The second source is new stock issues that involves bringing in new funds from current stockholders of the company, which represents internal equity.
c. Flotation costs reduce the amount of capital the firm receives from a new stock issue. The company must make each…
Why is the cost of retained earnings cheaper than the cost of issuing new common stock?
Group of answer choices
Issuing new common stock may send a negative signal to the capital markets, which may depress the stock price.
When a company issues new common stock they also have to pay flotation costs to the underwriter.
Either
Neither
Companies often are under pressure to meet or beat Wall Street earnings projections in order to increase stock prices and also to increase the value of stock options. Some resort to earnings management practices to artificially create desired results. Required: 1. How can a company manage earnings by changing its depreciation method? Is this an effective technique to manage earnings? 2. How can a company manage earnings by changing the estimated useful lives of depreciable assets? Is this an effective technique to manage earnings? 3. Using a fictitious example and numbers you make up, describe in your own words how asset impairment losses could be used to manage earnings. How might that benefit the company?
Chapter 15 Solutions
Fundamentals of Financial Management
Ch. 15 - Discuss the pros and cons of having the directors...Ch. 15 - Prob. 2QCh. 15 - Would it ever be rational for a form to barrow...Ch. 15 - Modigliani and Miller (MM), on the one hand, and...Ch. 15 - How would each of the following changes tend to...Ch. 15 - One position expressed in the financial literature...Ch. 15 - Prob. 7QCh. 15 - What the difference between a stock dividend and a...Ch. 15 - Most firms like to have their stock selling at a...Ch. 15 - Prob. 10Q
Ch. 15 - What is meant by catering theory, and how might it...Ch. 15 - RESIDUAL DIVIDEND MODEL Altamonte...Ch. 15 - Prob. 2PCh. 15 - STOCK REPURCHASES Gamma Industries has net income...Ch. 15 - STOCK SPLIT After a 5-for-l stock split, Tyler...Ch. 15 - EXTERNAL EQUITY FINANCING Coastal Carolina Heating...Ch. 15 - RESIDUAL DIVIDEND MODEL Walsh Company is...Ch. 15 - DIVIDENDS Brooks Sporting Inc. is prepared to...Ch. 15 - ALTERNATIVE DIVIDEND POLICIES Rubenstein Bros....Ch. 15 - ALTERNATIVE DIVIDEND POLICIES In 2017, Keenan...Ch. 15 - RESIDUAL DIVIDEND MODEL Buena Terra Corporation is...Ch. 15 - Prob. 11ICCh. 15 - Prob. 1TCLCh. 15 - Use online resources to work on this chapter's...Ch. 15 - Prob. 3TCLCh. 15 - Prob. 4TCLCh. 15 - Use online resources to work on this chapter's...Ch. 15 - Use online resources to work on this chapter's...
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- A firm is planning to borrow money to make an equity repurchase to increase its stock price. It is basing its analysis on the fact that there will be fewer shares outstanding after the repurchases, and higher earnings per share. There are no taxes. a. Will earnings per share always increase after such an action? Explain.b. Will the higher earnings per share always translate into a higher stock price? Explain.c. Under what conditions will such a transaction lead to a higher price?arrow_forwardThe _______________theory hypothesizes that the amount of dividends should not be the focus of the company, but that the company should simply declare a dividend from the earnings not currently needed for earmarked projects. This theory leads to erratic and unpredictable dividends.arrow_forwardPreferred stock may be good for a company because it a. is not as costly as common stock or bonds. b. expands the capital base of the firm without diluting the common stock ownership. c. has no future negative ramifications when dividend payments are missed. d. does not require interest payment in times of financial trouble, but are tax-deductible when dividends are paid.arrow_forward
- Which of the following is one of the causes of over capitalization? a. Reduction in the market price of shares. b. Buying of shares in the unleveraged firm. c. Borrowing huge amount at higher rate than rate at which company can earn. d. Reduction in the rate of dividend and interest paymentsarrow_forwardWhich of the following would not be an appropriate reason for a firm to repurchase its stock: As an investment if management believes the market has undervalued the stock price. In order to have sufficient shares to cover employee stock programs. Solely to boost Earnings Per Share. Both A and B.arrow_forwardWhich of the following statements is true? a. High liquidity means a company is short on cash and may be unable to pay its debts.b. When a company decides to go public through an IPO, it is typically targeting to sell its shares to only a handful of shareholders. c. If the company has a higher than expected extremely high profit this year, equity holders will benefit more than debt holders as debtholders are the residual claimers for the cash flows of the company.d. In the extreme case, the debt holders take legal ownership of the firm's assets through a process called bankruptcy.e. Equity holders expect to receive dividends and the firm is always legally obligated to pay them.arrow_forward
- Assume that a company announces an unexpectedly large cash dividend to its shareholders. In an efficient market without information leakage, one might expect:a. An abnormal price change at the announcement.b. An abnormal price increase before the announcement.c. An abnormal price decrease after the announcement.d. No abnormal price change before or after the announcement.arrow_forwardWhich of the following statements concerning common stock and the investment banking process is NOT CORRECT? a. The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue. b. The announcement of a large issue of new stock could cause the stock price to fall. This loss is called "market pressure," and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue. c. If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market. d. Listing a large firm's stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm. e. Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with…arrow_forwardExplain why the following statement is wrong: “The stock price is equal to the value of equity, divided by shares outstanding. Therefore, companies should avoid issuing equity because the number of shares outstanding goes up and thus the stock price would decrease."arrow_forward
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