Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
4th Edition
ISBN: 9780134083278
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
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Textbook Question
Chapter 17, Problem 20P
A stock that you know is held by long-term individual investors paid a large one-time dividend. You notice that the price drop on the ex-dividend date is about the size of the dividend payment. You find this relationship puzzling given the tax disadvantage of dividends. Explain how the dividend-capture theory might account for this behavior.
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In examining investors’ preferences for dividends, it is useful to begin with the concept of dividend irrelevance. Dividend irrelevance suggests that in a world with no taxes or brokerage (or transaction) costs, firms and investors are indifferent to the paying or receiving of dividends.
However, as these restrictions are relaxed, various factors suggest that firms should pursue high or low payouts. One such factor is:
Dividends received far into the future are significantly more uncertain than dividends received in the near future.
Based on the factor described, identify whether investors, in general, will tend to favor high or low payout ratios.
Favor a high payout
Favor a low payout
When a stock repurchase occurs, which of the following is not correct?a. EPS decreasesb. Shares are repurchased then cancelledc. Investors may regard this as a tax break compared to a dividend paymentd. Costs in servicing small shareholders may be reducede. All of the above are correct
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?
Chapter 17 Solutions
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
Ch. 17.1 - Prob. 1CCCh. 17.1 - Prob. 2CCCh. 17.2 - Prob. 1CCCh. 17.2 - In a perfect capital market, how important is the...Ch. 17.3 - Prob. 1CCCh. 17.3 - Prob. 2CCCh. 17.4 - Prob. 1CCCh. 17.4 - Prob. 2CCCh. 17.5 - Is there an advantage for a firm to retain its...Ch. 17.5 - Prob. 2CC
Ch. 17.6 - Prob. 1CCCh. 17.6 - Prob. 2CCCh. 17.7 - Prob. 1CCCh. 17.7 - Prob. 2CCCh. 17 - Prob. 1PCh. 17 - ABC Corporation announced that it will pay a...Ch. 17 - Prob. 3PCh. 17 - RFC Corp. has announced a 1 dividend. If RFCs...Ch. 17 - Prob. 5PCh. 17 - KMS Corporation has assets with a market value of...Ch. 17 - Natsam Corporation has 250 million of excess cash....Ch. 17 - Suppose the board of Natsam Corporation decided to...Ch. 17 - Prob. 9PCh. 17 - Suppose BE Press paid dividends at the end of each...Ch. 17 - The HNH Corporation will pay a constant dividend...Ch. 17 - Prob. 12PCh. 17 - Prob. 13PCh. 17 - Prob. 14PCh. 17 - Suppose that all capital gains are taxed at a 25%...Ch. 17 - Prob. 16PCh. 17 - Prob. 17PCh. 17 - Prob. 18PCh. 17 - Prob. 19PCh. 17 - A stock that you know is held by long-term...Ch. 17 - Clovix Corporation has 50 million in cash, 10...Ch. 17 - Assume capital markets are perfect. Kay Industries...Ch. 17 - Redo Problem 22., but assume that Kay must pay a...Ch. 17 - Harris Corporation has 250 million in cash, and...Ch. 17 - Redo Problem 22, but assume the following: a....Ch. 17 - Prob. 26PCh. 17 - Use the data in Table 15.3 to calculate the tax...Ch. 17 - Explain under which conditions an increase in the...Ch. 17 - Why is an announcement of a share repurchase...Ch. 17 - AMC Corporation currently has an enterprise value...Ch. 17 - Prob. 31PCh. 17 - Prob. 32PCh. 17 - Explain why most companies choose to pay stock...Ch. 17 - Prob. 34PCh. 17 - Prob. 35P
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- "The dividend discount model is used to find the price of a stock based on the expected dividends received by the shareholder and the discount rate. Therefore, all else constant, the price of a share of stock will increase if the discount rate decreases." A) True B) Falsearrow_forwardWhich of the following statements is correct? a. Companies may pay too high a price in a large open market repurchase if it takes too long to complete. 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. An investor's capital gains from selling stock in a repurchase are always taxed at a higher rate than if the distribution were dividends. d. The tax code encourages companies to pay dividends rather than reinvest earnings. e. The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model.arrow_forwardWhich of the following is the best reason why the price-earnings method is often used by investors to estimate the fair price of a stock? a) Because the earning multiples are easily found in online financial databases. b) Earnings per share is a known amount that is related to the payment of future dividends. c) Because the price-earnings method gives the same answer as the constant growth method and is easier to compute. d) The price-earnings method has been shown to provide the most accurate price estimate.arrow_forward
- Explain the effect of D/E on asset returns, equity returns (assuming that cost of debt is not affected), asset beta and equity beta (assuming that debt beta is zero). Should an investor choose to invest in a stock of a company with high or low D/E, or why expected returns on these stocks are equivalent, although they are not equal?arrow_forwardIndicate whether the following statements are true or false. If the statementis false, explain why.e. A company that has established a clientele of investors who prefer largedividends is unlikely to adopt a residual dividend policy.arrow_forwardEvaluate the following statement: When a firm pays dividend, its stock price decreases in the market. Therefore, it is always better to buy a stock on the date of dividend payment.arrow_forward
- On the average, the announcement of a decrease in dividends can be interpreted by investors as bad news, and the stock price drops good news, and the stock price increases. very good news, and the stock price jumps up. a nonevent that does not affect the stock prices.arrow_forwardBased upon the empirical evidence, state whether the following statements are true or false, and briefly explain why. a). Firms are reluctant to change dividends. b). Stock prices generally go up on the ex-dividend date by less than the amount of the dividend in classic tax system. c). Increasing dividend payments to stockholders generally makes bondholders in the firm better off. d). Dividends create a tax disadvantage for investors even when tax rates on dividends and capital gain is the same.arrow_forwardTo what extent do you feel the company’s dividend policies support or hinder their strategies? For example, if the company is attempting to grow, are they retaining and reinvesting their earnings rather than distributing them to investors through dividends? Be sure to substantiate your claims.arrow_forward
- 5. An optimal dividend policy is one that takes into consideration that:a) Dividends should only be distributed based on the profits of the last period.b) Dividends can be distributed even if the company recorded losses in the last period.c) The balance between current dividends and future growth is achieved, maximizing the value of the company.d) It manages to attract investors who have a predilection for relatively high risks.arrow_forwardCompanies are more apt to choose repurchases over dividends if doing so will enable them to I. take advantage of a market undervaluation of their shares. II. maintain or increase the value of executive stock options. III. offset the dilution created by the exercise of executive stock options. IV. distribute revenue increases that are considered temporary or short-term in nature.arrow_forwardIf the Modigliani and Miller hypothesis about dividends is correct, and if one found a group of companies which differed only with respect to dividend policy, which of the following statements would be most correct? Group of answer choices None of these statements is true. All of these statements are true. The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends. If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D1/P0 = a + b(g)) would be equal to +1.0. The residual dividend model should not be used, because it is inconsistent with the MM dividend hypothesis.arrow_forward
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