A firm's dividend policy may treat dividends either as the residual part of a financing decision or as an active policy strategy. Treating dividends as the residual part of a financing decision assumes that
Answer(s): A
According to the residual theory of dividends, the amount (residual) of earnings paid as dividends depends on the available investment opportunities and the debt-equity ratio at which cost of capital is minimized. The rational investor should prefer reinvestment of retained earnings when the return exceeds what the investor could earn on investments of equal risk. However, the firm may prefer to pay dividends when investment opportunities are poor and the use of internal equity financing would move the firm away from its ideal capital structure.
A firm's dividend policy may treat dividends either as the residual part of a financing decision or as an active policy strategy. Treating dividends as an active policy strategy assumes that
Stock prices often move in the same direction as dividends. Moreover, companies dislike cutting dividends. They tend not to raise dividends unless anticipated future earnings will be sufficient to sustain the higher payout. Thus, some theorists have proposed the information content or signaling hypothesis. According to this view, a change in dividend policy is a signal to the market regarding management's forecast of future earnings. Consequently, the relation of stock price changes to changes in dividends reflects not an investor preference for dividends over capital gains but rather the effect of the information conveyed.
A stock dividend
Answer(s): B
A stock dividend is a transfer of equity from retained earnings to paid-in capital. The debit is to retained earnings and the credits are to common stock and additional paid-In capital. Additional shares are outstanding following the stock dividend, but every shareholder maintains the same percentage of ownership In effect, a stock dividend divides the pie (the corporation) into more pieces, but the pie is still the same size. Hence, a corporation will have a lower EPS and a lower book value per share following a stock dividend, but every shareholder will be just as well off as previously. A stock dividend has no effect except on the composition of the shareholders' equity section of the balance sheet.
Brady Corporation has 6,000 shares of 5% cumulative, $100 par value preferred stock outstanding and 200,000 shares of common stock outstanding. Brady's board of directors last declared dividends for the year ended May31, Year 1, and there were no dividends in arrears. For the year ended May31, Year 3, Brady had net income of $1,750,000. The board of directors is declaring a dividend for common shareholders equivalent to 20% of net income. The total amount of dividends to be paid by Brady at May 31, Year 3, is
Answer(s): D
If a company has cumulative preferred stock, all preferred dividends for the current and any unpaid prior years must be paid before any dividends can be paid on common stock. The total preferred dividends that must be paid equal $60,000 (6,000 shares x $100 par x 5% x 2 years), and the common dividend is $350,000 ($1,750,000 x 20%), for a total of $410,000.
A 10% stock dividend most likely
Answer(s): C
A stock dividend is a transfer of equity from retained earnings to paid-in capital. The debit is to retained earnings, and the credits are to common stock and additional paid-in capital. Additional shares are outstanding following the stock dividend, but every shareholder maintains the same percentage of ownership. In effect, a stock dividend divides the pie (the corporation) into more pieces, but the pie is still the same size. Hence, a corporation will have a lower EPS and a lower book value per share following a stock dividend, but every shareholder will be just as well off as previously. A stock dividend has no effect except on the composition of the shareholders' equity section of the balance sheet.
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