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Free CMA Exam Braindumps (page: 146)

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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

  1. Dividends provide information to the market.
  2. The firm should pay dividends only after investing in all investment opportunities having an expected return greater than the cost of capital
  3. Dividends are irrelevant.
  4. Dividends are costly, and the firm should retain earnings and issue stock dividends

Answer(s): A

Explanation:

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.



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A stock dividend

  1. Increases the debt-to-equity ratio of a firm.
  2. Decreases future earnings per share.
  3. Decreases the size of the firm.
  4. Increases shareholder’s wealth

Answer(s): B

Explanation:

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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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

  1. $350.000
  2. $380.000
  3. $206.000
  4. $410.000

Answer(s): D

Explanation:

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.



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A 10% stock dividend most likely

  1. Increases the size of the firm.
  2. Increases shareholders' wealth.
  3. Decreases future earnings per share.
  4. Decreases net income.

Answer(s): C

Explanation:

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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