Answers to cash distributions & capital structure

1. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a low payout ratio. A) True B) False

2. If a firm adopts a residual distribution policy, distributions are determined as a residual after funding the capital budget. Therefore, the better the firm’s investment opportunities, the lower its payout ratio should be. A) True B) False

3. Stock dividends and stock splits should, at least conceptually, have the same effect on shareholders’ wealth. A) True B) False
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4. Blease Inc. has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio? A) 40.61% B) 42.75% C) 45.00% D) 47.37% E) 49.74%

5. Becker Financial recently completed a 7-for-2 stock split. Prior to the split, its stock sold for $90 per share. If the total market value was unchanged by the split, what was the price of the stock following the split? A) $23.21 B) $24.43 C) $25.71 D) $27.00 E) $28.35

6. Different borrowers have different risks of bankruptcy, and bankruptcy is costly to lenders. Therefore, lenders charge higher rates to borrowers judged to be more at risk of going bankrupt. A) True B) False

7. A firm’s business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses. A) True B) False

8. The trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing. A) True B) False

9. Elephant Books sells paperback books for $7 each. The variable cost per book is $5. At current annual sales of 200,000 books, the publisher is just breaking even. It is estimated that if the authors’ royalties are reduced, the variable cost per book will drop by $1. Assume authors’ royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even? A) $600,000 B) $466,667 C) $333,333 D) $200,000 E) None of the above

10. Vu Enterprises expects to have the following data during the coming year. What is Vu’s expected ROE? Assets $200,000 Interest rate 8%D/A 65% Tax rate 40%EBIT $25,000 A) 12.51% B) 13.14% C) 13.80% D) 14.49% E) 15.21%

 

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