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Dividends: affect to stock price, policy of smoothing, reducing dividend, new shares

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An increase in dividends might not increase price and may actually decrease stock price if:
A)the dividend increase cannot be sustained.
B)the firm does not maintain an exact dividend payout ratio.
C)the firm has too much retained earnings.
D)markets are weak-form efficient.

A policy of dividend "smoothing" refers to:
A)maintaining a constant dividend payout ratio.
B)keeping the regular dividend at the same level indefinitely.
C)maintaining a steady progression of dividend increases over time.
D)alternating cash dividends with stock dividends.

What is the most likely prediction after a firm reduces its regular dividend payment?
A)Earnings are expected to decline.
B)Investment is expected to increase.
C)Retained earnings are expected to decrease.
D)Share price is expected to increase.

Under the idealized conditions of MM, which statement is correct when a firm issues new stock in order to pay a cash dividend on existing shares?
A)The new shares are worth less than the old shares.
B)The old shares drop in value to equal the new price.
C)The value of the firm is reduced by the amount of the dividend.
D)The value of the firm is unaffected.

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Solution Preview

An increase in dividends might not increase price and may actually decrease stock price if:

A) The dividend increase cannot be sustained.
Dividend drops have a much greater negative impact on stocks compared to a dividend increase. If the new dividend was intended as permanent and cannot be maintained, the stock can have a negative reaction. Under MM, the dividend itself should not increase firm value. Also, by increasing dividends, the firm may be indicating that it has few profitable ...

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Text Problems

10. Stock Values. Integrated Potato Chips paid a $1 per share dividend yesterday. You expect the dividend to grow steadily at a rate of 4 percent per year.
1. What is the expected dividend in each of the next 3 years?
2. If the discount rate for the stock is 12 percent, at what price will the stock sell?
3. What is the expected stock price 3 years from now?
4. If you buy the stock and plan to hold it for 3 years, what payments will you receive? What is the present value of those payments? Compare your answer to (b).

19. Constant-Growth Model. Here are data on two stocks, both of which have discount rates of 15 percent:
10.
Stock A Stock B
Return on equity 15% 10%
Earnings per share $2.00 $1.50
Dividends per share $1.00 $1.00
a. What are the dividend payout ratios for each firm?
b. What are the expected dividend growth rates for each firm?
c. What is the proper stock price for each firm?

20. Dividend Policy. Here are several assertions about typical corporate dividend policies. Which of them are true? Write out a corrected version of any false statements.
a. Most companies set a target dividend payout ratio.
b. They set each year's dividend equal to the target payout ratio times that year's earnings.
c. Managers and investors seem more concerned with dividend changes than dividend levels.
d. Managers often increase dividends temporarily when earnings are unexpectedly high for a year or two.

21. Dividend Policy. For each of the following four groups of companies, state whether you would expect them to distribute a relatively high or low proportion of current earnings and whether you would expect them to have a relatively high or low price-earnings ratio.
a. High-Risk Companies
b. Companies that have recently experienced a temporary decline in profits.
c. Companies that expect to experience a decline in profits.
d. "Growth" companies with valuable future investment opportunities.

22. Dividend Policy. "Risky companies tend to have lower target payout ratios and more gradual adjustment rates." Explain what is meant by this statement. Why do you think it is so?

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