Multiple Choice Questions

1. Which of the following statements is most correct?

a. The tax preference theory states that, all else equal, investors prefer stocks that pay low dividends because retained earnings can lead to capital gains that are taxed preferentially.
b. An increase in the cost of equity capital (rs) when a company announces an increase in its dividend per share would be consistent with the bird-in-the-hand theory.
c. An increase in the stock price when a company decreases its dividend is consistent with the signaling theory.
d. A dividend policy that involves paying a consistent percentage of net income is the best policy if the "clientele effect" is correct.
e. Both statements a and d are correct.

2. Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the firm.

a. True
b. False

3. Others things held constant, which of the following will cause an increase in working capital?

a. Cash is used to buy marketable securities.
b. A cash dividend is declared and paid.
c. Merchandise is sold at a profit, but the sale is on credit.
d. Long-term bonds are retired with the proceeds of a preferred stock issue.
e. Missing inventory is written off against retained earnings.

4. Which of the following statements is most correct?

a. The bird-in-the-hand theory would predict that companies could decrease their cost of equity financing by raising their dividend payout.
b. The clientele effect can explain why firms often change their dividend policies.
c. One advantage of adopting a residual distribution policy (with all distributions in the form of dividends) is that it makes it easier for corporations to maintain dividend clienteles.
d. Answers a and c are correct.
e. None of the answers above is correct.

5. The firm's business risk is largely determined by the financial characteristics of its industry.

a. True
b. False

6. Which of the following statements is most correct?

a. The primary test of feasibility in reorganization is whether every claimant agrees with the reorganization plan.
b. The basic doctrine of fairness states that all debt holders must be treated equally.
c. Since the primary issue in bankruptcy is to determine the sharing of losses between owners and creditors, the "public interest" is not a relevant concern.
d. While the firm is in bankruptcy, the existing management is always allowed to remain in control of the firm, though the court monitors its actions closely.
e. To a large extent, the decision to dissolve a firm through liquidation or to keep it alive through reorganization depends on a determination of the value of the firm if it is rehabilitated versus the value of its assets if they are sold off individually.

7. Which of the following statement is most correct?

a. If a company increases its current liabilities by $1,000 and simultaneously increases its inventories by $1,000, its current ratio must rise.
b. If a company increases its current liabilities by $1,000 and simultaneously increases its inventories by $1,000, its quick ratio must fall.
c. A company's quick ratio may never exceed its current ratio.
d. Answers b and c are correct.
e. None of the answers above is correct.

8. Which of the following would increase the likelihood that a company would increase its debt ratio in its capital structure?

a. An increase in costs incurred when filing for bankruptcy.
b. An increase in the corporate tax rate.
c. An increase in the personal tax rate.
d. A decrease in the firm's business risk.
e. Statements b and d are correct.