IMANET IMANET Certifications IMANET-CMA Questions & Answers

• Question 661:

  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

  A. Dividends provide information to the market.

  B. The firm should pay dividends only after investing in all investment opportunities having an expected return greater than the cost of capital

  C. Dividends are irrelevant.

  D. Dividends are costly, and the firm should retain earnings and issue stock dividends

  Correct Answer: A

  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.

• Question 662:

  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

  A. Earnings should be retained and reinvested as long as profitable projects are available.

  B. Dividends are important to shareholders, and any earnings left over after paying dividends should be invested in high-return assets

  C. Dividend payments should be consistent.

  D. Dividends are relevant to a financing decision.

  Correct Answer: 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.

• Question 663:

  Residco; Inc expects net income of $800,000 for the next fiscal year. Its targeted and current capital structure is 40% debt and 60% common equity. The director of capital budgeting has determined that the optimal capital spending for next year is $1 2 million. If Residco follows a strict residual dividend policy, what is the expected dividend-payout ratio for next year'?

  A. 90.0%

  B. 66.7%

  C. 40.0%

  D. 10.0%

  Correct Answer: D

  Under the residual theory of dividends, the residual of earnings paid as dividends depends on the available investments 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 returns are poor and the internal equity financing would move the firm away from its ideal capital structure. If Residco wants to maintain its current structure, 60% of investments should be financed from equity. Hence, it needs $720,000 ($1,200,000 x 60%) of equity funds, leaving $80,000 of net income ($800,000 NI - $720,000) available for dividends. The dividend-payout ratio is therefore 10% ($80,000 --$800,000 NI)

• Question 664:

  In practice, dividends

  A. Usually exhibit greater stability than earnings.

  B. Fluctuate more widely than earnings.

  C. Tend to be a lower percentage of earnings for mature firms.

  D. Are usually changed every year to reflect earnings changes.

  Correct Answer: A

  Dividend policy determines the portion of net income distributed to stockholders. Corporations normally try to maintain a stable level of dividends, even though profits may fluctuate considerably, because many stockholders buy stock with the expectation of receiving a certain dividend every year. Thus, management tends not to raise dividends if the payout cannot be sustained. The desire for stability has led theorists to propound the information content or signaling hypothesis a change in dividend policy is a signal to the market regarding management's forecast of future earnings. This stability often results in a stock that sells at a higher market price because stockholders perceive less risk in receiving their dividends.

• Question 665:

  The Dawson Corporation projects the following for the year Earrings before interest and taxes $35 million

  

  The expected common stock dividend per share for Dawson Corporation is The company's net income is $18,000,000 [($35,000,000 EBIT - $5,000,000 interest) x (1.0 – .4 tax rate)]. Thus, the earnings available to common shareholders equal $14,000,000 ($18,000,000 - $4,000,000 preferred dividends), and EPS is $7 ($14,000,000 ÷ 2,000,000 common shares). Given a dividend-payout ratio of 30%, the dividend to common shareholders is expected to be $2.10 per share ($7 x 30%).

  A. $2.34

  B. $2.70

  C. $1.80

  D. $2.10

  Correct Answer: D

• Question 666:

  A financial manager usually prefers to issue preferred stock rather than debt because

  A. Payments to preferred stockholders are not considered fixed payments

  B. The cost of fixed debt is less expensive since it is tax deductible even if a sinking fund is required to retire the debt.

  C. The preferred dividend is often cumulative, whereas interest payments are not.

  D. In a legal sense, preferred stock is equity, therefore, dividend payments are not legal obligations

  Correct Answer: D

  For a financial manager, preferred stock is preferable to debt because dividends do not have to be paid on preferred stock, but failure to pay interest on debt could lead to bankruptcy. Thus, preferred stock is less risky than debt. However, debt has some advantages over preferred stock, the most notable of which is that interest payments are tax deductible. Preferred stock dividends are not.

• Question 667:

  From an investor's viewpoint, the least risky type of bond in which to invest is a(n)

  A. Debenture bond

  B. Deep discount bond.

  C. Income bond

  D. Secured bond.

  Correct Answer: D

  A secured bond is backed by tangible property, making it the safest type for the investor four listed.

• Question 668:

  If a bond sells at a premium, the

  A. Stated coupon rate must be less than the required market rate

  B. Nominal rate must be less than the yield rate.

  C. Bond purchase price must be more than the fair market value of the bond.

  D. Stated coupon rate must be more than the required market rate.

  Correct Answer: D

  If the stated, or coupon, rate of a bond is higher (lower) than the effective; or market; rate on the date of issue, the bonds sell at a premium (discount).

• Question 669:

  Randolf Castell opened a small general store in 1964. A cousin, Alfred Bedford, served as bookkeeper and office manager while Castell concentrated on operations. The business prospered and each of Castell's three sons joined their father in the business. In fact, as each son finished school, Castell opened a new store and put the son in charge. In time, each son began to specialize: one in hardware; another in dry goods, and the third in furniture. Further expansion took place, and the business was incorporated as Four Castles Inc. with all of the stock being held by the family. Castell closed his original store to serve as president and concentrate on administration. As Four Castles prospered and more stores opened, the company needed additional capital Bedford suggested "going public" but pointed out that this required accounting and reporting procedures with which he was unfamiliar. Therefore, a trained and qualified accountant was hired as controller. The new controller has had to provide explanations to Castell and Bedford on the accounting and reporting requirements of public companies. From the viewpoint of the investor, which of the following securities provides the least risk?

  A. Mortgage bond.

  B. Subordinated debenture

  C. Income bond.

  D. Debentures.

  Correct Answer: A

  A mortgage bond is secured with specific fixed assets, usually real property. Thus, under the rights enumerated in the bond indenture, creditors will be able to receive payments from liquidation of the property in case of default. In a bankruptcy proceeding, these amounts are paid before any transfers are made to other creditors, including those preferences. Hence, mortgage bonds are less risky than the others listed.

• Question 670:

  A firm has $3 million in total assets and $1.65 million in equity. How much of its $500,000 capital budget should be debt- financed to retain the same debt-equity ratio?

  A. $50,000

  B. $225,000

  C. $275,000

  D. $450,000

  Correct Answer: B

  The firm's total assets are $3 million and total equity is $1.65 million. Thus, liabilities are $1.35 million ($3 million - $1.65 million). The current debt-equity ratio is 1.35 to 1.65, or 45% ($1.35 million ?$3 million) to 55% ($1.65 million ?$3 million). Thus, to maintain this ratio, 45% of all new investment should come from debt financing. Multiplying 45% times the $500,000 capital budget results in a need for $225,000 in debt financing.