March 2012
Intermediate to advanced
142 pages
3h 10m
English
CHAPTER 7
DIVIDENDS AND SHARE REPURCHASES: ANALYSIS
SOLUTIONS
1. The appropriate matches are as follows:
| Column A | Column B |
| 1. Bird in the hand | a) Dividend policy matters |
| 2. Homemade dividends | b) Dividend policy is irrelevant |
| 3. High tax rates on dividends | c) Dividend policy matters |
2. B is correct. The MM dividend theory assumes no taxes or transaction costs, but does not assume a clientele effect.
3. B is correct. The clientele effect implies that there are varying preferences for dividends among distinct investor groups.
4. C is correct. Because the clientele for PAT Company investors has the same tax rate (zero) for dividends and capital gains, the ex-dividend stock price of PAT should decline by the amount of the dividend to €40−€1.50=€38.50. She will purchase €150,000/€38.50=3,896 additional shares. This increases her total shares owned to 103,896. Chan’s new share ownership is closest to 103,900.
5. B is correct. A decrease in the quarterly dividend rate is likely to signal negative information. A decrease is typically understood as signaling poor future business prospects.
6. B is correct. The effective tax rate can be computed as 1 minus the fraction of 1 unit of earnings that investors retain after all taxes, or 1−(1−0.40)(1−0.30)=0.58 or 58% effective tax rate. Another way to obtain the solution: Corporate taxes=1.00×0.40=0.40 and personal taxes=0.60 in dividends×0.30=0.18, so total tax=0.40+0.18=0.58, a 58% effective rate.
7. A is correct. With low growth ...
