1.Which of the following statements best describes the optimal capital structure?

a.The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's earnings per share (EPS).

b.The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's stock price.

c.The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company's cost of equity.

d.The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company's cost of debt.

e.The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company's cost of preferred stock.

2.Which of the following statements is CORRECT?

a.When a company increases its debt ratio, the costs of equity and debt capital both increase. Therefore, the WACC must also increase.

b.The capital structure that maximizes stock price is generally the capital structure that also maximizes earnings per share.

c.All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.

d.Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase the company's WACC.

e.Since debt financing is cheaper than equity financing, increasing a company's debt ratio will always reduce the company's WACC.

3.In the real world, we find that dividends

a.Are usually more stable 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, and these changes are randomly higher or lower, depending on whether earnings went up or down.

e.Are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS = $2.00, then DPS will equal $0.80. Once the percentage is set, then dividend policy is on "automatic pilot."

4.Which of the following statements about dividend policies is CORRECT?

a.Modigliani and Miller argue that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the "bird-in-the hand" effect.

b.One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than stock repurchases.

c.One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest.

d.One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy.

e.The clientele effect suggests that companies should follow a stable dividend policy.

5.Which of the following SHOULD NOT influence a firm's dividend policy decision?

a.The firm's ability to accelerate or delay investment projects.

b.A strong preference by most shareholders in the economy for current cash income versus capital gains.

c.Constraints imposed by the firm's bond indenture.

d.The fact that much of the firm's equipment has been leased rather than bought and owned.

e.The fact that Congress is considering tax law changes regarding the taxation of dividends versus capital gains.

6.Which of the following statements is CORRECT?

a.The tax code encourages companies to pay dividends.

b.If a company uses the residual dividend model to determine its dividend payments, dividends payout will tend to increase whenever its profitable investment opportunities increase.

c.The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model.

d.Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm's financial risk.

e.A dollar paid out to repurchase stock is taxed at the same rate as a dollar paid out in dividends. Thus, both companies and investors are indifferent between distributing cash through dividends and stocks repurchase programs.