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Finance – Question & Answers

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Finance – Question & Answers

14.3 Stock Dividend & Stock Split

A stock dividend is given to shareholders as an additional share in a company in the form

of a dividend, while a stock split is related to the increase in the number of shares by the

company to boost the liquidity of the company’s stock. Both actions are feasible either a

company declares a 100% stock dividend or a 2-for-1 split as both actions dilute the price of a

share, which results in a large number of stock shares. However, the ownership of stakeholders

remains the same in both cases (Matt, 2021).

14.4 Residual Policy & Dividends

The residual policy implies that all earnings should be paid first to capital expenditure

and then paid in form of dividends even if all distributions are in the form of dividends (Adam,

2022).

Ratios Forms of Dividend Pay- Investment Opportunities

out Ratios

1. Dividend Pay-out Ratios Dividends Paid/Net Feasible for Dividends and Net

income income of the company as an

investment

2. Dividend Pay-out Ratios 1 – Retention Ratios Feasible for Price for share

stocks as an investment

3. Dividend Pay-out Ratios Dividend Per Feasible for earning per share

Share/Earning Per Share ratios as an investment

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14.5 True & False Statements

a. If a firm repurchases its stock in the open market, the shareholders who tender the stock are

subject to capital gains taxes. (True)

b. If you own 100 shares in a company’s stock and the company’s stock splits 2- for-1, then you

will own 200 shares in the company following the split. (True)

c. Some dividend reinvestment plans increase the amount of equity capital available to the firm.

(True)

d. The Tax Code encourages companies to pay a large percentage of their net income in the form

of dividends. (False)

As the tax code encourages companies to use debt, and pay interest instead of a large percentage

in form of dividends.

e. A company that has established a clientele of investors who prefer large dividends is unlikely

to adopt a residual dividend policy (True).

f. If a firm follows a residual dividend policy then, holding all else constant, its dividend pay-out

will tend to rise whenever the firm’s investment opportunities improve (False).

If a firm follows a residual dividend policy then, holding all else constant, its dividend pay-out

will tend to decline whenever the firm’s investment opportunities improve.

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Chapter 15

15.1 Explanation of Terms

a. Capital Structure is the combination of equity and debt, and it is used by the company

to finance its growth and operation. Business risk is defined as any exposure to an organization

that has the potential to lower the profit of a company, while the financial risk is defined as the

possibility of a loss of money either due to investment or business.

b. Operating leverage is related to the cost accounting formula, which measures the

degree of potential to which a firm can increase its operating income through an increase in

revenue streams. Financial leverage is an investment strategy, which includes the use of various

financial instruments to increase the return on investments. The Break-even point is related to

trade or an investment and it is determined by the comparison of market price and the original

cost of an asset.

c. Reserve Borrowing capacity is related to a maximum amount of money that the lender

evaluates based on the collateral values.

15.2 Projection of future ROIC

Business Risk is a term that refers to the uncertainty inherent in a projection of future

ROIC, and business risk is defined as any exposure to an organization that has the potential to

lower the profit of a company.

15.3 Firms with Non-Financial Fixed Costs

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Firms that have high non-financial fixed costs are said to have a high degree of operating

leverage, and it measures the degree of potential to which a firm can increase its operating

income through an increase in revenue streams (Telis, 2022).

15.4 EBIT and EPS

Operating leverage affects both EBIT and EPS because operating leverage is the

percentage change in EBIT for a percentage change in sales, therefore when EBIT is affected by

operating leverage, it affects the EPS as well. But, financial leverage affects EPS, because

financial leverage is the percentage change in EPS for a percentage change in earnings, and,

EBIT is affected by financial leverage (Ivanis, 2022).

15.5 Explanation of True Statement

The statement ‘Other things being the same, firms with relatively stable sales can carry

relatively high debt ratios’ is true, because, under normal economic conditions, a firm can carry a

high debt ratio because of a greater expected rate of return.

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References

Matt Lee (2021). Investopedia. Does a Stock Dividend Dilute the Price Per Share as Would a

Forward Stock Split?

https://www.investopedia.com/ask/answers/06/stockdividendvsstocksplit.asp

Adam Hayes (2022). Investopedia. Residual Dividend.

https://www.investopedia.com/terms/r/residual-dividend.asp#:~:text=A%20residual%20dividend

%20policy%20means,issuing%20more%20stock%20(equity).

Telis Demos (2022). Wall Street Journal. Banks’ Rising Expenses Don’t Have to Be So Costly

https://www.wsj.com/articles/banks-rising-expenses-dont-have-to-be-so-costly-11642622351

Ivanis Marko (2022). Ebsco Host. EBIT - EPS

https://web.p.ebscohost.com/abstract?

site=ehost&scope=site&jrnl=18208819&AN=62824533&h=Xw33%2fLXDjFLWivmW9

BukcFktN%2bAeQaGGbnvA0YBcOk4S02W9CdvVkZPb

%2bNHYJWB0msDcFO8J5nkdnSBdIymnoQ%3d

%3d&crl=c&resultLocal=ErrCrlNoResults&resultNs=Ehost&crlhashurl=login.aspx

%3fdirect%3dtrue%26profile%3dehost%26scope%3dsite%26authtype%3dcrawler

%26jrnl%3d18208819%26AN%3d62824533