1. According to Gordon's Dividend Growth Model, the market value of a share depends on:
Only the retention ratio.
Dividend per share, Cost of Equity, and Growth rate.
Book value of assets.
Only the current dividend.
Explanation:
Gordon's Formula: P = D1 / (Ke - g). It values a stock based on the next expected dividend (D1), the cost of equity (Ke), and the constant growth rate (g).
2. According to Walter’s Model, if the firm’s Return on Investment (r) is greater than its Cost of Capital (k), the firm should:
It does not matter.
Distribute 50% dividend.
Distribute 100% dividend.
Retain 100% earnings (0% dividend).
Explanation:
If r > k, the firm can earn more on the money than the shareholders can earn elsewhere. Therefore, to maximize value, the firm should retain all earnings and reinvest them.
3. According to the "Residual Theory of Dividends", a firm should pay dividends only when:
Competitors are paying dividends.
Profits are high.
Shareholders demand it.
There are earnings left over after financing all acceptable investment opportunities.
Explanation:
This theory views dividends as a passive residual. Priority is given to reinvesting in profitable projects. Only if funds remain, dividend is paid.
4. A Share Buyback is economically equivalent to:
Paying cash dividend.
Rights issue.
Issuing bonus shares.
Stock split.
Explanation:
Buyback returns excess cash to shareholders, similar to a dividend. However, it provides tax advantages (Capital Gains tax vs Dividend Tax) and signals management confidence.
5. Issuing Bonus Shares results in:
Cash outflow from the company.
Decrease in Share Capital.
Increase in Net Worth.
Capitalization of Reserves without affecting Net Worth.
Explanation:
Bonus shares convert free reserves into share capital. The total Net Worth (Capital + Reserves) remains the same; only the composition changes.
6. A policy of "Stable Dividend" usually means:
Fluctuating dividend based on daily profits.
Paying no dividend.
Paying 100% profits as dividend.
Paying a fixed percentage of earnings (Constant Payout) or a fixed amount per share.
Explanation:
Companies maintain stable dividends to signal consistency and reliability to investors, avoiding sharp drops even when profits dip temporarily.
7. The "Modigliani-Miller (MM) Dividend Irrelevance Theory" assumes:
High taxes on dividends.
High transaction costs.
Investors prefer dividends over capital gains.
Perfect capital markets and no taxes.
Explanation:
MM argue that in a perfect world without taxes or transaction costs, dividend policy does not affect share price; investors can create their own dividends by selling shares.
8. A Stock Split (e.g., 1 share of ?10 becomes 2 shares of ?5) results in:
Cash outflow for the company.
Increase in Paid-up Capital.
Increase in Reserves.
Decrease in Face Value per share, but Total Share Capital remains same.
Explanation:
Stock split increases the number of shares and reduces the face value per share proportionately. It does not change the total capital or reserves, unlike a Bonus Issue which capitalizes reserves.
9. A policy of paying a low constant dividend per share plus an extra dividend in years of high profit is called:
Residual Dividend Policy.
Constant Payout Ratio.
Low Regular Dividend plus Extra Dividend Policy.
Stable Dividend Policy.
Explanation:
This policy gives shareholders a reliable steady income while allowing the firm to share prosperity in boom years without committing to a permanently high dividend.
10. According to the "Tax Preference Theory", investors may prefer low dividends and high retained earnings if:
The company is making losses.
Dividends are tax-free.
Capital Gains tax is lower than Dividend Income tax.
There is no tax.
Explanation:
Retained earnings lead to share price appreciation (Capital Gains). If capital gains are taxed at a lower rate than dividend income (or deferred), investors prefer retention over payout.
11. The "Bird-in-the-Hand" theory of dividend policy implies that:
Investors prefer capital gains for tax reasons.
Investors are indifferent between dividends and capital gains.
Dividends reduce the value of the firm.
Investors prefer current dividends (certain) over future capital gains (uncertain).
Explanation:
Proposed by Gordon and Lintner, this theory argues that dividends are less risky than future capital appreciation. Therefore, a higher dividend payout reduces the cost of equity and increases share price.
12. The "Clientele Effect" suggests that:
Dividends are irrelevant.
All investors want high dividends.
Different groups of investors prefer different dividend policies (e.g., retirees prefer high dividends, young investors prefer growth/capital gains).
Companies should change their dividend policy frequently.
Explanation:
Firms attract a specific clientele based on their payout policy. Changing the policy might alienate the existing shareholder base and affect the stock price.
13. Can a company declare dividends if it has incurred a loss in the current year?
Yes, out of Capital.
Yes, out of accumulated free reserves, subject to certain conditions.
Yes, by taking a bank loan.
No, strictly prohibited.
Explanation:
Companies Act allows declaring dividend out of reserves if current profits are insufficient, provided conditions regarding rate of dividend and withdrawal amount are met.