1. According to Gordon's Dividend Growth Model, the market value of a share depends on:
Only the current dividend.
Only the retention ratio.
Book value of assets.
Dividend per share, Cost of Equity, and Growth rate.
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:
Retain 100% earnings (0% dividend).
Distribute 50% dividend.
Distribute 100% dividend.
It does not matter.
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:
Shareholders demand it.
There are earnings left over after financing all acceptable investment opportunities.
Profits are high.
Competitors are paying dividends.
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:
Issuing bonus shares.
Paying cash dividend.
Rights issue.
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.
Capitalization of Reserves without affecting Net Worth.
Decrease in Share Capital.
Increase in 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:
Paying 100% profits as dividend.
Paying a fixed percentage of earnings (Constant Payout) or a fixed amount per share.
Paying no dividend.
Fluctuating dividend based on daily profits.
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:
Investors prefer dividends over capital gains.
Perfect capital markets and no taxes.
High taxes on dividends.
High transaction costs.
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:
Decrease in Face Value per share, but Total Share Capital remains same.
Increase in Reserves.
Increase in Paid-up Capital.
Cash outflow for the company.
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:
Constant Payout Ratio.
Low Regular Dividend plus Extra Dividend Policy.
Residual 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:
There is no tax.
The company is making losses.
Capital Gains tax is lower than Dividend Income tax.
Dividends are tax-free.
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 are indifferent between dividends and capital gains.
Investors prefer capital gains for tax reasons.
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:
All investors want high dividends.
Dividends are irrelevant.
Companies should change their dividend policy frequently.
Different groups of investors prefer different dividend policies (e.g., retirees prefer high dividends, young investors prefer growth/capital gains).
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, by taking a bank loan.
No, strictly prohibited.
Yes, out of accumulated free reserves, subject to certain conditions.
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.