1) The purchase of treasury stock with a firm’s surplus cash

A. Increases a firm’s assets.

B. Increases a firm’s financial leverage.
C. Increases a firm’s interest coverage ratio.
D. Dilutes a firm’s earnings per share.

A. Increases a firm’s assets.

Answer (A) is incorrect.
Assets decrease when treasury stock is purchased.

Increases a firm’s financial leverage.

B.
Answer (B) is correct.
A purchase of treasury stock involves a decrease in assets (usually cash) and a corresponding
decrease in equity. Thus, equity is reduced and the debt-to-equity ratio and financial leverage
increase.

C. Increases a firm’s interest coverage ratio.

Answer (C) is incorrect.
A firm’s interest coverage ratio is unaffected. Earnings, interest expense, and taxes will all be the
same regardless of the transaction.

Dilutes a firm’s earnings per share.

D.
Answer (D) is incorrect.
The purchase of treasury stock is antidilutive; the same earnings will be spread over fewer shares.
Some firms purchase treasury stock for this reason.

2) A corporation has 6,000 shares of 5% cumulative, $100 par value preferred stock outstanding
and 200,000 shares of common stock outstanding. The corporation’s board of directors last
declared dividends for the year ended May 31, Year 1, and there were no dividends in arrears.
For the year ended May 31, Year 3, the corporation had net income of $1,750,000. The board
of directors is declaring a dividend for common shareholders equivalent to 20% of net income.
The total amount of dividends to be paid at May 31, Year 3, is

A. $350,000
B. $380,000
C. $206,000
 D. $410,000

A. $350,000
Answer (A) is incorrect.
The amount of $350,000 is the common stock dividend.

B. $380,000
Answer (B) is incorrect.
The amount of $380,000 omits the $30,000 of cumulative dividends for the year ended May 31,
Year 2.

C. $206,000
Answer (C) is incorrect.
The amount of $206,000 is based on a flat rate of $1 per share of stock.

$410,000
D.
Answer (D) is correct.
If a company has cumulative preferred stock, all preferred dividends for the current and any unpaid
prior years must be paid before any dividends can be paid on common stock. The total preferred
dividends that must be paid equal $60,000 (6,000 shares × $100 par × 5% × 2 years), and the
common dividend is $350,000 ($1,750,000 × 20%), for a total of $410,000.

3) A stock dividend

A. Increases the debt-to-equity ratio of a firm.

B. Decreases future earnings per share.
C. Decreases the size of the firm.
D. Increases stockholders’ wealth.

Increases the debt-to-equity ratio of a firm.

A.
Answer (A) is incorrect.
A stock dividend has no effect except on the composition of the stockholders’ equity section of the
balance sheet.
 Decreases future earnings per share.
B.
Answer (B) is correct.
A stock dividend is a transfer of equity from retained earnings to paid-in capital. The transaction
decreases retained earnings and increases common stock and additional paid-in capital. Additional
shares are outstanding following the stock dividend, but every stockholder maintains the same
percentage of ownership. In effect, a stock dividend divides the pie (the corporation) into more
pieces, but the pie is still the same size. Thus, a corporation has a lower EPS and a lower book
value per share following a stock dividend, but every stockholder is just as well off as previously. A
stock dividend has no effect except on the composition of the stockholders’ equity section of the
balance sheet.

Decreases the size of the firm.

C.
Answer (C) is incorrect.
A stock dividend has no effect except on the composition of the stockholders’ equity section of the
balance sheet.

D. Increases stockholders’ wealth.

Answer (D) is incorrect.
A stock dividend has no effect except on the composition of the stockholders’ equity section of the
balance sheet.

4) In practice, dividends

A. Usually exhibit greater stability 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.

A. Usually exhibit greater stability than earnings.

Answer (A) is correct.
Dividend policy determines the portion of net income distributed to stockholders. Corporations
normally try to maintain a stable level of dividends, even though profits may fluctuate considerably,
because many stockholders buy stock with the expectation of receiving a certain dividend every
year. Thus, management tends not to raise dividends if the payout cannot be sustained. The desire
for stability has led theorists to propound the information content or signaling hypothesis: A change
in dividend policy is a signal to the market regarding management’s forecast of future earnings. This
stability often results in a stock that sells at a higher market price because stockholders perceive
less risk in receiving their dividends.
 B. Fluctuate more widely than earnings.
Answer (B) is incorrect.
Most companies try to maintain stable dividends.

C. Tend to be a lower percentage of earnings for mature firms.

Answer (C) is incorrect.
Mature firms have less need of earnings to reinvest for expansion; thus, they tend to pay a higher
percentage of earnings as dividends.

D. Are usually changed every year to reflect earnings changes.

Answer (D) is incorrect.
Most companies try to maintain stable dividends.

5) When a company desires to increase the market value per share of common stock, the
company will implement

A. The sale of treasury stock.

B. A reverse stock split.
C. The sale of preferred stock.
D. A stock split.

A. The sale of treasury stock.

Answer (A) is incorrect.
A sale of treasury stock increases the supply of shares and could lead to a decline in market price.

B. A reverse stock split.

Answer (B) is correct.
A reverse stock split decreases the number of shares outstanding, thereby increasing the market
price per share. A reverse stock split may be desirable when a stock is selling at such a low price
that management is concerned that investors will avoid the stock because it has an undesirable
image.

C. The sale of preferred stock.

Answer (C) is incorrect.
A sale of preferred stock will take dollars out of investors’ hands, thereby reducing funds available to
invest in common stock; therefore, market price per share of common stock will not increase.
 D. A stock split.
Answer (D) is incorrect.
A stock split increases the shares issued and outstanding. The market price per share is likely to
decline as a result.

Fact Pattern: A firm’s dividend policy may treat dividends either as the residual part of a financing
decision or as an active policy strategy.

6) Treating dividends as the residual part of a financing decision assumes that

A. Earnings should be retained and reinvested as long as profitable projects are available.
B. Dividends are important to shareholders, and any earnings left over after paying dividends should be invested
in high-return assets.
C. Dividend payments should be consistent.
D. Dividends are relevant to a financing decision.

A. Earnings should be retained and reinvested as long as profitable projects are available.
Answer (A) is correct.
According to the residual theory of dividends, the amount (residual) of earnings paid as dividends
depends on the available investment opportunities and the debt-equity ratio at which cost of capital
is minimized. The rational investor should prefer reinvestment of retained earnings when the return
exceeds what the investor could earn on investments of equal risk. However, the firm may prefer to
pay dividends when investment opportunities are poor and the use of internal equity financing would
move the firm away from its ideal capital structure.

B. Dividends are important to shareholders, and any earnings left over after paying dividends should
be invested in high-return assets.
Answer (B) is incorrect.
A residual theory assumes that investors want the company to reinvest earnings in worthwhile
projects, not pay dividends.

C. Dividend payments should be consistent.

Answer (C) is incorrect.
Dividend payments will not be consistent under a residual theory. The corporation will pay dividends
only when internal investment options are unacceptable.

D. Dividends are relevant to a financing decision.

Answer (D) is incorrect.
 Dividends would not be important to a financing decision under the residual theory.

Fact Pattern: A firm’s dividend policy may treat dividends either as the residual part of a financing
decision or as an active policy strategy.

7) Treating dividends as an active policy strategy assumes that

A. Dividends provide information to the market.

B. The firm should pay dividends only after investing in all investment opportunities having an expected return
greater than the cost of capital.
C. Dividends are irrelevant.
D. Dividends are costly, and the firm should retain earnings and issue stock dividends.

Dividends provide information to the market.

A.
Answer (A) is correct.
Stock prices often move in the same direction as dividends. Moreover, companies dislike cutting
dividends. They tend not to raise dividends unless anticipated future earnings will be sufficient to
sustain the higher payout. Thus, some theorists have proposed the information content or signaling
hypothesis. According to this view, a change in dividend policy is a signal to the market regarding
management’s forecast of future earnings. Consequently, the relation of stock price changes to
changes in dividends reflects not an investor preference for dividends over capital gains but rather
the effect of the information conveyed.

B. The firm should pay dividends only after investing in all investment opportunities having an expected
return greater than the cost of capital.
Answer (B) is incorrect.
The residual theory of dividends assumes that the firm should pay dividends only after investing in
all investment opportunities having an expected return greater than the cost of capital.

C. Dividends are irrelevant.

Answer (C) is incorrect.
An active dividend policy suggests management assumes that dividends are relevant to investors.

Dividends are costly, and the firm should retain earnings and issue stock dividends.
D.
Answer (D) is incorrect.
An active dividend policy recognizes that investors want dividends.
8) On August 15, a corporation announced a 1-for-10 reverse split, the event to occur on
September 6, subject to shareholder approval. The stock’s closing price on August 14 was
$1.375. If nothing changes, at what price would you expect the stock to sell after the stock split
is made effective on September 6?

A. $13.75
B. $10.00
C. $2.75
D. $1.38

$13.75
A.
Answer (A) is correct.
A reverse stock split, like a regular stock split, does not change the corporation’s market
capitalization. Thus, if there are 1/10 as many shares outstanding as previously, they should be
worth 10 times as much. Thus, the price after the reverse split would be $13.75 (10 × $1.375).

B. $10.00
Answer (B) is incorrect.
The shares should be worth 10 times as much as before the split.

C. $2.75
Answer (C) is incorrect.
The shares should be worth 10 times as much as before the split.

D. $1.38
Answer (D) is incorrect.
The shares should be worth 10 times as much as before the split.

9) A firm has 1,000 shares outstanding and retained earnings of $25,000. Theoretically, what
would you expect to happen to the price of the firm’s stock, currently selling for $50 per share,
if a 20% stock dividend is declared?

A. Price should increase to $60 per share.

B. Price should decrease to $40 per share.
 C. Price should decrease to $41.67 per share.
D. Nothing; price should remain at $50.

A. Price should increase to $60 per share.

Answer (A) is incorrect.
Share price should fall since the corporate pie is being divided into more pieces.

B. Price should decrease to $40 per share.

Answer (B) is incorrect.
This would mean a drop in market capitalization.

Price should decrease to $41.67 per share.

C.
Answer (C) is correct.
The total market capitalization of 1,000 shares is $50,000. That should remain about the same
following the issuance of the 200 shares of stock dividend. Thus, dividing $50,000 by 1,200 shares
equals $41.67 per share.

D. Nothing; price should remain at $50.

Answer (D) is incorrect.
The price per share should drop since each shareholder will now have more shares representing
the same total ownership.

10) If a company uses the residual dividend policy, it will pay

A. A fixed cash dividend each quarter and use the residual as retained earnings.
B. A fixed stock dividend each quarter and retain all earnings as a residual.
C. All earnings as dividends each year.
D. Dividends only if earnings exceed the amount needed to support an optimal capital budget.

A fixed cash dividend each quarter and use the residual as retained earnings.
A.
 Answer (A) is incorrect.
The cash dividend would not be stable, but a residual.

B. A fixed stock dividend each quarter and retain all earnings as a residual.
Answer (B) is incorrect.
The residual theory concerns cash dividends.

All earnings as dividends each year.

C.
Answer (C) is incorrect.
All earnings are not distributed as dividends.

D. Dividends only if earnings exceed the amount needed to support an optimal capital budget.
Answer (D) is correct.
Under the residual theory of dividends, the amount (residual) of earnings paid as dividends depends
on the available investment opportunities and the debt-equity ratio at which cost of capital is
minimized. The rational investor should prefer reinvestment of retained earnings when the return
exceeds what the investor could earn on investments of equal risk. However, the firm may prefer to
pay dividends when investment opportunities are poor and the use of internal equity financing would
move the firm away from its ideal capital structure.

11) Stock dividends and stock splits differ in that

A. Stock splits involve a bookkeeping transfer from retained earnings to the capital stock account.
B. Stock splits are paid in additional shares of common stock, whereas a stock dividend results in replacement of
all outstanding shares with a new issue of shares.
C. In a stock split, a larger number of new shares replaces the outstanding shares.
D. A stock dividend results in a decline in the par value per share.

A. Stock splits involve a bookkeeping transfer from retained earnings to the capital stock account.
Answer (A) is incorrect.
Stock dividends involve a bookkeeping transfer. Stock splits do not involve a change in the capital
accounts.

B. Stock splits are paid in additional shares of common stock, whereas a stock dividend results in
replacement of all outstanding shares with a new issue of shares.
 Answer (B) is incorrect.
Stock dividends are paid in additional shares of common stock. In stock splits, all outstanding
shares are replaced with a new issue of shares.

C. In a stock split, a larger number of new shares replaces the outstanding shares.
Answer (C) is correct.
A stock split does not involve any accounting entries. Instead, a larger number of new shares are
issued to replace and retire all outstanding shares.

D. A stock dividend results in a decline in the par value per share.

Answer (D) is incorrect.
In a stock split, there is a large decline in the book value and in the market value per share. A stock
dividend does not affect the par value of stock.

12) A company following a residual dividend payout policy will pay higher dividends when,
everything else equal, it has

A. Less-attractive investment opportunities.

B. Lower earnings available for reinvestment.
C. A lower targeted debt-to-equity ratio.
D. A lower opportunity cost of retained earnings.

Less-attractive investment opportunities.

A.
Answer (A) is correct.
Under the residual theory of dividends, the firm prefers to pay dividends when investment
opportunities are poor and internal financing would move the firm away from its ideal capital
structure. Thus, a company with less-attractive investment opportunities will have a lower optimal
capital budget. Under a residual dividend policy, a lower optimal capital budget will result in a higher
dividend payout ratio, other factors being constant.

B. Lower earnings available for reinvestment.

Answer (B) is incorrect.
When lower earnings are available for reinvestment, any level of capital expenditures will require,
other factors being constant, a greater proportion of available internal funds. The dividend payout
ratio will then be lower, not higher, under a residual payout policy.

C. A lower targeted debt-to-equity ratio.

Answer (C) is incorrect.
 The lower the debt-to-equity ratio, the higher the proportion of new investments financed with equity.
Under a residual dividend payout policy, the result will be a lower, not a higher, dividend payout as
more internally available funds are retained for reinvestment.

A lower opportunity cost of retained earnings.

D.
Answer (D) is incorrect.
The lower the opportunity cost of funds, the lower the discount rate used to evaluate capital projects
and the more attractive the investment opportunities. Under a residual payout policy, more internally
generated funds will be required to finance the optimal capital budget, and the dividend payout will
be lower, not higher.

13) The date when the right to a dividend expires is called the

A. Declaration date.
B. Ex-dividend date.
C. Holder-of-record date.
D. Payment date.

A. Declaration date.
Answer (A) is incorrect.
On the declaration date, the directors formally vote to declare a dividend.

B. Ex-dividend date.
Answer (B) is correct.
The ex-dividend date is typically set before the date of record. Unlike the other relevant dates, it is
not established by the corporate board of directors but by the stock exchanges. The period between
the ex-dividend date and the date of record gives the stock exchange members time to process any
transactions in time for the new shareholders to receive the dividend to which they are entitled. An
investor who buys a share of stock before the ex-dividend date will receive the dividend that has
been previously declared. An investor who buys on or after the ex-dividend date (but before the
date of record or payment date) will not receive the declared dividend.

C. Holder-of-record date.
Answer (C) is incorrect.
On the date of record, the corporation determines which shareholders will receive the declared
dividend.

D. Payment date.
 Answer (D) is incorrect.
On the date of payment, the dividend is actually paid.

14) The policy decision that by itself is least likely to affect the value of the firm is the

A. Investment in a project with a large net present value.

B. Sale of a risky division that will now increase the credit rating of the entire company.
C. Distribution of stock dividends to shareholders.
D. Use of a more highly leveraged capital structure that resulted in a lower cost of capital.

A. Investment in a project with a large net present value.

Answer (A) is incorrect.
A positive NPV project should increase the value of the firm.

Sale of a risky division that will now increase the credit rating of the entire company.
B.
Answer (B) is incorrect.
The higher credit rating should reduce the cost of capital and therefore increase the value of the
firm.

C. Distribution of stock dividends to shareholders.

Answer (C) is correct.
A stock dividend does not significantly affect the value of the firm. It simply divides ownership
interests into smaller pieces without changing any shareholder’s proportionate share of ownership.

D. Use of a more highly leveraged capital structure that resulted in a lower cost of capital.
Answer (D) is incorrect.
The lower cost of capital should reduce the required rate of return and increase the value of the firm.

Fact Pattern: A company has 1,000 shares of $10 par value common stock and $5,000 of retained
earnings. Two proposals are under consideration. The first is a stock split giving each shareholder
two new shares for each share formerly held. The second is to declare and distribute a 50% split-up
effected in the form of a dividend.
15) The stock split proposal will <List A> earnings per share by <List B> than will the proposal for a
split-up effected in the form of a dividend.
List A List B
 A. Increase More

B. Increase Less

C. Decrease More

D. Decrease Less

A. Increase More
Answer (A) is incorrect.
The stock split results in a greater number of shares outstanding and a lower EPS.

B. Increase Less
Answer (B) is incorrect.
The stock split results in a greater number of shares outstanding and a lower EPS.

C. Decrease More
Answer (C) is correct.
The stock split will double the number of shares outstanding to 2,000. The 50% split-up effected in
the form of a dividend will increase the number of outstanding shares to 1,500. The higher number
of shares in the stock split will result in a lower earnings per share than will result from the split-up
effected in the form of a dividend.

D. Decrease Less
Answer (D) is incorrect.
The stock split results in a greater number of shares outstanding and a lower EPS.

Fact Pattern: A company has 1,000 shares of $10 par value common stock and $5,000 of retained
earnings. Two proposals are under consideration. The first is a stock split giving each shareholder
two new shares for each share formerly held. The second is to declare and distribute a 50% split-up
effected in the form of a dividend.

16) Under the <List A>, the par value per outstanding share will <List B>.
List A List B

A. Split-up effected in the form of a dividend Increase

B. Stock split Increase

 C. Split-up effected in the form of a dividend Decrease

D. Stock split Decrease

A. Split-up effected in the form of a dividend Increase

Answer (A) is incorrect.
Par value per share does not change following a split-up effected in the form of a dividend.

B. Stock split Increase

Answer (B) is incorrect.
Par value per share decreases following a stock split.

C. Split-up effected in the form of a dividend Decrease

Answer (C) is incorrect.
Par value per share does not change following a split-up effected in the form of a dividend.

Stock split Decrease

D.
Answer (D) is correct.
A stock split results in a lower par value per share because the total number of shares increases but
the total par value of outstanding stock does not change.

17) A company declares and pays both a $200,000 cash dividend and a 10% stock dividend. The
effect of the <List A> dividend is to <List B>.
List A List B

A. Cash Increase retained earnings

B. CashDecrease retained earnings and increase equity

C. Stock Decrease retained earnings

D. StockDecrease retained earnings and decrease equity

A. Cash Increase retained earnings

Answer (A) is incorrect.
Cash dividends reduce retained earnings.
 CashDecrease retained earnings and increase equity
B.
Answer (B) is incorrect.
Cash dividends decrease both retained earnings and equity.

Stock Decrease retained earnings

C.
Answer (C) is correct.
A stock dividend results in a transfer from retained earnings to paid-in capital equal to the fair value
of the stock.

D. StockDecrease retained earnings and decrease equity

Answer (D) is incorrect.
Stock dividends have no net effect on equity.

18) How would a 5% stock dividend affect a company’s additional paid-in capital and retained
earnings when declared?
Additional Retained
Paid-in Capital Earnings

A. No change Increase

B. No change Decrease

C. Increase Increase

D. Increase Decrease

A. No change Increase
Answer (A) is incorrect.
Retained earnings is the cumulative accrual-basis income of the corporation, minus amounts paid
out in cash dividends, minus amounts reclassified as additional paid-in capital from stock dividends.
Thus, stock dividends increase additional paid-in capital and decrease retained earnings.

No change Decrease
B.
Answer (B) is incorrect.
Retained earnings is the cumulative accrual-basis income of the corporation, minus amounts paid
out in cash dividends, minus amounts reclassified as additional paid-in capital from stock dividends.
Thus, stock dividends increase additional paid-in capital.

C. Increase Increase
Answer (C) is incorrect.
 Retained earnings is the cumulative accrual-basis income of the corporation, minus amounts paid
out in cash dividends, minus amounts reclassified as additional paid-in capital from stock dividends.
Thus, stock dividends decrease retained earnings.

Increase Decrease
D.
Answer (D) is correct.
Retained earnings is the cumulative accrual-basis income of the corporation, minus amounts paid
out in cash dividends, minus amounts reclassified as additional paid-in capital from stock dividends.
Thus, stock dividends increase additional paid-in capital and decrease retained earnings.

Fact Pattern: Jensen Corporation’s board of directors met on June 3 and declared a regular
quarterly cash dividend of $.40 per share for a total value of $200,000. The dividend is payable on
June 24 to all stockholders of record as of June 17. Excerpts from the statement of financial position
for Jensen Corporation as of May 31 are presented as follows.
Cash $ 400,000

Accounts receivable (net) 800,000

Inventories 1,200,000

Total current assets $2,400,000

Total current liabilities $1,000,000

Assume that the only transactions to affect Jensen Corporation during June are the dividend
transactions.

19) Jensen’s total stockholders’ equity would be

A. Unchanged by the dividend declaration and decreased by the dividend payment.

B. Decreased by the dividend declaration and increased by the dividend payment.
C. Unchanged by either the dividend declaration or the dividend payment.
D. Decreased by the dividend declaration and unchanged by the dividend payment.

A. Unchanged by the dividend declaration and decreased by the dividend payment.

Answer (A) is incorrect.
A dividend declaration reduces retained earnings and total stockholders’ equity. The subsequent
payment will have no effect on stockholders’ equity because only cash and dividends payable are
reduced.

Decreased by the dividend declaration and increased by the dividend payment.

B.
Answer (B) is incorrect.
A dividend declaration reduces retained earnings and total stockholders’ equity. The subsequent
payment will have no effect on stockholders’ equity because only cash and dividends payable are
 reduced.

C. Unchanged by either the dividend declaration or the dividend payment.

Answer (C) is incorrect.
A dividend declaration reduces retained earnings and total stockholders’ equity. The subsequent
payment will have no effect on stockholders’ equity because only cash and dividends payable are
reduced.

D. Decreased by the dividend declaration and unchanged by the dividend payment.

Answer (D) is correct.
A dividend declaration reduces retained earnings and thus total stockholders’ equity. The
subsequent payment will have no effect on stockholders’ equity since only cash and dividends
payable are reduced.

Fact Pattern: Jensen Corporation’s board of directors met on June 3 and declared a regular
quarterly cash dividend of $.40 per share for a total value of $200,000. The dividend is payable on
June 24 to all stockholders of record as of June 17. Excerpts from the statement of financial position
for Jensen Corporation as of May 31 are presented as follows.
Cash $ 400,000

Accounts receivable (net) 800,000

Inventories 1,200,000

Total current assets $2,400,000

Total current liabilities $1,000,000

Assume that the only transactions to affect Jensen Corporation during June are the dividend
transactions.

20) If the dividend declared by Jensen Corporation had been a 10% stock dividend instead of a cash dividend,
Jensen’s current liabilities would have been

A. Unchanged by the dividend declaration and increased by the dividend distribution.

B. Unchanged by the dividend declaration and decreased by the dividend distribution.
C. Increased by the dividend declaration and unchanged by the dividend distribution.
D. Unchanged by either the dividend declaration or the dividend distribution.

A. Unchanged by the dividend declaration and increased by the dividend distribution.

Answer (A) is incorrect.
A stock dividend requires transfer of an amount from retained earnings to paid-in capital.
Consequently, no liability accounts are affected by either the declaration or the distribution of a
stock dividend.
 B. Unchanged by the dividend declaration and decreased by the dividend distribution.
Answer (B) is incorrect.
A stock dividend requires transfer of an amount from retained earnings to paid-in capital.
Consequently, no liability accounts are affected by either the declaration or the distribution of a
stock dividend.

C. Increased by the dividend declaration and unchanged by the dividend distribution.

Answer (C) is incorrect.
A stock dividend requires transfer of an amount from retained earnings to paid-in capital.
Consequently, no liability accounts are affected by either the declaration or the distribution of a
stock dividend.

Unchanged by either the dividend declaration or the dividend distribution.

D.
Answer (D) is correct.
A stock dividend requires transfer of an amount from retained earnings to paid-in capital.
Consequently, no liability accounts are affected by either the declaration or the distribution of a
stock dividend.

Fact Pattern: Excerpts from the statement of financial position for Landau Corporation as of
September 30 of the current year are presented as follows.
Cash $ 950,000

Accounts receivable (net) 1,675,000

Inventories 2,806,000

Total current assets $5,431,000

Accounts payable $1,004,000

Accrued liabilities 785,000

Total current liabilities $1,789,000

The board of directors of Landau Corporation met on October 4 of the current year and declared the
regular quarterly cash dividend amounting to $750,000 ($.60 per share). The dividend is payable on
October 25 of the current year to all shareholders of record as of October 12 of the current year.
Assume that the only transactions to affect Landau Corporation during October of the current year are
the dividend transactions and that the closing entries have been made.
21) Landau Corporation’s total equity was

A. Unchanged by the dividend declaration and decreased by the dividend payment.

B. Decreased by the dividend declaration and increased by the dividend payment.
C. Unchanged by either the dividend declaration or the dividend payment.
D. Decreased by the dividend declaration and unchanged by the dividend payment.

A. Unchanged by the dividend declaration and decreased by the dividend payment.

Answer (A) is incorrect.
The declaration of a cash dividend reduces equity.

B. Decreased by the dividend declaration and increased by the dividend payment.

Answer (B) is incorrect.
The payment of a cash dividend decreases assets and liabilities, but has no effect on equity.

Unchanged by either the dividend declaration or the dividend payment.

C.
Answer (C) is incorrect.
The declaration of a cash dividend reduces equity.

D. Decreased by the dividend declaration and unchanged by the dividend payment.

Answer (D) is correct.
A dividend declaration decreases equity, of which retained earnings is a component, by the amount
of the dividend. Because equity equals assets minus liabilities, the subsequent payment of the
dividend had no effect on equity because an asset and a liability were decreased by the same
amount.

Fact Pattern: Excerpts from the statement of financial position for Landau Corporation as of
September 30 of the current year are presented as follows.
Cash $ 950,000

Accounts receivable (net) 1,675,000

Inventories 2,806,000

Total current assets $5,431,000

Accounts payable $1,004,000

Accrued liabilities 785,000

Total current liabilities $1,789,000

The board of directors of Landau Corporation met on October 4 of the current year and declared the
regular quarterly cash dividend amounting to $750,000 ($.60 per share). The dividend is payable on
October 25 of the current year to all shareholders of record as of October 12 of the current year.
Assume that the only transactions to affect Landau Corporation during October of the current year are
the dividend transactions and that the closing entries have been made.

22) If the dividend declared by Landau Corporation had been a 10% stock dividend instead of a
cash dividend, Landau’s current liabilities would have been

A. Unchanged by the dividend declaration and increased by the dividend distribution.

B. Unchanged by the dividend declaration and decreased by the dividend distribution.
C. Increased by the dividend declaration and unchanged by the dividend distribution.
D. Unchanged by either the dividend declaration or the dividend distribution.

A. Unchanged by the dividend declaration and increased by the dividend distribution.

Answer (A) is incorrect.
Neither the declaration nor the distribution of a stock dividend has an effect on current liabilities.

B. Unchanged by the dividend declaration and decreased by the dividend distribution.

Answer (B) is incorrect.
Neither the declaration nor the distribution of a stock dividend has an effect on current liabilities.

C. Increased by the dividend declaration and unchanged by the dividend distribution.

Answer (C) is incorrect.
Neither the declaration nor the distribution of a stock dividend has an effect on current liabilities.

Unchanged by either the dividend declaration or the dividend distribution.

D.
Answer (D) is correct.
A stock dividend (one less than 20% to 25% of the shares outstanding) requires a decrease to one
equity account (retained earnings) and an increase to one or more other equity accounts (common
stock dividend distributable and paid-in capital in excess of par) for the fair value of the stock. The
subsequent distribution of that stock dividend involves recording a common stock dividend
distributable and an increase to common stock, both of which are equity accounts. Thus, liabilities
are unaffected by either the declaration or distribution of a stock dividend.
Fact Pattern: Excerpts from the statement of financial position for Landau Corporation as of
September 30 of the current year are presented as follows.
Cash $ 950,000

Accounts receivable (net) 1,675,000

Inventories 2,806,000

Total current assets $5,431,000

Accounts payable $1,004,000

Accrued liabilities 785,000

Total current liabilities $1,789,000

The board of directors of Landau Corporation met on October 4 of the current year and declared the
regular quarterly cash dividend amounting to $750,000 ($.60 per share). The dividend is payable on
October 25 of the current year to all shareholders of record as of October 12 of the current year.
Assume that the only transactions to affect Landau Corporation during October of the current year are
the dividend transactions and that the closing entries have been made.

23) If the dividend declared by Landau had been a 10% stock dividend instead of a cash dividend,
Landau’s total stockholders’ equity would have been

A. Decreased by the dividend declaration and increased by the dividend distribution.

B. Unchanged by the dividend declaration and increased by the dividend distribution.
C. Increased by the dividend declaration and unchanged by the dividend distribution.
D. Unchanged by either the dividend declaration or the dividend distribution.

A. Decreased by the dividend declaration and increased by the dividend distribution.

Answer (A) is incorrect.
Neither the distribution nor the declaration of a stock dividend has an effect on total stockholders’
equity.

B. Unchanged by the dividend declaration and increased by the dividend distribution.

Answer (B) is incorrect.
The distribution of a stock dividend has no effect on total stockholders’ equity

C. Increased by the dividend declaration and unchanged by the dividend distribution.

Answer (C) is incorrect.
The declaration of a stock dividend has no effect on total stockholders’ equity.
 D. Unchanged by either the dividend declaration or the dividend distribution.
Answer (D) is correct.
The entry to record the declaration of a small stock dividend (one less than 20% to 25% of the
shares outstanding) involves a decrease to one stockholders’ equity account (retained earnings)
and an increase to one or more other stockholders’ equity accounts (common stock dividend
distributable and paid-in capital in excess of par) for the fair value of the stock. Consequently, the
declaration has no effect on total stockholders’ equity because the entry merely entails a transfer
from retained earnings to permanent capital. The subsequent distribution of a stock dividend
requires recording a common stock dividend distributable and an increase to common stock.
Because both are stockholders’ equity accounts, the distribution has no effect on total stockholders’
equity.

24) Which one of the following best describes the record date as it pertains to common stock?

A. Four business days prior to the payment of a dividend.

B. The 52-week high for a stock published in The Wall Street Journal.
C. The date that is chosen to determine the ownership of shares.
D. The date on which a prospectus is declared effective by the Securities and Exchange Commission.

A. Four business days prior to the payment of a dividend.

Answer (A) is incorrect.
Four business days prior to the payment of a dividend is not a significant date; at one time, 4 days
before the record date was called the ex-dividend date for stock-exchange-listed companies. That
period is now 2 days.

B. The 52-week high for a stock published in The Wall Street Journal.
Answer (B) is incorrect.
The 52-week high for a stock is not relevant to the distribution of dividends.

C. The date that is chosen to determine the ownership of shares.

Answer (C) is correct.
Three dates are important in the declaration and distribution of dividends: the date of declaration,
the date of record, and the date of distribution. The date of record is the date as of which the
corporation determines the shareholders who will receive the declared dividend. Essentially, the
corporation closes its shareholder records on this date. Only those shareholders who own the stock
on the date of record will receive the dividend.
 The date on which a prospectus is declared effective by the Securities and Exchange Commission.
D.
Answer (D) is incorrect.
The SEC’s treatment of a prospectus filing is not relevant to the distribution of dividends.

25) The chief financial officer of a Midwestern machine parts manufacturer is considering splitting
the company’s stock, which is currently selling at $80 per share. The stock currently pays a $1
per share dividend. If the split is two-for-one, the post-split price will be

A. Exactly $40, regardless of dividend policy.

B. Greater than $40, if the dividend is changed to $0.45 per new share.
C. Greater than $40, if the dividend is changed to $0.55 per new share.
D. Less than $40, regardless of dividend policy.

A. Exactly $40, regardless of dividend policy.

Answer (A) is incorrect.
The new price may be slightly higher because there might be greater demand for a $40 stock than
for an $80 stock because more investors can afford a cheaper stock than a higher-priced stock.

B. Greater than $40, if the dividend is changed to $0.45 per new share.
Answer (B) is incorrect.
The lower total dividend would lower the overall stock price.

C. Greater than $40, if the dividend is changed to $0.55 per new share.
Answer (C) is correct.
If the pre-stock dividend payout rate were maintained, the post-split dividend would be $0.50 per
share ($1 ÷ 2). Thus, if the dividend post-split is raised to $0.55, investors will bid up the price of the
stock from its immediate post-split price of $40 per share ($80 ÷ 2).

D. Less than $40, regardless of dividend policy.

Answer (D) is incorrect.
A lower dividend will lead to a lower stock price and vice versa.

26) The residual theory of dividends argues that dividends

A. Are necessary to maintain the market price of the common stock.

 B. Are irrelevant.
C. Can be forgone unless there is an excess demand for cash dividends.
D. Can be paid if there is income remaining after funding all attractive investment opportunities.

A. Are necessary to maintain the market price of the common stock.

Answer (A) is incorrect.
The residual theory of dividends does not hold that dividends are necessary to maintain the price of
the stock.

B. Are irrelevant.
Answer (B) is incorrect.
The residual theory of dividends does not hold that dividends are irrelevant.

C. Can be forgone unless there is an excess demand for cash dividends.

Answer (C) is incorrect.
The residual theory of dividends does not hold that dividends can be forgone unless there is an
excess demand for cash dividends.

D. Can be paid if there is income remaining after funding all attractive investment opportunities.
Answer (D) is correct.
The residual theory of dividends holds that the amount (residual) of earnings paid as dividends
depends on the available investment opportunities and the debt-equity ratio at which cost of capital
is minimized. The rational investor should prefer reinvestment of retained earnings when the return
exceeds what the investor could earn on investments of equal risk. However, the firm may prefer to
pay dividends when investment opportunities are poor and the use of internal equity financing would
move the firm away from its ideal capital structure.

27) When determining the amount of dividends to be declared, the most important factor to
consider is the

A. Expectations of the shareholders.

B. Future planned uses of retained earnings.
C. Impact of inflation on replacement costs.
D. Future planned uses of cash.
 A. Expectations of the shareholders.
Answer (A) is incorrect.
Shareholder expectations should not affect a decision concerning the amount of dividends to be
declared. Alternatively, investors may select investments that have traditionally matched their
expectations, but this is not a decision facing corporate directors.

B. Future planned uses of retained earnings.

Answer (B) is incorrect.
Retained earnings is an accrual-basis amount; dividends are paid in cash.

C. Impact of inflation on replacement costs.

Answer (C) is incorrect.
The impact of inflation of replacement costs does not affect a decision concerning the amount of
dividends to be declared.

D. Future planned uses of cash.

Answer (D) is correct.
When determining the amount of dividends to be declared, the most important factor to consider is
the future planned uses of cash. If the monies that would have been paid out in the form of excess
dividends could provide the equity holders a higher return if employed in some productive capacity,
a rational investor should not expect the excess payout.

28) A corporation has issued 25,000 shares of its authorized 50,000 shares of common stock.
There are 5,000 shares of common stock that have been repurchased and are classified as
treasury stock. The corporation has 10,000 shares of preferred stock. If a $0.60 per share
dividend has been authorized on its common stock, what will be the total common stock
dividend payment?

A. $12,000
B. $15,000
C. $21,000
D. $30,000

$12,000
A.
Answer (A) is correct.
Declared dividends are only paid on the outstanding shares of the class of stock to which they
apply. Thus, the treasury stock and the preferred stock are not included in the dividend calculation.
The total common stock dividend payment is [(25,000 shares issued – 5,000 shares repurchased) ×
$.60 per share = $12,000].
 $15,000
B.
Answer (B) is incorrect.
This amount results from using the total shares issued rather than the shares outstanding.

C. $21,000
Answer (C) is incorrect.
This amount results from failing to subtract the shares repurchased and from improperly including
preferred stock.

D. $30,000
Answer (D) is incorrect.
This amount results from using the total shares authorized rather than the shares issued and
outstanding.

29) A corporation has 200,000 shares of common stock outstanding. Net income for the recently
ended fiscal year was $500,000, and the stock has a price-earnings ratio of eight. The board of
directors has just declared a three-for-two stock split. For an investor who owns 100 shares of
stock before the split, the approximate value (rounded to the nearest dollar) of the investment
in the corporation’s stock immediately after the split is

A. $250
B. $1,333
C. $2,000
D. $3,000

$250
A.
Answer (A) is incorrect.
The amount of $250 represents the annual earnings on 100 shares.

B. $1,333
Answer (B) is incorrect.
The amount of $1,333 assumes that the value of the total investment declines after the split.

C. $2,000
 Answer (C) is correct.
EPS equals $2.50 ($500,000 NI ÷ 200,000 pre-split shares). Thus, 100 shares had a value of
$2,000 (100 shares × $2.50 EPS × 8 P/E ratio) before the split. This value is unchanged by the
stock split. Although the stockholder has more shares, the total value of the investment is the same.

D. $3,000
Answer (D) is incorrect.
The amount of $3,000 assumes that the value of the investment as well as the number of shares
increases by 50%.

30) On January 1 of the current year, Corporation X had 50,000 shares of 5% preferred stock
($100 par value) and 100,000 shares of common stock ($3 par value) outstanding. On July 1,
Corporation X declared and executed a 1-for-2 reverse stock split on its common shares. X
subsequently declared a common stock dividend of $1 per share on November 1, payable on
December 1 of the current year. Assuming that all preferred dividends have been paid, what is
the total amount of common stock dividends that were paid in the current year?

A. $50,000
B. $100,000
C. $250,000
D. $300,000

$50,000
A.
Answer (A) is correct.
A reverse stock split reduces the applicable shares outstanding based on the ratio of the split. In this
case, the ratio is 1:2, meaning that for every existing 2 shares of common stock, 1 new share will
replace the existing 2. Accordingly, given 100,000 shares outstanding prior to the split, a total of
50,000 shares remain after the split. There are no other common stock transactions; therefore,
50,000 shares represents the number of shares receiving the dividend. Because each share
receives a dividend of $1, the total common dividends paid in the current year are $50,000.

B. $100,000
Answer (B) is incorrect.
The amount of $100,000 does not consider the effect of the reverse stock split.

C. $250,000
Answer (C) is incorrect.
The amount of $250,000 represents the preferred dividends that are paid in the current period.
 $300,000
D.
Answer (D) is incorrect.
The amount of $300,000 incorrectly includes the preferred dividends that are paid in the current
period.

31) At the beginning of the current year, Corporation A had 500,000 common shares outstanding.
On March 1, A repurchased 200,000 of the outstanding shares to be held as treasury stock. On
June 1, A announced a 2-for-1 stock split on all issued shares. On September 1 of the current
year, A reissued 100,000 shares of treasury stock. On December 1, A declared and paid a
dividend of $2 per share on all outstanding shares. What is the total amount of dividends paid
by A in the current year?

A. $1,200,000
B. $1,000,000
C. $1,400,000
D. $2,000,000

A. $1,200,000
Answer (A) is incorrect.
The amount of $1,200,000 does not consider the reissuance of treasury stock.

B. $1,000,000
Answer (B) is incorrect.
The amount of $1,000,000 does not consider the effects of the treasury shares or stock split.

C. $1,400,000
Answer (C) is correct.
The stock split was made on all issued shares; thus, the shares held as treasury stock are subject to
the split. After the split, the number of issued shares was 1,000,000 (500,000 × 2). However,
because dividends are paid only on shares outstanding, treasury shares do not receive dividends.
The total shares outstanding (i.e., those eligible for dividends) is 700,000 shares {1,000,000 issued
shares – [(200,000 original treasury shares × 2) – 100,000 shares reissued]}. Given a dividend
payment of $2 per outstanding share, the total dividends paid are $1,400,000.

$2,000,000
D.
Answer (D) is incorrect.
Dividends are not paid on treasury shares.

32) At the beginning of the current year, Corporation B had 100,000 shares of 5% preferred stock ($100 par
 value) and 200,000 shares of common stock ($5 par value) outstanding. On January 14 of the current year,
Corporation B issued a 10% stock dividend on common shares. On May 1, B repurchased 45,000 shares of
common stock to be held as treasury stock. On August 1, B declared and paid a dividend of $1 per common
share. What is the total amount of dividends paid in the current year by Corporation B?

A. $500,000
B. $675,000
C. $700,000
D. $720,000

A. $500,000
Answer (A) is incorrect.
The amount of $500,000 represents only the preferred dividends. Common share dividends should
also be included.

B. $675,000
Answer (B) is correct.
By definition, preferred dividends are required to be paid completely before any common share
dividends are issued. Accordingly, the preferred dividends paid in the current year amount to
$500,000 [$100 par (5% × 100,000 shares)]. Additionally, a stock dividend does not result in any
payment, but it does affect the number of shares outstanding. After the stock dividend, 220,000
(200,000 × 1.10) common shares were outstanding; however, 45,000 of these shares were
repurchased as treasury stock. Because dividends are not paid on treasury stock, the total number
of common shares eligible for dividends is 175,000 (220,000 – 45,000). The dividend per common
share is stated as $1 per share; therefore, the total amount of dividends paid is $675,000 ($500,000
preferred + $175,000 common).

C. $700,000
Answer (C) is incorrect.
The amount of $700,000 does not consider the effects of the stock dividend and the treasury stock.

$720,000
D.
Answer (D) is incorrect.
Dividends are not paid on shares that are held as treasury stock.

33) Which one of the following is not a relevant factor that influences the dividend policy of a firm?

A. The amount of cash not needed for operations.

B. The credit policy of the company.
C. The available investment projects.
D. The dividend income tax rate.
 A. The amount of cash not needed for operations.
Answer (A) is incorrect.
The amount of cash not needed for operations is a reasonable consideration in a company’s
dividend policy.

B. The credit policy of the company.

Answer (B) is correct.
A company’s dividend policy is influenced by the amount of cash needed for operations, the
availability of profitable investment projects, and the level of income taxes that have to be paid by
stockholders on any dividends received. For example, if taxes on dividends are high, stockholders
might prefer to forgo dividends and receive capital gains instead. The company’s credit policy is not
a consideration in its dividend policy.

C. The available investment projects.

Answer (C) is incorrect.
The available investment projects are a reasonable consideration in a company’s dividend policy.

D. The dividend income tax rate.

Answer (D) is incorrect.
The dividend income tax rate is a reasonable consideration in a company’s dividend policy.

34) A 10% stock dividend most likely

A. Increases the size of the firm.

B. Increases shareholders’ wealth.
C. Decreases future earnings per share.
D. Decreases net income.

A. Increases the size of the firm.

Answer (A) is incorrect.
A stock dividend has no effect except on the composition of the shareholders’ equity section of the
balance sheet.

B. Increases shareholders’ wealth.

Answer (B) is incorrect.
A stock dividend has no effect except on the composition of the shareholders’ equity section of the
 balance sheet.

C. Decreases future earnings per share.

Answer (C) is correct.
A stock dividend is a transfer of equity from retained earnings to paid-in capital. The transaction
decreases retained earnings and increases common stock and additional paid-in capital. Additional
shares are outstanding following the stock dividend, but every shareholder maintains the same
percentage of ownership. In effect, a stock dividend divides the pie (the corporation) into more
pieces, but the pie is still the same size. Hence, a corporation will have a lower EPS and a lower
book value per share following a stock dividend, but every shareholder will be just as well off as
previously. A stock dividend has no effect except on the composition of the shareholders’ equity
section of the balance sheet.

D. Decreases net income.

Answer (D) is incorrect.
A stock dividend has no effect except on the composition of the shareholders’ equity section of the
balance sheet.