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Categorize financing based on whether the payments are contractual or residual. If the payments on the securities are contractual, the financing is closest to what?
Categorize financing based on whether the payments are contractual or residual. If the payments on the securities are contractual, the financing is closest to what?
Categorize financing based on whether the payments are tax-deductible. If the payments are tax-deductible, the financing is closest to what?
Categorize financing based on whether the payments are tax-deductible. If the payments are tax-deductible, the financing is closest to what?
Categorize financing based on whether the payments have a priority if the firm faces financial trouble. If the payments have a high priorities, the financing is closest to what?
Categorize financing based on whether the payments have a priority if the firm faces financial trouble. If the payments have a high priorities, the financing is closest to what?
Categorize financing based on whether the security has a fixed life. If the security has a fixed life, the financing is closest to what?
Categorize financing based on whether the security has a fixed life. If the security has a fixed life, the financing is closest to what?
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Categorize financing based on whether the security holders have a share of the control of management. If the security holders have a share of the control of management, the financing is closest to what?
Categorize financing based on whether the security holders have a share of the control of management. If the security holders have a share of the control of management, the financing is closest to what?
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Preferred dividends are tax-deductible for the issuer.
Preferred dividends are tax-deductible for the issuer.
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Preferred stock dividends can be passed, meaning the company does not have to pay them.
Preferred stock dividends can be passed, meaning the company does not have to pay them.
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What is the type of lease that transfers all the risks and rewards of the leased property to the lessee?
What is the type of lease that transfers all the risks and rewards of the leased property to the lessee?
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What type of lease effectively transfers risks and rewards similar to a sales with financing arrangement?
What type of lease effectively transfers risks and rewards similar to a sales with financing arrangement?
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Sale-leaseback arrangements typically create two sets of cash flows.
Sale-leaseback arrangements typically create two sets of cash flows.
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Capital leases provide for maintenance services.
Capital leases provide for maintenance services.
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What is the economic equivalent of a rent transaction?
What is the economic equivalent of a rent transaction?
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A cancellation clause lowers the risk of a lease to the lessee, but increases the risk to the lessor.
A cancellation clause lowers the risk of a lease to the lessee, but increases the risk to the lessor.
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A warrant is a long-term option to buy a stated number of shares of common stock at a specified price.
A warrant is a long-term option to buy a stated number of shares of common stock at a specified price.
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A convertible security is usually a bond or preferred stock that gives the holder the option to exchange it for the common stock of the issuing firm.
A convertible security is usually a bond or preferred stock that gives the holder the option to exchange it for the common stock of the issuing firm.
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Conversion price is the par value of the bond divided by the number of shares received upon conversion.
Conversion price is the par value of the bond divided by the number of shares received upon conversion.
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The decision to pay out earnings versus retaining and reinvesting them is called what?
The decision to pay out earnings versus retaining and reinvesting them is called what?
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Which of these is NOT a common dividend policy element?
Which of these is NOT a common dividend policy element?
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A passive dividend policy is when dividends are not paid out until after all positive-NPV projects have been funded.
A passive dividend policy is when dividends are not paid out until after all positive-NPV projects have been funded.
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In the Bird-in-the-Hand Theory, investors prefer low dividend payouts to high payout dividends.
In the Bird-in-the-Hand Theory, investors prefer low dividend payouts to high payout dividends.
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The Tax Preference Theory suggests that investors prefer high dividends to low dividends, due to favorable tax treatment of dividends over capital gains.
The Tax Preference Theory suggests that investors prefer high dividends to low dividends, due to favorable tax treatment of dividends over capital gains.
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The Modigliani-Miller Irrelevance Theory suggests that dividend policy is an important consideration for investors because it meaningfully impacts the firm's value.
The Modigliani-Miller Irrelevance Theory suggests that dividend policy is an important consideration for investors because it meaningfully impacts the firm's value.
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If a company has a higher return on equity, would a higher dividend payout be more likely under the residual dividend model?
If a company has a higher return on equity, would a higher dividend payout be more likely under the residual dividend model?
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What might be a disadvantage of the residual dividend policy?
What might be a disadvantage of the residual dividend policy?
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Announcing a dividend policy is generally seen as a negative for a company.
Announcing a dividend policy is generally seen as a negative for a company.
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A stock split and a stock dividend are the same action.
A stock split and a stock dividend are the same action.
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The residual dividend model seeks to minimize the weighted average cost of capital (WACC).
The residual dividend model seeks to minimize the weighted average cost of capital (WACC).
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Increasing investment opportunities would lead to increases in dividends under the residual model.
Increasing investment opportunities would lead to increases in dividends under the residual model.
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What is the main advantage of having a formally announced firm's dividend policy?
What is the main advantage of having a formally announced firm's dividend policy?
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Study Notes
Long Term Financing Decisions
- Businesses can raise money through debt or equity.
- Debt involves fixed payments (interest and principal). Failure to pay can lead to loss of business control.
- Equity involves receiving remaining cash flows after paying off debt obligations.
- Debt is characterized by a fixed claim, tax deductibility, high priority in financial trouble, and fixed maturity. It also has no management control.
- Equity is characterized by a residual claim, lack of tax deductibility, lowest priority in financial trouble, infinite maturity, and management control.
Debt vs. Equity
- Categorizing financing as debt or equity depends on contractual agreements and tax deductibility.
- Contractual payments indicate debt, while residual payments suggest equity.
- Tax-deductible payments are closer to debt; non-deductible payments indicate equity.
- High priority in financial trouble points to debt; low priority suggests equity.
- Fixed maturity indicates debt; infinite maturity suggests equity.
- Lack of management control is a feature of debt, while management control is characteristic of equity.
Preferred Stock
- Preferred stock provides an obligation to pay fixed dividends that are not contractual.
- Issuing preferred stock avoids dilution of common equity.
- Preferred stock dividends are not tax-deductible for the issuer, resulting in a higher after-tax cost compared to debt.
- Preferred dividends are intended to be paid but can be deferred.
- Preferred stock increases the financial risk of the firm, raising the cost of common equity.
Operating vs. Capital Lease
- Operating leases are typically short-term, focusing on a portion of the asset's economic life. It's equivalent to rent.
- Capital leases effectively transfer risk and reward to the lessee, similar to purchase with financing.
Sale and Leaseback
- A transaction where a firm sells an asset and immediately leases it back.
- Two sets of cash flows occur: cash received from the sale and periodic lease payments.
Cost of Owning vs. Leasing
- In a lease analysis, the after-tax cost of borrowing should be used as the discount rate.
- Depreciation provides a tax saving, which needs to be accounted for in cost analysis.
Information Content/Signaling Hypothesis
- Investors interpret actions taken by a company's management, such as dividend announcements, as signals about the company's future prospects.
- Companies with better information often use dividends to signal positive or negative views on future financial performance to investors.
- Asymmetric Information: Managers usually have better insight into the firm's prospects than outside investors.
Clientele Effect
- Different groups of investors (clienteles) prefer different dividend policies.
- Factors like tax considerations and investment needs impact investor preferences for specific dividend policies.
Residual Dividend Model
- Companies first finance their capital budget requirements from retained earnings.
- Dividends are paid out from the remaining earnings.
- The model minimizes financing costs through using internal funds when possible.
Effects of Investment Opportunities
- Increased investment opportunities often lead to reduced dividend payouts.
- Reduced investment opportunities often lead to increased dividend payouts.
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Description
Test your understanding of long-term financing decisions in business. This quiz covers the key differences between debt and equity, including their characteristics, implications for control, and financial priority. Explore how contractual agreements and tax deductibility play a role in financing decisions.
