FIN 3403 Final Exam Conceptual
Questions
Agency Costs: - correct answer-Paying dividends may reduce agency costs between
managers and shareholders.
Paying dividends reduces retained earnings and forces the firm to raise external equity
financing.
Raising external equity subjects the firm to scrutiny of regulators (SEC) and investors and
therefore helps monitor the performance of managers.
Another name for Internal Financing is... - correct answer-Retained Earnings
Bond convenants: - correct answer-Require managers to be monitored. The monitoring
expense is an agency cost, which increases as debt increases
Business Risk - correct answer-The volatility of EBIT
Capital Structure affects which kinds of leverage? - correct answer-Financial Leverage
Clientele Effects: - correct answer-Different investor clienteles prefer different dividend
payout levels.
Some firms, such as utilities, pay out over 70% of their earnings as dividends. These attract
a clientele that prefers high dividends.
Growth-oriented firms which pay low (or no) dividends attract a clientele that prefers price
appreciation to dividends.
Expectations Theory: - correct answer-Investors form expectations concerning the amount of
a firm's upcoming dividend.
Expectations are based on past dividends, expected earnings, investment and financing
decisions, the economy, etc.
The stock price will likely react if the actual dividend is different from the expected dividend
Financial Risk - correct answer-Risk driven by the presence of fixed finance costs in the
firm's capital structure (as opposed to variable finance costs such as dividends declared and
paid)
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