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a. If a firm follows the residual dividend policy, then a sudden increase
in the number of profitable projects is likely to reduce the firm’s
dividend payout.
b. The clientele effect can explain why so many firms change their
dividend policies so often.
c. One advantage of adopting the residual dividend policy is that this
policy makes it easier for corporations to develop a specific and well-
identified dividend clientele.
d. New-stock dividend reinvestment plans are similar to stock dividends
because they both increase the number of shares outstanding but don’t
change the firm’s total amount of book equity.
e. Investors who receive stock dividends must pay taxes on the value of
the new shares in the year the stock dividends are received.
5. DeAngelo Corp.'s projected net income is $150.0 million, its target
capital structure is 25% debt and 75% equity, and its target payout ratio
is 65%. DeAngelo has more positive NPV projects than it can finance
without issuing new stock, but its board of directors had decreed that it
cannot issue any new shares in the foreseeable future. The CFO now
wants to determine how the maximum capital budget would be affected
by changes in capital structure policy and/or the target dividend payout
policy. Versus the current policy, how much larger could the capital
budget be if (1) the target debt ratio were raised to 75%, other things
held constant, (2) the target payout ratio were lowered to 20%, other
things held constant, and (3) the debt ratio and payout were both
changed by the indicated amounts.