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Preferred dividends decreased this year because some preferred stock was retired

Finance

  1. Preferred dividends decreased this year because some preferred stock was retired. How would this influence the earnings per share computation this year?
  2. Retroactive recognition is given to stock dividends and stock splits on common stock when computing earnings per share. Why?
  3. Why do many firms try to maintain a stable percentage of earnings retained?
  4. Why is the price/earnings ratio considered a gauge of future earning power?
  5. Why does a relatively new firm often have a low dividend payout ratio? Why does a firm with a substantial growth record and/or substantial growth prospects often have a low dividend payout ratio?
  6. Why would an investor ever buy stock in a firm with a low dividend yield?
  7. Why is book value often meaningless? What improvements to financial statements would make it more meaningful?
  8. Why should an investor read the note concerning stock options? How might stock options affect profitability?
  9. Which of the following is not considered to be a recurring item?
  10. Ideally, which of these ratios will indicate the highest return for an individual firm?

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  1. Preferred dividends decreased this year because some preferred stock was retired. How would this influence the earnings per share computation this year?

Less preferred dividends will be subtracted from net income in the numerator of the earnings per share computation. This will increase earnings per share. In practice, whether earnings per share will be increased or decreased depends on the after-tax earnings that the firm would have from the funds used to retire the preferred stock in relation to the dividend decrease.

  1. Retroactive recognition is given to stock dividends and stock splits on common stock when computing earnings per share. Why?

Stock dividends and stock splits do not provide the firm with more funds; they only change the number of outstanding shares. Earnings per share should be related to the outstanding common stock after the stock dividend or stock split.

  1. Why do many firms try to maintain a stable percentage of earnings retained?

Many firms try to maintain a stable percentage because they have a policy on the percentage of earnings that they want retained for internal growth.

  1. Why is the price/earnings ratio considered a gauge of future earning power?

Investors attach a higher price to securities that they feel have higher potential. This gives a higher price/earnings ratio.

  1. Why does a relatively new firm often have a low dividend payout ratio? Why does a firm with a substantial growth record and/or substantial growth prospects often have a low dividend payout ratio?

A relatively new firm often has a low dividend payout ratio because it needs funds to establish itself (i.e. increase inventory, increase accounts receivable, etc.).

A firm with a substantial growth record and/or substantial growth prospects needs funds for expansion. They utilize them in this manner rather than paying them out to the owners.

  1. Why would an investor ever buy stock in a firm with a low dividend yield?

A low dividend yield may indicate that the firm is retaining its earnings for growth. The investor might expect to get his/her returns in the form of market price appreciation.

  1. Why is book value often meaningless? What improvements to financial statements would make it more meaningful?

Book value is based on a mixture of valuation basis, such as historical costs. Current value accounting should make book value closer to market.

  1. Why should an investor read the note concerning stock options? How might stock options affect profitability?

Stock options are a form of potential dilution of earnings. With the requirement that stock option expense be recorded in the income statement, the dilution will reduce earnings each year.

  1. Which of the following is not considered to be a recurring item?

Interest expense represents a recurring item.

  1. Ideally, which of these ratios will indicate the highest return for an individual firm?

Ideally, return on common equity will indicate the highest return. This is the way it should be since the common equity holders take the most risk.