Chambers and Lacey Modern Corporate Finance

Transcription

1 Chambers and Lacey Modern Corporate Finance The Dividend Decision Model Answers 5th Edition Chapter 15 Problem Fill in each blank space with a type of dividend payment. Choose from the following: stock, extra, regular, liquidating, special. Dividends that shareholders expect to receive on a periodic basis are called regular dividends; however, other types of dividends exist. For example extra dividends are paid in addition to regular dividends, and special dividends are reserved for special situations. Further, dividends in the form of shares of stock instead of cash are called stock dividends. Finally, companies that expect to terminate operations may pay a liquidating dividend. Problem2. 2. Fill in each blank with a dividend related date. Choose from the following: announcement, record, ex-dividend, payment. The dividend payment procedure is often spread out over a number of weeks and follows a certain sequence. The date the board of directors meet and make public the firm's intent to pay a dividend is the announcement date. The dividend will be sent to all shareholders who own stock on the record date. Because it normally takes three business days after stock is sold to record the name and address of the new owner on the company official list, the two business day prior to the record date is known as the ex-dividend date. Dividend payments are mailed to the shareholders about two weeks after the record date, known as the payment date. Problem The dividend payout ratio is the percentage of the firm's residual cash flow paid to the shareholders in the form of a dividend. The annual dividend is usually divided into quarterly chunks. Simon's Suitcases, Inc., has a payout ratio of 60 percent. Calculate Simon's annual and quarterly dividend if its residual cash flow is $4.00 per share. Annual dividend = earnings * payout ratio = $ 4.00 * 0.60 = $ 2.40 Quarterly dividend = annual dividend / 4 = $ 2.40 / 4 = $0.60 The Dividend Decision 1 Model Answers

2 Problem Alfred is a wise investor who picks stocks on the basis of the firm's dividend payout ratio. He invests in a stock only if the dividend payout ratio is at least 40 percent. Help Alfred determine if he should consider the following four stocks for his portfolio: 1: Quarterly dividend = $0.30 per share, annual residual cash flow = $ 2.00 share. 2: Quarterly dividend = $2.50 per share, annual residual cash flow = $ share. 3: Quarterly dividend = $0.75 per share, annual residual cash flow = $ 4.00 share. 4: Quarterly dividend = $1.25 per share, annual residual cash flow = $12.50 share. Dividend Payout = Annual Dividend / Annual Residual Cash Flow Problem Dividend Payout = $ 0.30 * 4 / $ 2.00 = $ 1.20 / $ 2.00 = 60% : Yes 2. Dividend Payout = $ 2.50 * 4 / $ = $ / $ = 44.44% : Yes 3. Dividend Payout = $ 0.75 * 4 / $ 4.00 = $ 3.00 / $ 4.00 = 75% : Yes 4. Dividend Payout = $ 1.25 * 4 / $ = $ 5.00 / $ = 40% : Yes 5. Jim Simpson, the founder of Simpson's Saxophones, knows much about saxophones but little about finance. The other day he was alarmed when his company's stock price, which had been $50 per share, fell to $48.50 per share. The reason he was alarmed was because he knew things were going well for the firm, and that no bad news had been released. Explain to Jim how dividends might explain the movement in share price. On the day that a stock goes ex-dividend its market price will generally fall by an amount approximately equal to that of the dividend. Thus, one possible explanation for the drop in the share price would be that the stock went ex-dividend and it would not be a cause for alarm. Problem McMann's Marble Shoppes has stock currently trading at $8.00 per share. The firm has announced a $0.50 quarterly dividend. a. What is McMann's expected price per share on the ex dividend date? b. Ruth purchases 500 shares of McMann stock on the day prior to the ex dividend date. Jerry purchases 500 shares of McMann stock on the ex dividend date. Given your answer in part (a), show how these investments are equivalent. a. All things being equal, assuming the ex-dividend date is soon and that markets are perfect, the stock price should fall by the amount of the dividend from $ 8.00 to ($ $ 0.50) $ 7.50 a share. b. Ruth buys the shares for $ 8.00 a share ($ 4,000 in total) and will soon receive a $ 0.50 dividend ($ 250 in total). At that point the shares will have cost Ruth $ 4,000 - $ 250 or The Dividend Decision 2 Model Answers

3 Problem 7. $3,750. Jerry will pay about $ 7.50 a share ($ 3,750 in total). Ruth s cost for her shares and Jerry s cost for his shares are the same. 7. The following is the abbreviated balance sheet for DiConcini Boats and Yachts. Cash $ 500,000 Debt $ 0 Other Assets $ 9,500,000 Equity $10,000,000 Shares outstanding = 100,000 DiConcini has just paid a cash dividend of $1.00 per share. Show what will likely happen to the firm's balance sheet and share price after the dividend payment. Cash $ 500,000 ($ 1.00 * 100,000 shares) = $ 400,000 Debt $ 0 Other Assets $ 9,500,000 Equity $ 10,000,000 - $100,000 = $ 9,900,000 Total Assets $ 9,900,000 Total Liabilities $ 9,900,000 Problem Recall DiConcini Boats and Yachts. Hatch is an unhappy DiConcini shareholder, as he has no use for the $1 dividend. Hatch owns 1,000 shares. Show how Hatch can (approximately) negate the dividend. Hatch can re-invest his $ 1,000 in dividends in the purchase of additional stock. At its exdividend price of $99 a share, Hatch can purchase 10.1 shares. Share prices are found by dividing the firm s equity by the number of its shares. Price $ 100 Price $ 99 Shares 1,000 Shares 1,010.1 Total Invested $ 100,000 Total Invested $ 100,000 The Dividend Decision 3 Model Answers

4 Problem Mary-Ellen Kennedy is also a DiConcini shareholder who owns 1,000 shares. Unlike Mr. Hatch, Ms. Kennedy loves dividends. In fact, Mary-Ellen would prefer that the firm double its dividend to $2 per share. Show how she can use homemade dividends to achieve (approximately) her desired dividend. Kennedy can sell $ 1,000 in stock to produce an extra $ 1,000 in homemade dividends. At its ex-dividend price of $99 a share, Kennedy must sell 10.1 shares. Share prices are found by dividing the firm s equity by the number of its shares. Price $ 100 Price $ 99 Shares 1,000 Shares Total Invested $ 100,000 Total Invested $ 98,000 Cash $ 2,000 Total $ 100,000 Problem The following is the abbreviated balance sheet for Bryant Mining. Cash $ 6,000 Debt $ 0 Other Assets $14,000 Equity $20,000 Shares outstanding 2,000 Bryant has just paid a cash dividend of $1.00 per share. Show what will likely happen to the firm's balance sheet and share price after the dividend payment. Cash $ 4,000 Debt $ 0 Other Assets $14,000 Equity $20,000 - $ 2,000 = $ 18,000 Total Assets $ 18,000 Total Liabilities $ 18,000 The Dividend Decision 4 Model Answers

5 Problem Refer to Bryant Mining in Problem 10. Becker Shembo owns 100 shares of Bryant, but he decides that he does not want his investment in the firm reduced. Show how Becker Shembo can negate the dividend. Repeat the analysis for a $2 dividend payment. Shembo can reinvest his $ 100 dividend to purchase additional stock. At its ex-dividend price of $ 9 a share, Shembo can purchase 11.1 shares. Share prices are found by dividing the firm s equity by its number of shares. Price $ 10 Price $ 9 Shares Shares Total Invested $ 1,000 Total Invested $ 1,000 For a two dollar dividend, Bryant Mining s balance sheet would look as follows: Cash $ 2,000 Debt $ 0 Other Assets $14,000 Equity $20,000 - $ 4,000 = $ 16,000 Total Assets $ 16,000 Total Liabilities $ 16,000 The share price would be $ 16,000 / 2,000 shares = $ Shembo would reinvest $200 dollars received from the dividend distribution to purchase additional stock. At its ex-dividend price of $ 8 a share, Shembo can purchase shares. Price $ 10 Price $ 8 Shares Shares 125 Total Invested $ 1,000 Total Invested $ 1,000 Problem The Duke Football Company has equity valued at $60,000, 10,000 shares outstanding, and a current price per share of $6.00. Duke just paid a $1.00 dividend per share. You own 500 shares of Duke. Show how you can negate the dividend. After the dividend, the share price would be $ 60,000 / 10,000 shares = $ 6.00 Before the dividend, the share price would have been $ 70,000 / 10,000 shares = $ 7.00 You would reinvest the $500 dollars received from the dividend distribution to purchase additional stock. At its ex-dividend price of $ 6 a share, you can purchase shares. The Dividend Decision 5 Model Answers

6 Price $ 7 Price $ 6 Shares Shares Total Invested $ 3,500 Total Invested $ 3,500 Problem Sacco Genetech has a policy of retaining after-tax income for future growth opportunities. Sacco has equity valued at $500,000 and has 5,000 shares of stock outstanding. As a shareholder with 100 shares, you desire a dividend to meet cash needs. If your cash needs are $500, show how you can use a homemade dividend to realize the $500. With assets of $ 500,000 and 5,000 shares, the share price would be $ 500,000 / 5,000 shares = $ You can sell $ 500 in stock to produce $ 500 in homemade dividends. At its price of $ 100 a share, you must sell 5 shares. Price $ 100 Price $ 100 Shares Shares 95.0 Total Invested $ 10,000 Total Invested $ 9,500 Cash $ 500 Total $ 10,000 Problem Duffie Dog Collars has 60.0,000 shares outstanding and a market equity value of $2.4 million. The firm has just paid a dividend of $1.00 per share. As a shareholder with 1,000 shares, however, you desire a $3.00 dividend. Use homemade dividends to create (approximately) the desired dividend. After the dividend, the share price would be $ 2,400,000 / 600,000 shares = $ 4.00 Before the dividend, the share price would have been $ 3,000,000 / 600,000 shares = $ 5.00 The Dividend Decision 6 Model Answers

7 You can sell $ 2,000 in stock to produce $ 2,000 in homemade dividends. At its ex-dividend price of $ 4 a share, you must sell shares. Price $ 5 Price $ 4 Shares 1,000.0 Shares Total Invested $ 5,000 Total Invested $ 2,000 Cash $ Total $ 5,000 Problem Sandusky Real Estate estimates dividends next year at $1.50. The firm's required rate of return on equity is 12 percent. If the firm's rate of growth in annual dividends is 6 percent, calculate the price per share of Sandusky using the perpetual growth model. Problem 16. DIV ( r-g) 1 $1.50 $ P = = = = 0 $ The Board of Directors of Sandusky Real Estate (see Problem 15) announces that next year's dividend, expected to be $1.50, will be lowered to $1.00 in order to retain additional funds for investment purposes. Given a required rate of return on equity at 12 percent, calculate the new growth rate in dividends that would produce the share price of $25. P 0 = Problem 17. DIV ( r-g) 1 $1.00 $25.00 = 0.12 g $ g = = 0.04 $25.00 g = = 0.08 = 8% 17. J and J Cowboy Paraphernalia, Inc., pays a dividend of $2.00 per share. All of J and J's shareholders are taxed at the rate of 31 percent. Calculate the after-tax proceeds per share of the shareholder's dividend payment. After Tax Dividend = Dividend * ( Te) = $ 2.00 *( ) = $2.00 * 0.69 = $ 1.38 The Dividend Decision 7 Model Answers

8 Problem Elvis Humperdinck is a retired tightrope walker. Mr. Humperdinck relies mostly on his dividend check from RRR Corp. to meet living expenses. He owns 10,000 shares of RRR, which pays a dividend of $1 per share, and he is in the 15 percent tax bracket. Problem 19. a. Calculate Mr. Humperdinck's after tax dividend proceeds. b. Suppose that the taxing authorities raise Mr. Humperdinck's tax rate to 25 percent. How much higher would the dividend of RRR need to be in order to keep Elvis's after tax dividend income the same as it was under the old tax rates? a. After Tax Dividend = Dividend * ( Te) = $ 10, *( ) = $ 1, * 0.85 = $ 8,500 b. After Tax Dividend = Dividend * ( Te) $ 8,500 = 10,000 * Per Share Dividend * ( ) Per Share Dividend = ( $8,500 / 10,000 ) / 0.75 = $ OR 13.33% higher. 19. Recall Mary-Ellen Kennedy (Problem 9), who owns 1,000 shares of DiConcini, Inc. Ms. Kennedy is in the 31 percent tax bracket. a. Compute Ms. Kennedy's after tax dividend payment per share, assuming that she pays her taxes on time. b. Problem 9 illustrated how Ms. Kennedy used homemade dividends to create her desired dividend payment. Show that, considering personal taxes, Ms. Kennedy would be better off creating the homemade dividend than she would be if the firm increased the dividend. Assume her original purchase price for DiConcini was $70.00 per share. a. After Tax Dividend = Dividend * ( Te) = $1.00 * ( ) = $ 0.85 b. Kennedy needed to sell $ 1,000 in stock to produce the extra $ 1,000 she sought. At its ex-dividend price of $99 a shares, Kennedy had to sell 10.1 shares. Assuming the Firm Pays a $1 Dividend Assuming the Firm Pays a $2 Dividend Price $ Price $ Shares Shares 1,000.0 Total Stock $ 98,000 Total Stock $ 98,000 Cash $ 2,000 Cash $ 2,000 Tax on Dividend $ Tax on Dividend $ Tax on Sale $ Tax on Sale $ 0.00 Total $ 99, Total $99, The Dividend Decision 8 Model Answers

9 The tax on the dividend is computed as the total cash dividend multiplied by the tax rate. The tax on the homemade dividend is calculated by multiplying the capital gain by the tax rate. The capital gain is computed by multiplying the number of shares sold by the (sales price less the purchase price). Sales Price Buying Price Gain # of shares Total Gain Tax Due $ $ $ $ $ Problem 20. Note that Ms. Kennedy is better off with the homemade extra $1 dividend since her after tax cash and share holdings will be higher. 20. Washington Turf is a large corporation with equity valued at $5 million but no debt. Rust Roofing is also a large corporation with $3 million in debt and $2 million in equity. Both companies are close to bankruptcy. Calculate the maximum amount of a liquidating dividend that each firm can make. In which firm would you rather have a $1,000 investment? Explain. Washington Turf can pay a $ 5,000,000 liquidating dividend and thus the holder of a $ 1,000 investment would expect to receive $ 1,000. However, in theory, Rust Roofing can also pay a $ 5,000,000 liquidating dividend by selling all of its assets, paying the dividend and leaving the debt holders with nothing. In this event, the $2,000,000 of equity would receive $ 5,000,000 and a holder of $ 1,000 equity would receive $ 2,500. In practice, neither the bond holders nor the government are likely to permit such an extreme liquidating dividend. Problem Parcells Pools has 5,000 shares of stock outstanding and a current stock price of $5.00 per share. Parcells has no debt. The company is short on cash and announces that, instead of a cash dividend, the firm will pay a stock dividend one new share of stock for each 10 held. a. Calculate the new share price after the stock dividend goes into effect. b. L.T., a Parcells shareholder with 100 shares, wonders what the stock dividend means to him. Show L.T. that the stock dividend does not increase his wealth. a. The firm used to be worth $ 5.00 * 5,000 = $25,000. After the stock dividend the firm will still be worth $ 25,000. After the stock dividend there will be 5, shares. Each share will be worth $ 25,000 / 5,500 = $ b. Before Stock Dividend After Stock Dividend # shares Price $ 5.00 $ 4.55 Total Value $ $ The Dividend Decision 9 Model Answers

10 Problem Madden Airlines is so strapped for cash that it has decided to scrap any plans for a cash dividend and to "reward" its shareholders with a stock dividend. Madden's share price is currently at $10 per share. There are 10,000 shares outstanding and its equity value is $100,000. Madden decides to keep its shareholders happy by providing 10 new shares for each one share held. Patrick Summerhill, a loyal Madden shareholder, has 10 shares before the stock dividend. Explain to Summerhill both the good news and the bad news of the stock dividend. Firm worth $100,000 and each share is worth $ After 10 shares for each current share there will be 100, ,000 shares = 110,000 shares. Each share will be worth $100,000 / 110,000 = $ which is the bad news! The good news is that Patrick s 110 shares, after the stock dividend, are worth no less than the 10 shares from before the stock dividend. Before Stock Dividend After Stock Dividend # shares Price $ $ 0.91 Total Value $ $ Problem 23. No wealth has been created and no wealth has been transferred. The pie has simply been cut into more pieces. Owning more, smaller, pieces or the pie, Summerhill does not own a different percentage of the pie. 23. Ryan's Buddy System, a company specializing in social skills training, makes the big announcement: The firm will split its stock two-for-one. Ryan's stock is currently at $150 per share, and there are 1,000 shares outstanding. a. What will happen to the price of each share upon the announcement? b. Demonstrate that a shareholder with 50 shares does not gain by the split. a. Absent an information signal, nothing will happen at the announcement. But on the effective day of the split, the price will drop from $ 150 to $ 75: b. No wealth is created or transferred: New Stock Price = Old Stock Price * ( Old # of Shares / New # of Shares ) New Stock Price = $ * ( 1,000 / 2,000 ) = $ The Dividend Decision 10 Model Answers

11 Before Stock Dividend After Stock Dividend # shares Price $ $ Total Value $ 7, $ 7, Problem There are some who believe that firms split their stock in order to bring the per share price down to a trading range affordable to most investors. Darlene's Dance Company is currently trading at $180 per share, but would like to see its shares trade at $45. Design a stock split strategy for Darlene to accomplish its trading range objective. New Stock Price = Old Stock Price * ( Old # of Shares / New # of Shares ) Problem 25. $ 45 = $ 180 * ( Old # of Shares / New # of Shares ) ( Old # of Shares / New # of Shares ) = 0.25 ( New # of Shares / Old # of Shares ) = 4.00 Darlene s Dance company needs to engage in a 4 for 1 split. 25. Shula Air Attach, a manufacturer of navigational systems, is near bankruptcy with shares trading at $0.25 each. Shula has 100,000 shares outstanding. The firm's founder, sensing that the end is near, has given up all hope of his goal to head a firm whose share price is more than $100 per share. Show how the founder can obtain his goal through the reverse stock split. New Stock Price = Old Stock Price * ( Old # of Shares / New # of Shares ) $ = $ 0.25 * ( Old # of Shares / New # of Shares ) ( Old # of Shares / New # of Shares ) = 400 Shula Air Attach needs to engage in at least a 1 for 400 reverse split. The Dividend Decision 11 Model Answers