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Exam 15: Distributions to Shareholders-Dividends and Repurchases

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Question 21

Multiple Choice

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The following data apply to Garber Industries, Inc. (GII) : $\begin{array}{l}\begin{array} { l } \text {Value of operations}\\\text {Short-term investments}\\\text {Debt}\\\text { Numher of shares }\end{array}\begin{array} { l } \$ 1,000 \\\$ 100 \\\$ 300\\\$ 100\end{array}\end{array}$ The company plans on distributing $100 as dividend payments. What will the intrinsic per share stock price be immediately after the distribution?

A) $6.32
B) $6.65
C) $7.00
D) $7.35
E) $7.72

F) A) and B)
G) A) and C)

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Question 22

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The announcement of an increase in the cash dividend should, according to MM, lead to an increase in the price of the firm's stock.

A) True
B) False

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Question 23

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The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price.

The following data apply to Elizabeth's Electrical Equipment: $\begin{array}{l}\begin{array} { l } \text {Value of operations}\\\text {Short-term investments}\\\text {Debt}\\\text { Numher of shares }\end{array}\begin{array} { l } \$ 20,000 \\\$ 1,000\\\$ 6,000\\\$ 300\\\end{array}\end{array}$ The company plans on distributing $1,000 by repurchasing stock. What will the intrinsic per share stock price be immediately after the repurchase?

The capital budget forecast for the Santano Company is $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $500,000. If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be?

A reverse split reduces the number of shares outstanding.

Silvana Inc. projects the following data for the coming year. If the firm follows the residual dividend policy and also maintains its target capital structure, what will its payout ratio be? $\begin{array}{l}\begin{array}{lc}\text { EBIT } & \$ 2,000,000 \text { Capital budget } \\\text { Interest rate } & 10 \% \% \text { Debt } \\\text { Debt outstanding } & \$ 5,000,000 \% \text { Equity } \\\text { Shares outstanding } & \$ 5,000,000 \text { Tax rate }\end{array}\begin{array}{r}\$ 850,000 \\40 \% \\60 \% \\40 \%\end{array}\end{array}$

If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a low payout ratio.

Which of the following statements is correct?

Yesterday, Berryman Investments was selling for $90 per share. Today, the company completed a 7-for-2 stock split. If the total market value was unchanged by the split, what is the price of the stock today?

Sanchez Company has planned capital expenditures that total $2,000,000. The company wants to maintain a target capital structure that is 35% debt and 65% equity. The company forecasts that its net income this year will be $1,800,000. If the company follows a residual dividend policy, what will be its total dividend payment?

Brinkley Resources stock has increased significantly over the last five years, selling now for $175 per share. Management feels this price is too high for the average investor and wants to get the price down to a more typical level, which it thinks is $25 per share. What stock split would be required to get to this price, assuming the transaction has no effect on the total market valueσ Put another way, how many new shares should be given per one old share?

MM's dividend irrelevance theory says that while dividend policy does not affect a firm's value, it can affect the cost of capital.

Norton Electrical has quite a few positive NPV projects from which to choose. The problem is that it has more of these projects than it can finance without issuing new stock and the board of directors refuses to issue any new shares in the foreseeable future. Norton'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%. 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.

If the shape of the curve depicting a firm's WACC versus its debt ratio is more like a sharp "V", as opposed to a shallow "U", it will be easier for the firm to maintain a steady dividend in the face of varying investment opportunities or earnings from year to year.

If management wants to maximize its stock price, and if it believes that the dividend irrelevance theory is correct, then it must adhere to the residual distribution policy.

In the real world, dividends

If a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio) , then the firm should pay

Which of the following should not influence a firm's dividend policy decision?

David Rose Inc. forecasts a capital budget of $500,000 next year with forecasted net income of $400,000. The company wants to maintain a target capital structure of 30% debt and 70% equity. If the company follows the residual dividend policy, how much in dividends, if any, will it pay?