Finance Chapter 18

8/10/2019 Finance Chapter 18

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Chapter 18

Discussion Questions18-1. How does the marginal principle of retained earnings relate to the returns that a

stockholder may make in other investments?

The marginal principle of retained earnings suggests that the corporation must doan analysis of whether the corporation or the stockholders can earn the most onfunds associated with retained earnings. Thus, we must consider what thestockholders can earn on other investments.

18-2. iscuss the difference !etween a passive and an active dividend policy.

" passive dividend policy suggests that dividends should !e paid out if thecorporation cannot make !etter use of the funds. #e are looking more atalternate investment opportunities than at preferences for dividends.$f dividends are considered as an active decision varia!le, stockholder preferencefor cash dividends is considered very early in the decision process.

18-%. How does the stockholder, in general, feel a!out the relevance of dividends?

The stockholder would appear to consider dividends as relevant. ividends doresolve uncertainty in the minds of investors and provide information content. &omestockholders may say that the dividends are relevant, !ut in a different sense. 'erhapsthey prefer to receive little or no dividends !ecause of the immediate income ta(.

18-). *(plain the relationship !etween a company+s growth possi!ilities and itsdividend policy.

The greater a company+s growth possi!ilities, the more funds that can !e ustified for profita!le internal reinvestment. This is very well illustrated in Ta!le 18-1 in whichwe show four-year growth rates for selected .&. corporations and their associateddividend payout percentages. This is also discussed in the life cycle of the firm.

18- . &ince initial contri!uted capital theoretically !elongs to the stockholders, why arethere legal restrictions on paying out the funds to the stockholders?

/reditors have e(tended credit on the assumption that a given capital !ase wouldremain intact throughout the life of a loan. #hile they may not o! ect to the

payment of dividends from past and current earnings, they must have the protection of keeping contri!uted capital in place.

&18-1


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18-0. iscuss how desire for control may influence a firm+s willingness to paydividends.

anagement+s desire for control could imply that a closely held firm shouldavoid dividends to minimi e the need for outside financing. 3or a larger firm,

management may have to pay dividends in order to maintain their current position through keeping stockholders happy.

18-4. $f you !uy stock on the e(-dividend date, will you receive the upcoming 5uarterlydividend?

6o, the old stockholder receives the upcoming 5uarterly dividend. 7f course,if you continue to hold the stock, you will receive the ne(t dividend.

18-8. How is a stock split versus a stock dividend9 treated on the financialstatements of a corporation?

3or a stock split, there is no transfer of funds, !ut merely a :reduction in par value and a :proportionate increase in the num!er of shares outstanding.

$mpact of a &tock &plit

;efore "fter /ommon stock 1,


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18-1


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Chapter 18

Problems

1. oon and &ons, $nc., earned =12< million last year and retained =42 million. #hat is the payout ratio?

18-1. Solution:

Moon and Sons, Inc .

ividends C earnings : retained funds9C =12< mil. : =42 mil. C =)8 mil.

'ayout ratio C dividends earningsC =)8 mil. =12< mil. C )


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%. &wank /lothiers earned =0)< million last year and had a %< percent payout ratio.How much did the firm add to its retained earnings?

18-#. Solution:

S$an% Clothiers

"ddition to retained earnings C *arnings : ividendsividends C %


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. Hearst Transportation /o. earned =>0< million last year and paid out %< percent of earningsin dividends.a . ;y how much did the company+s retained earnings increase?b. #ith 2


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4. 'lanetary Travel /o. has =2)


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8. " financial analyst is attempting to assess the future dividend policy of $nteractiveTechnology !y e(amining its life cycle. &he anticipates no payout of earnings in theform of cash dividends during the development stage $9. uring the growth stage $$9,she anticipates 1< percent of earnings will !e distri!uted as dividends. "s the firm

progresses to the e(pansion stage $$$9, the payout ratio will go up to )< percent, and

eventually reach 0< percent during the maturity stage $ 9.a . "ssuming earnings per share will !e the following during each of the four stages,

indicate the cash dividend per share if any9 during each stage.

&tage $..................... = .2. &5uash elight, $nc., has the following !alance sheetG

ssets

/ash................................................................ = 1


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18- . 4Continued5

!. 1


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18-1 . Solution:

9e$ell abs, Inc .

a. 'lan " =2. < L 2. L 2. < L 2.0 L 2.0 9 C =12.8'lan ; =.8< L %.%< L .% L 2.8< L 0.0% = .412 %.%< .4>4 2.0%% .% .412 .2) 2.8< .0%0 1.48

0.0< . 04 %.4)'resent alue of future dividends =>.11

'lan " will provide the higher present value of futuredividends.

&18-11


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11. The stock of 'ills ;erry /ompany is currently selling at =0< per share. The firm pays adividend of =1.8< per share.a . #hat is the annual dividend yield?b. $f the firm has a payout rate of < percent, what is the firm+s ' * ratio?

18-11. Solution:

Pills 7err( Compan(

a. "nnual dividend yield C cash dividend priceC =1.8< =0< C %.


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1%. s. Nueen is in a % percent marginal ta( !racket. $f s. Nueen receives =%.8< in cashdividends, how much in ta(es per share9 will she pay? Becall the 1 percent rule.9

18-1#. Solution:

Ms. Queen

=%.8< /ash dividend 1 D ividend ta( rate.=


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18-1&. 4Continued5

Ta(es on /apital gains

&ales price = %9 million shares would !e outstanding at a par valueof =%.%% per share. *verything else will !e the same.

c. *'& !efore C =0,


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21. "ce 'roducts sells marked playing cards to !lack ack dealers. $t has not paid a dividend inmany years, !ut is currently contemplating some kind of dividend. The capital accounts forthe firm are as followsG

/ommon stock 2,


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22. atri( /orp., $nc. is considering a 1 D stock dividend. The capital accounts are as followsG

/ommon stock ),


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18-22. Solution:

Matri> S(stems

a. /ommon stock ),0


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18-22. 4Continued5

e. "fter

11 F =)< C =),0


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18-2&. 4Continued5

f. 6o. #ith the cash dividendGarket value per share =)penditure1 = million = ) million2 8 million 0 million% 1< million 8 million) 4 million 4 million

12 million million

The a estic /orporation has 1 million shares outstanding the following 5uestions areseparate from each other9.

a . $f the residual theory of dividends is applied, how much in total cash dividends will !e paid over the five years?

b. $f the firm simply uses a payout ratio of )< percent of net income, how much in totalcash dividends will !e paid?

c. $f the firm pays a 1< percent stock dividend in years 2 through , and also pays a cashdividend of =2. < per share for each of the five years, how much in total dividends will

!e paid?d . "ssume the payout ratio in each year is to !e %< percent of net income and the firm will

pay a 2< percent stock dividend in years 2 through . How much will dividends pershare for each year !e?

18-2). Solution:

MaBestic Corporation

a. ividends represent what is left over after profita!le capitale(penditures are undertaken.

6ear9et

Income :

ProAitableCapital

0>penditures Di/idends

1 = mil. =) mil. = 1 mil.2 8 mil. 0 mil. 2 mil.% 1< mil. 8 mil. 2 mil.) 4 mil. 4 mil. < mil.

12 mil. mil. 4 mil.Total cash dividends =12 mil.

&18-%1


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18-2). 4Continued5

!.

6ear9et

Income FPa(out

atio Di/idends

1 = mil. .)< = 2.< mil.2 8 mil. .)< %.2 mil.% 1< mil. .)< ).< mil.) 4 mil. .)< 2.8 mil.

12 mil. .)< ).8 mil.Total cash dividends =10.8 mil.

c.

6earShares


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CP18-1. 4Continued5

c. 'ortfolio value&tock 1


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@07 0 0 CIS0

7racle was referred to as a profita!le, rapid-growth company in this chapter.This presuma!ly ustifies the firm not paying a cash dividend. Eo to its #e! site,www.oracle.com, and follow the steps !elowG

1. /lick on @$nvestors.A2. /lick on @ etailed 3inancialsA under @$nvestor Belations.A%. &elect the most recent full year.). &croll down and use the data to compute the following ratios for the most recent full

year, and compare them to the stock analysts+ target numbers forthe company.

+ar'et

a . 6et income Total revenue................................................. 12D

b. 7perating income Total revenue....................................... 2 Dc. /ost of services Total revenue the lower the !etter9........ )

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Finance Chapter 18

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