Week 12 Questions
Chapter 16
2. Dividend policy – Here are several “facts” about typical corporate dividend policies. Which are true and which are false?
a. Companies decided each year’s dividend by looking at their capital expenditure requirements and then distributing whatever cash is left over.
False. The dividend depends on past dividends and current and forecasted earnings.
b. Managers and investors seem more concerned with dividend changes than with dividend levels.
True. Dividend changes convey information to investors.
c. Managers often increase dividends temporarily when earnings are unexpectedly high for a year or two.
False. Dividends are “smoothed.” Managers rarely increase regular dividends temporarily. They may pay
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How many shares will need to be repurchased? Again, assuming investors learn nothing from the announcement about the House of Herring’s prospects.
Nothing. The stock price will stay at $130. 846,154 shares will be repurchased.
c. Suppose the company increase dividends to $5.50 per share and then issues new shares to recoup the extra cash paid out as dividends. What happens to the with- and ex-dividend share prices? How many shares will need to be issued Again, assume investors learn nothing from the announcement about House of Herring’s prospects.
The with-dividend price stays at $130. Ex-dividend drops to $124.50; 883,534 shares will be issued.
25. Payout and the cost of capital – Comment briefly on each of the following statements:
a. “Unlike American firms, which are always being pressured by their shareholders to increase dividends, Japanese companies pay out a much smaller proportion of earnings and so enjoy a lower cost of capital.”
This statement implicitly equates the cost of equity capital with the stock’s dividend yield. If this were true, companies that pay no dividend would have a zero cost of equity capital, which is clearly not correct.
b. “Unlike new capital, which needs a stream of new dividends to service it, retained earnings have zero cost.”
One way to think of retained earnings is that, from an economic standpoint, the company earns money on behalf of the shareholders, who then immediately reinvest the
The dividend policy has grown over the years. This may be so that the company projects itself as a less risky share and thus also gaining investors faith. The investors buy its shares and thus increase its demand. This helps to gives positive signals to the investors signalling that the company is stable and can generate earnings steadily. This hypothesis is gains standing from the dividend hypothesis theory.
When a company decides to pay dividends, it has to be careful on how much it will be given to the shareholders. It is of no use to pay shareholders dividends
2. The written agreement between a corporation and its bondholders might contain a prohibition against paying dividends in excess of current earnings. This prohibition is an example of a(n):
a) How many shares will the firm have to issue, assuming they issue the new shares at the current price per share?
The capital structure of a company changes the risks exposure highlighting the need to determine the impact of debt levels on financial risk (Pearson Learning, 2014). The dividend payout is the ratio of dividends per share to the earnings per share, and both ratios increased for the three years. The increase in the DPS rose at a decreasing rate resulting in slower growth in the dividend payout. The dividend per share is dependent on the total number of dividends paid out in an interim year, and the increase in the DPS was in line with the management’s efforts to reward the investors as the earnings improved. The dividend yield representing the dividend paid out relative to the share price, and the lower divided yield in December 2014 can be attributed to the higher share price hovering over $40, which was more than double the share price in the previous
- A firm has a market value equal to its book value. Currently, the firm has excess cash of $1,200 and other assets of $10,800. Equity is worth $12,000. The firm has 750 shares of stock outstanding and net income of $775. What will the new earnings per share be if the firm uses its excess cash to complete a stock repurchase?
Retained earnings represent the amount a company has left after it has paid all its expenses, taxes, and dividends. A company can return all the cash it has left after it has taken care of its obligations, but that would handicap its efforts to expand operations, make
4) The firm will pay the dividend to all shareholders of record on a specific date, set by the board, called the ________ date.
The number of shares outstanding will remain the same and thus, the only change in the equity side of the balance sheets for the next three years will be the change in the amount of retained earnings. This change will be equal to the net income of the company for last year because the company will not pay a dividend.
It is also important to note that these assumptions are untenable in the real world and if violated may lead to the relevance of dividend policy not because dividends are preferred.
Assume the ROE and payout ratio stay the same for the next 4 years. After that competition forces ROE down to 11.5% and the payout increases to 0.8. The cost of capital is 11.5%. (15 points)
In practice, dividend policy will be affected by taxes as tax rates for different categories of investors will differ. Also, a firm’s dividend policy is perceived by the financial markets to be a signaling mechanism. A cut back in dividends may signify that the firm perceives tough
Generally, firms can choose among various capital structures in order to maximize overall market value of the company. It is proposed however, that
Because often dividends are perceived as spendable income (some stock holders look at stocks as a source of income as it is easier to get a dividend instead of selling the stocks). Sometimes investment opportunities are low, they reach the limit of their marketplace, so companies decides to distribute cash in the form of dividends. For some companies it is a way of showing that the company is stable financially and can fulfill the commitment of paying out a dividend. Also it is a way for companies to mitigate agency problems when they have excess cash.
* Please choose either the CAPM estimate or the DDM estimate for cost of equity based on your answer to Question 3.