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Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham CHAPTER 17 DISTRIBUTIONS TO SHAREHOLDERS: DIVIDENDS AND REPURCHASES Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject lines. True/False Easy: (17.3) Optimal distribution policy 1. FR Answer: a EASY The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm’s stock price. a. True b. False (17.3) Dividend irrelevance 2. FR Answer: b EASY The dividend irrelevance theory, proposed by Miller and Modigliani, says that provided a firm pays at least some dividends, how much it pays does not affect either its cost of capital or its stock price. a. True b. False (17.3) Dividend irrelevance 3. FR Answer: b EASY MM's dividend irrelevance theory says that while dividend policy does not affect a firm's value, it can affect the cost of capital. a. True b. False (17.3) Investors’ dividend preferences 4. FR Answer: a 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. a. True b. False full file at http://testbankeasy.com EASY (17.3) Dividends and stock prices 5. FR Answer: b EASY 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 (17.7) Residual distribution policy 6. FR Answer: a EASY If a firm adopts a residual distribution policy, distributions are determined as a residual after funding the capital budget. Therefore, the better the firm's investment opportunities, the lower its payout ratio should be. a. True b. False (17.13) Stock dividends and splits 7. FR Answer: a EASY Stock dividends and stock splits should, at least conceptually, have the same effect on shareholders’ wealth. a. True b. False (17.33) Reverse split 8. FR Answer: a EASY A reverse split reduces the number of shares outstanding. a. True b. False Medium: (17.3) Dividend irrelevance 9. FR Answer: a MEDIUM Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk. a. True b. False (17.3) Dividend-growth tradeoff 10. FR Answer: a MEDIUM One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm's required return constant, other things held constant. a. True b. False Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham (17.5) Signaling hypothesis 11. FR Answer: a MEDIUM If the information content, or signaling, hypothesis is correct, then changes in dividend policy can have an important effect on the firm’s value and capital costs. a. True b. False (17.7) Residual distribution policy 12. FR Answer: b MEDIUM 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. a. True b. False (17.7) WACC and dividend policy 13. FR If the shape of the curve depicting a firm's WACC is more like a sharp "V", as opposed to a shallow easier for the firm to maintain a steady dividend varying investment opportunities or earnings from Answer: b MEDIUM versus its debt ratio "U", it will be in the face of year to year. a. True b. False (17.13) Stock splits 14. FR Answer: a MEDIUM Even if a stock split has no information content, and even if the dividend per share adjusted for the split is not increased, there can still be a real benefit (i.e., a higher value for shareholders) from such a split, but any such benefit is probably small. a. True b. False full file at http://testbankeasy.com Multiple Choice: Conceptual Easy: (17.6) Dividend payout 15. CR Answer: a EASY In the real world, dividends a. b. c. d. are usually more stable than earnings. fluctuate more widely than earnings. tend to be a lower percentage of earnings for mature firms. are usually changed every year to reflect earnings changes, and these changes are randomly higher or lower, depending on whether earnings increased or decreased. e. are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS = $2.00, then DPS will equal $0.80. Once the percentage is set, then dividend policy is on “automatic pilot” and the actual dividend depends strictly on earnings. (17.13) Stock splits 16. CR Answer: a EASY Poff Industries’ stock currently sells for $120 a share. You own 100 shares of the stock. The company is contemplating a 2-for-1 stock split. Which of the following best describes what your position will be after such a split takes place? a. You will have 200 shares of stock, and the stock will trade at or near $60 a share. b. You will have 100 shares of stock, and the stock will trade at or near $60 a share. c. You will have 50 shares of stock, and the stock will trade at or near $120 a share. d. You will have 50 shares of stock, and the stock will trade at or near $60 a share. e. You will have 200 shares of stock, and the stock will trade at or near $120 a share. Medium: (17.3) Dividends versus capital gains 17. CR Answer: c MEDIUM Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that a. investors require that the dividend yield and capital gains yield equal a constant. b. capital gains are taxed at a higher rate than dividends. c. investors view dividends as being less risky than potential future capital gains. d. investors value a dollar of expected capital gains more highly than a dollar of expected dividends because of the lower tax rate on capital gains. e. a. investors are indifferent between dividends and capital gains. (17.3) Optimal dividend policy CR Answer: c MEDIUM Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham 18. Which of the following should NOT influence a firm’s dividend policy decision? a. A strong preference by most shareholders for current cash income versus capital gains. b. Constraints imposed by the firm’s bond indenture. c. The fact that much of the firm’s equipment has been leased rather than bought and owned. d. The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains. e. The firm’s ability to accelerate or delay investment projects. (17.5) Dividend theories 19. CR Answer: d MEDIUM Which of the following statements about dividend policies is CORRECT? a. One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than gains on stock repurchases. b. One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest. c. One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy. d. The clientele effect suggests that companies should follow a stable dividend policy. e. Modigliani and Miller argue that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the “bird-in-the hand” effect. (17.7) Dividend payout 20. CR Answer: b MEDIUM Which of the following would be most likely to lead to a decrease in a firm’s dividend payout ratio? a. Its access to the capital markets increases. b. Its R&D efforts pay off, and it now has more high-return investment opportunities. c. Its accounts receivable decrease due to a change in its credit policy. c. Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages. e. Its earnings become more stable. (17.7) Residual dividend policy 21. CR Answer: e MEDIUM Reynolds Paper Products Corporation follows a strict residual dividend policy. All else equal, which of the following factors would be most likely to lead to an increase in the firm’s dividend per share? a. The company increases the percentage of equity in its target capital structure. b. The number of profitable potential projects increases. c. Congress lowers the tax rate on capital gains. The remainder of the tax code is not changed. d. Earnings are unchanged, but the firm issues new shares of common stock. e. The firm’s net income increases. (17.8) Residual dividend policy 22. CR Answer: a MEDIUM 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 a. no dividends to common stockholders. b. dividends only out of funds raised by the sale of new common stock. c. dividends only out of funds raised by borrowing money (i.e., issue debt). d. dividends only out of funds raised by selling off fixed assets. e. no dividends except out of past retained earnings. (17.8) Residual dividend policy 23. Answer: b MEDIUM If a firm adheres strictly to the residual dividend policy, the issuance of new common stock would suggest that a. b. c. d. e. the dividend payout ratio is increasing. no dividends were paid during the year. the dividend payout ratio is decreasing. the dollar amount of investments has decreased. the dividend payout ratio has remained constant. (17.10) Stock repurchases and DRIPs 24. CR CR Answer: b MEDIUM Which of the following statements is CORRECT? a. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account. b. Stock repurchases can be used by a firm that wants to increase its debt ratio. c. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities. d. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding. e. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company. Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham (17.10) Dividends, DRIPs, and repurchases 25. CR Answer: c MEDIUM Which of the following statements is CORRECT? a. One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends. b. Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend, and as a result share prices fall when dividend increases are announced. The reason is that investors interpret the increase as a signal that the firm has relatively few good investment opportunities. c. If a company wants to raise new equity capital rather steadily over time, a new stock dividend reinvestment plan would make sense. However, if the firm does not want or need new equity, then an open market purchase dividend reinvestment plan would probably make more sense. d. Dividend reinvestment plans have not caught on in most industries, and today about 99% of all companies with DRIPs are utilities. e. Under the tax laws as they existed in 2008, a dollar received for repurchased stock must be taxed at the same rate as a dollar received as dividends. (17.10) Dividend policy and stock repurchases 26. CR Answer: c MEDIUM Which of the following statements is CORRECT? a. If a company uses the residual dividend model to determine its dividend payments, dividends payout will tend to increase whenever its profitable investment opportunities increase. b. The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model. c. Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm’s financial risk. d. A dollar paid out to repurchase stock is taxed at the same rate as a dollar paid out in dividends. Thus, both companies and investors are indifferent between distributing cash through dividends and stock repurchase programs. e. The tax code encourages companies to pay dividends rather than retain earnings. (17.10) Miscellaneous dividend concepts 27. CR Answer: b MEDIUM Which of the following statements is CORRECT? a. Capital gains earned in a share repurchase are taxed less favorably than dividends; this explains why companies typically pay dividends and avoid share repurchases. b. Very often, a company’s stock price will rise when it announces that it plans to commence a share repurchase program. Such an announcement could lead to a stock price decline, but this does not normally happen. c. Stock repurchases increase the number of outstanding shares. d. The clientele effect is the best explanation for why companies tend to vary their dividend payments from quarter to quarter. e. If a company has a 2-for-1 stock split, its stock price should roughly double. (17.12) Dividend theory 28. CR Answer: d MEDIUM Which of the following statements is CORRECT? a. One advantage of the residual dividend policy is that it leads to a stable dividend payout, which investors like. b. An increase in the stock price when a company decreases its dividend is consistent with signaling theory as postulated by MM. c. If the “clientele effect” is correct, then for a company whose earnings fluctuate, a policy of paying a constant percentage of net income will probably maximize the stock price. d. Stock repurchases make the most sense at times when a company believes its stock is undervalued. e. Firms with a lot of good investment opportunities and a relatively small amount of cash tend to have above average payout ratios. (17.12) Dividend policy 29. CR Answer: a MEDIUM Which of the following statements is CORRECT? a. If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not follow the strict residual dividend policy. b. If a firm follows a strict residual dividend policy, then, holding all else constant, its dividend payout ratio will tend to rise whenever the firm’s investment opportunities improve. c. If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends unchanged, this would motivate companies to increase their dividend payout ratios. d. Despite its drawbacks, following the residual dividend policy will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees. e. One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive. Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham (17.12) Miscellaneous dividend concepts 30. CR Answer: a MEDIUM Consider two very different firms, M and N. Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M’s growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is CORRECT? a. Firm M probably has a higher dividend payout ratio than Firm N. b. If the corporate tax rate increases, the debt ratio of both firms is likely to decline. c. The two firms are equally likely to pay high dividends. d. Firm N is likely to have a clientele of shareholders who want to receive consistent, stable dividend income. e. Firm M probably has a lower debt ratio than Firm N. (17.13) Stock dividends and stock splits 31. CR Answer: d MEDIUM Which of the following statements is CORRECT? a. Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and it is illegal today. b. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits. c. When a company declares a stock split, the price of the stock typically declines—by about 50% after a 2-for-1 split—and this necessarily reduces the total market value of the equity. d. If a firm’s stock price is quite high relative to most stocks—say $500 per share—then it can declare a stock split of say 10-for-1 so as to bring the price down to something close to $50. Moreover, if the price is relatively low—say $2 per share—then it can declare a “reverse split” of say 1-for-25 so as to bring the price up to somewhere around $50 per share. e. When firms are deciding on the size of stock splits—say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used. (Comp: 17.9-17.13) Miscellaneous dividend concepts CR 32. Answer: e MEDIUM Which of the following statements is CORRECT? a. An open-market dividend reinvestment plan will be most attractive to companies that need new equity and would otherwise have to issue additional shares of common stock through investment bankers. b. Stock repurchases tend to reduce financial leverage. c. If a company declares a 2-for-1 stock split, its stock price should roughly double. d. One advantage of adopting the residual dividend policy is that this makes it easier for corporations to meet the requirements of Modigliani and Miller’s dividend clientele theory. e. If a firm repurchases some of its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes. (Comp: 17.9-17.14) Miscellaneous dividend concepts CR 33. Answer: d Which of the following actions will best enable a company to raise additional equity capital? a. b. c. d. e. Declare a stock split. Begin an open-market purchase dividend reinvestment plan. Initiate a stock repurchase program. Begin a new-stock dividend reinvestment plan. Refund long-term debt with lower cost short-term debt. (Comp: 17.13,17.14) Stock repurchases and stock splits CRAnswer: d 34. MEDIUM MEDIUM Which of the following statements is NOT CORRECT? a. After a 3-for-1 stock split, a company’s price per share should fall, but the number of shares outstanding will rise. b. Investors can interpret a stock repurchase program as a signal that the firm’s managers believe the stock is undervalued. c. Companies can repurchase shares to distribute large inflows of cash, say from the sale of a division, to stockholders without paying cash dividends. d. Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan. e. Stock repurchases can be used by a firm as part of a plan to change its capital structure. Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham Medium/Hard: (17.12) Dividend policy 35. CR Answer: e MEDIUM/HARD Which of the following statements is CORRECT? a. The clientele effect can explain why so many firms change their dividend policies so often. b. One advantage of adopting the residual dividend policy is that this policy makes it easier for corporations to develop a specific and well-identified dividend clientele. c. New-stock dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don’t change the firm’s total amount of book equity. d. Investors who receive stock dividends must pay taxes on the value of the new shares in the year the stock dividends are received. e. If a firm follows the residual dividend policy, then a sudden increase in the number of profitable projects is likely to reduce the firm’s dividend payout. Multiple Choice: Problems Note to Professors: Most of these problems may be changed algorithmically. Those that cannot are labeled nonalgorithmic. With some combinations of variables, the residual policy may result in zero dividends and a zero payout ratio. When this possibility exists, we so indicate. With other similar problems, we set the algorithmic constraints so that there will always be a positive dividend. Easy: 36. (17.7) Residual model-divs paid, divs always positive Answer: e EASY CR The projected capital budget of Kandell Corporation is $1,000,000, its target capital structure is 60% debt and 40% equity, and its forecasted net income is $550,000. If the company follows a residual dividend policy, what total dividends, if any, will it pay out? a. b. c. d. e. $122,176 $128,606 $135,375 $142,500 $150,000 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 17: Dividends Problems Page 505 37. (17.7) Residual dividend model--dividend payout ratio Answer: d EASY CR Grandin Inc. is evaluating its dividend policy. It has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio? a. b. c. d. e. 40.61% 42.75% 45.00% 47.37% 49.74% (17.7) Residual dividend policy—nonalgorithmic 38. Answer: a EASY The capital budget of Creative Ventures Inc. is $1,000,000. The company wants to maintain a target capital structure that is 30% debt and 70% equity. The company forecasts that its net income this year will be $800,000. If the company follows a residual dividend policy, what will be its total dividend payment? a. b. c. d. e. $100,000 $200,000 $300,000 $400,000 $500,000 (17.7) Residual dividend policy—nonalgorithmic 39. CR CR Answer: c EASY Rohter Galeano Inc. is considering how to set its dividend policy. It has a capital budget of $3,000,000. The company wants to maintain a target capital structure that is 15% debt and 85% equity. The company forecasts that its net income this year will be $3,500,000. If the company follows a residual dividend policy, what will be its total dividend payment? a. b. c. d. e. $205,000 $500,000 $950,000 $2,550,000 $3,050,000 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Page 506 Problems Chapter 17: Dividends Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham (17.7) Residual dividend policy—nonalgorithmic 40. EASY $100,000 $200,000 $300,000 $400,000 $500,000 (17.13) Stock splits--fractional splits CR Answer: c EASY 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? a. b. c. d. e. $23.21 $24.43 $25.71 $27.00 $28.35 (17.13) Stock splits--simple splits 42. Answer: e 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? a. b. c. d. e. 41. CR CR Answer: a EASY Last week, Weschler Paint Corp. completed a 3-for-1 stock split. Immediately prior to the split, its stock sold for $150 per share. The firm's total market value was unchanged by the split. Other things held constant, what is the best estimate of the stock's post-split price? a. b. c. d. e. $50.00 $52.50 $55.13 $57.88 $60.78 Easy/Medium: 43. (17.7) Residual dividend model--find net income Answer: b EASY/MEDIUM CR McCann Publishing has a target capital structure of 35% debt and 65% equity. This year’s capital budget is $850,000 and it wants to pay a dividend of $400,000. If the company follows a residual dividend policy, how much net income must it earn to meet its capital budgeting requirements and pay the dividend, all while keeping its capital structure in balance? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 17: Dividends Problems Page 507 a. b. c. d. e. $904,875 $952,500 $1,000,125 $1,050,131 $1,102,638 (17.7) Residual div. model--find net income CR 44. Answer: b EASY/MEDIUM Harvey’s Industrial Plumbing Supply’s target capital structure consists of 40% debt and 60% equity. Its capital budget this year is forecast to be $650,000. It also wants to pay a dividend of $225,000. If the company follows the residual dividend policy, how much net income must it earn to meet its capital requirements, pay the dividend, and keep the capital structure in balance? a. b. c. d. e. $584,250 $615,000 $645,750 $678,038 $711,939 Medium: (17.7) Residual model--divs paid, divs are zero 45. Answer: e MEDIUM Victor Rumsfeld Inc.’s dividend policy is under review by its board. Its projected capital budget is $2,000,000, its target capital structure is 60% debt and 40% equity, and its forecasted net income is $600,000. If the company follows a residual dividend policy, what total dividends, if any, will it pay out? a. b. c. d. e. $240,000 $228,000 $216,600 $205,770 $0 (17.7) Resid. model--find NI, divs and payout CR 46. CR Answer: a MEDIUM 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. b. c. d. e. Net Income $898,750 $943,688 $990,872 $1,040,415 $1,092,436 Payout 55.63% 58.41% 61.34% 64.40% 67.62% © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Page 508 Problems Chapter 17: Dividends Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham (17.7) Residual dividend policy 47. Answer: d $673,652 $709,107 $746,429 $785,714 $825,000 (17.7) Residual dividend policy CR Answer: d MEDIUM 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? EBIT Interest rate Debt outstanding Shares outstanding a. b. c. d. e. $2,000,000 10% $5,000,000 $5,000,000 Capital budget % Debt % Equity Tax rate $850,000 40% 60% 40% 37.2% 39.1% 41.2% 43.3% 45.5% (17.7) Residual div. policy; dividend may be zero CR 49. MEDIUM United Builders wants to maintain a target capital structure with 30% debt and 70% equity. Its forecasted net income is $550,000, and because of market conditions, the company will not issue any new stock during the coming year. If the firm follows the residual dividend policy, what is the maximum capital budget that is consistent with maintaining the target capital structure? a. b. c. d. e. 48. CR Answer: d MEDIUM 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? a. b. c. d. e. $42,869 $45,125 $47,500 $50,000 $52,500 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 17: Dividends Problems Page 509 (17.13) Stock splits--reverse split 50. CR 47.50 49.88 50.00 52.50 55.13 (17.13) Stock splits--optimal stock split CR Answer: c MEDIUM Brinkley Resources stock has 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 value? Put another way, how many new shares should be given per one old share? a. b. c. d. e. 6.65 6.98 7.00 7.35 7.72 (17.13) Stock splits--positive market reaction 52. MEDIUM In recent years Constable Inc. has suffered losses, and its stock currently sells for only $0.50 per share. Management wants to use a reverse split to get the price up to a more "reasonable" level, which it thinks is $25 per share. How many of the old shares must be given up for one new share to achieve the $25 price, assuming this transaction has no effect on total market value? a. b. c. d. e. 51. Answer: c CR Answer: c MEDIUM Downie Foods recently completed a 4-for-1 stock split. Prior to the split, its stock sold for $120 per share. If the firm's total market value increased by 5% as a result of increased liquidity caused by the split, what was the stock price following the split? a. b. c. d. e. $28.43 $29.93 $31.50 $33.08 $34.73 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Page 510 Problems Chapter 17: Dividends Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham Medium/Hard: 53. (17.7) Residual dividend model--req'd debt ratio Answer: e MEDIUM/HARD CR Warren Supply Inc. is evaluating its capital budget. The company finances with debt and common equity, but because of market conditions, wants to avoid issuing any new common stock during the coming year. It is forecasting an EPS of $3.00 for the coming year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at $800,000, and it is committed to maintaining a $2.00 dividend per share. Given these constraints, what percentage of the capital budget must be financed with debt? a. b. c. d. e. 30.54% 32.15% 33.84% 35.63% 37.50% (17.13) Stock splits--positive market reaction 54. Answer: b MEDIUM/HARD The Meltzer Corporation is contemplating a 7-for-3 stock split. The current stock price is $75.00 per share, and the firm believes that its total market value would increase by 5% as a result of the improved liquidity that it thinks would follow the split. What is the stock's expected price following the split? a. b. c. d. e. 55. CR $32.06 $33.75 $35.44 $37.21 $39.07 (17.7) Residual model--divs paid or stock issued Answer: e MEDIUM/HARD CR Getler Inc.’s projected capital budget is $2,000,000, its target capital structure is 40% debt and 60% equity, and its forecasted net income is $1,000,000. If the company follows a residual dividend policy, how much dividends will it pay or, alternatively, how much new stock must it issue? a. b. c. d. e. Dividends $514,425 $541,500 $570,000 $600,000 $0 Stock Issued $162,901 $171,475 $180,500 $190,000 $200,000 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 17: Dividends Problems Page 511 Hard: (17.7) Residual model--divs paid or stock issued 56. Answer: e HARD 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. a. b. c. d. e. 57. CR Increase Increase Debt to 75% $114.0 $120.0 $126.4 $133.0 $140.0 in Capital Budget Lower Payout to 20% Do Both $73.3 $333.9 $77.2 $351.5 $81.2 $370.0 $85.5 $389.5 $90.0 $410.0 (17.10) Dividends and intrinsic stock price CR Answer: c The following data apply to Garber Industries, Inc. (GII): Value of operations Short-term investments Debt Number of shares HARD $1,000 $100 $300 100 The company plans on distributing $50 million as dividend payments. What will the intrinsic per share stock price be immediately after the distribution? a. b. c. d. e. $6.32 $6.65 $7.00 $7.35 $7.72 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Page 512 Problems Chapter 17: Dividends Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham 58. (17.10) Repurchases and intrinsic stock price CR Answer: b The following data apply to Elizabeth’s Electrical Equipment: Value of operations Short-term investments Debt Number of shares HARD $20,000 $1,000 $6,000 300 The company plans on distributing $50 million by repurchasing stock. What will the intrinsic per share stock price be immediately after the repurchase? a. b. c. d. e. $47.50 $50.00 $52.50 $55.13 $57.88 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 17: Dividends Problems Page 513 CHAPTER 17 ANSWERS AND SOLUTIONS 1. (17.3) Optimal distribution policy FR Answer: a EASY 2. (17.3) Dividend irrelevance FR Answer: b EASY 3. (17.3) Dividend irrelevance FR Answer: b EASY 4. (17.3) Investors’ dividend preferences FR Answer: a EASY 5. (17.3) Dividends and stock prices FR Answer: b EASY 6. (17.7) Residual distribution policy FR Answer: a EASY 7. (17.13) Stock dividends and splits FR Answer: a EASY 8. (17.13) Reverse split FR Answer: a EASY 9. (17.3) Dividend irrelevance FR Answer: a MEDIUM 10. (17.3) Dividend-growth tradeoff FR Answer: a MEDIUM 11. (17.5) Signaling hypothesis FR Answer: a MEDIUM 12. (17.7) Residual distribution policy FR Answer: b MEDIUM 13. (17.7) WACC and dividend policy FR Answer: b MEDIUM 14. (17.13) Stock splits FR Answer: a MEDIUM 15. (17.6) Dividend payout CR Answer: a EASY 16. (17.13) Stock splits CR Answer: a EASY 17. (17.3) Dividends versus capital gains CR Answer: c MEDIUM 18. (17.3) Optimal dividend policy CR Answer: c MEDIUM 19. (17.5) Dividend theories CR Answer: d MEDIUM 20. (17.7) Dividend payout CR Answer: b MEDIUM 21. (17.7) Residual dividend policy CR Answer: e MEDIUM 22. (17.8) Residual dividend policy CR Answer: a MEDIUM 23. (17.8) Residual dividend policy CR Answer: b MEDIUM 24. (17.10) Stock repurchases and DRIPs CR Answer: b MEDIUM © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Page 514 Answers Chapter 17: Dividends Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham 25. (17.10) Dividends, DRIPs, and repurchases CR Answer: c 26. (17.10) Dividend policy and stock repurchases 27. (17.10) Miscellaneous dividend concepts CR Answer: b MEDIUM 28. (17.12) Dividend theory CR Answer: d MEDIUM 29. (17.12) Dividend policy CR Answer: a MEDIUM 30. (17.12) Miscellaneous dividend concepts CR Answer: a MEDIUM 31. (17.13) Stock dividends and stock splits CR Answer: d MEDIUM 32. (Comp: 17.9-17.13) Miscellaneous dividend concepts CR Answer: e MEDIUM 33. (Comp: 17.9-17.14) Miscellaneous dividend concepts CR Answer: d MEDIUM 34. (Comp: 17.13,17.14) Stock repurchases and stock splits CRAnswer: d MEDIUM 35. (17.12) Dividend policy 36. (17.7) Residual model-divs paid, divs always positive CR Answer: e CR CR MEDIUM Answer: c MEDIUM Answer: e MEDIUM/HARD EASY Capital budget $1,000,000 % Equity 40% Net income (NI) $550,000 Dividends paid = NI – [% Equity(Capital budget)] $150,000 37. (17.7) Residual dividend model--dividend payout ratio CR Answer: d Capital budget Equity ratio Net income (NI) Dividends paid = NI – (Equity ratio)(Capital budget) Dividend payout ratio = Dividends paid/NI 38. EASY $625,000 40% $475,000 $225,000 47.37% (17.7) Residual dividend policy—nonalgorithmic CR Answer: a EASY Answer: c EASY The amount of new investment which must be financed with equity is: $1,000,000 70% = $700,000. Since the firm has $800,000 of net income only $100,000 will be left for dividends. 39. (17.7) Residual dividend policy—nonalgorithmic CR The amount of new investment which must be financed with equity is: © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 17: Dividends Answers Page 515 $3,000,000 85% = $2,550,000. Since the firm has $3,500,000 of net income, $950,000 = $3,500,000 – $2,550,000 will be left for dividends. 40. (17.7) Residual dividend policy—nonalgorithmic CR Answer: e EASY The amount of new investment which must be financed with equity is: $2,000,000 65% = $1,300,000. Since the firm has $1,800,000 of net income only $500,000 = $1,800,000 – $1,300,000 will be left for dividends. 41. (17.13) Stock splits--fractional splits CR Answer: c EASY CR Answer: a EASY Number of new shares 7 Number of old shares 2 Old (pre-split) price $90 New price = Old price × (Old shrs/New shrs) $25.71 42. (17.13) Stock splits--simple splits Number of new shares Number of old shares Pre-split stock price Post-split stock price: P0/New per old = 43. 3 1 $150 $50.00 (17.7) Residual dividend model-find net income CR Answer: b Capital budget Equity ratio Dividends to be paid Required net income = Dividends + (Capital budget % Equity) 44. $850,000 65% $400,000 $952,500 (17.7) Residual dividend model-find net income CR Answer: b Capital budget % Equity Dividends to be paid Required net income = Dividends + (Capital budget % Equity) 45. EASY/MEDIUM $650,000 60% $225,000 $615,000 (17.7) Residual model--divs paid, divs are zero Answer: e MEDIUM (17.7) Residual model-find NI, then divs and payout CR Answer: a MEDIUM Capital budget % Equity Net income (NI) Dividends paid = NI – [% Equity(Capital Budget)] 46. EASY/MEDIUM Capital budget Equity ratio CR $2,000,000 40% $600,000 $0 $725,000 55% © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Page 516 Answers Chapter 17: Dividends Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham Dividends paid NI=Divs + (Eq % × Cap Bud) Payout = Dividends/NI 47. $500,000 $898,750 55.63% (17.7) Residual dividend policy CR % Debt % Equity Net income Max capital budget = NI/% Equity Check: Is calculated max cap bud %Equity = NI? 48. 30% 70% $550,000 $785,714 $550,000 (17.7) Residual dividend policy EBIT Interest rate Debt outstanding Shares outstanding $2,000,000 10% $5,000,000 $5,000,000 Answer: d Answer: d Capital budget % Debt % Equity Tax rate $850,000 40% 60% 40% $2,000,000 500,000 $1,500,000 600,000 $900,000 510,000 $390,000 43.33% MEDIUM 30% 70% $500,000 $400,000 $350,000 $50,000 (17.13) Stock splits--reverse split CR Current price Target price Old shares surrendered per 1 new share = Target price/Old price 51. MEDIUM (17.7) Residual dividend policy; dividend may be zero CRAnswer: d % Debt % Debt Capital budget Net income Equity requirement = Cap Bud x % Equity = Dividends = NI − Equity requirement = 50. = net income CR EBIT − Interest expense = interest rate × debt Taxable income − Taxes = Tax rate × income Net income (NI) − Equity needed for capital budget = % Equity(capital budget) = Dividends = NI − Equity needed Payout ratio = Dividends/NI 49. MEDIUM (17.13) Stock splits--optimal stock split Current price Target price Answer: c MEDIUM Answer: c MEDIUM $0.50 $25.00 50.00 CR $175.00 $25.00 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 17: Dividends Answers Page 517 No. of new shares per 1 old share = Current price/Target price 7.00 52. (17.13) Stock splits--positive market reaction CR Answer: c 53. New shares per 1 old share 4 Pre-split stock price $120 % value increase 5% Post-split stock price = (P0/New per old)(% Value increase) $31.50 (17.7) Residual dividend model-req'd debt ratio CR Answer: e MEDIUM MEDIUM/HARD EPS $3.00 Shares outstanding 500,000 DPS $2.00 Capital budget $800,000 Net income = EPS × Shares outstanding = $1,500,000 Dividends paid = DPS × Shares outstanding = $1,000,000 Retained earnings available $500,000 Capital budget − Retained earnings = Debt needed $300,000 Debt needed/Capital budget = % Debt financing 37.5% 54. (17.13) Stock splits--positive market reaction CR Number of new shares Number of old shares Old (pre-split) price % Increase in value New price before value increase = Old price/(Old shares/New shares) New price after value increase = Prior (1 + % Value increase) 55. Answer: b MEDIUM/HARD 7 3 $75.00 5% $32.14 $33.75 (17.7) Residual model-divs paid or stock issued CR Answer: e $2,000,000 60% $1,000,000 Dividends: Dividends paid = NI − [% Equity(Cap. Bud)], stock issued if dividends zero or neg $0 MEDIUM/HARD Capital budget % Equity Net income (NI) 56. (17.7) Residual model--divs paid or stock issued Current maximum NI $150.0 %Debt 25.0% %Equity 75.0% % Payout 65.0% Dividends $97.5 Retained earnings $52.5 Max. capital budget = RE/%Equity $70.0 Increase over current: Changed amt − Current max. NA CR or new stock: $200,000 Answer: e New Maximums: If increase If lower debt payout $150.0 $150.0 75.0% 25.0% 25.0% 75.0% 65.0% 20.0% $97.5 $30.0 $52.5 $120.0 $210.0 $160.0 $140.0 $90.0 HARD If do both $150.0 75.0% 25.0% 20.0% $30.0 $120.0 $480.0 $410.0 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Page 518 Answers Chapter 17: Dividends Full file at http://testbankeasy.eu/SolutionManual-for-Intermediate-Financial-Management,-12thEdition,-Eugene-F.-Brigham 57. (17.10) Dividends and intrinsic stock price Value of operations Prior to Distribution $1,000.00 After Distribution $1,000.00 + Value of nonoperating assets Total intrinsic value of firm 100.00 $1,100.00 0.00 $1,000.00 − Debt Intrinsic value of equity 300.00 $800.00 300.00 $700.00 ÷ Number of shares 100.00 $8.00 100.00 $7.00 Intrinsic price per share 58. CR (17.10) Repurchases and intrinsic stock price CR Value of operations Prior to Distribution $20,000 After Distribution $20,000 + Value of nonoperating assets Total intrinsic value of firm $1,000 $21,000 $0 $20,000 − Debt Intrinsic value of equity $6,000 $15,000 $6,000 $14,000 ÷ Number of shares 300 $50.00 280 $50.00 Intrinsic price per share # shares repurchased = Value of nonoperating assets / Price prior to distribution Answer: c HARD Answer: b HARD $20.00 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 17: Dividends Answers Page 519