Lahore School of Economics

Financial Management II
Distributions to Shareholders: Dividends and Share Repurchases – 2
Assignment 19

Examples
1. Suppose you have 100 common shares of Tillman Industries. The EPS is $4.00, the DPS is $2.00, and the stock sells
for $60 per share. Now Tillman announces a two-for-one split. Immediately after the split, how many shares will you have,
what will be the adjusted EPS and DPS, and what would you expect the stock price to be?

2. American Development Corporation (ADC) expects to earn $4.4 million in 2009, and 50% of this amount (or $2.2
million) has been allocated for distribution to common shareholders. There are 1.1 million shares outstanding, and the
market price is $20 a share. ADC believes that it can use the $2.2 million to repurchase 100,000 of its shares through a
tender offer at $22 a share or pay a cash dividend of $2 a share. What is the effect of the repurchase on the EPS and market
price per share of the remaining stock?

3. In 2011, Keenan Company paid dividends totaling $3,600,000 on net income of $10.8 million. Note that 2011 was a
normal year and that for the past 10 years, earnings have grown at a constant rate of 10%. However, in 2012, earnings are
expected to jump to $14.4 million and the firm expects to have profitable investment opportunities of $8.4 million. It is
predicted that Keenan will not be able to maintain the 2012 level of earnings growth—the high 2012 earnings level is
attributable to an exceptionally profitable new product line introduced that year—and the company will return to its
previous 10% growth rate. Keenan’s target capital structure is 40% debt and 60% equity.
a) Calculate Keenan’s total dividends for 2012 assuming that it follows each of the following policies:
i) Its 2012 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.
ii) It continues the 2011 dividend payout ratio.
iii) It uses a pure residual dividend policy (40% of the $8.4 million investment is financed with debt and 60% with
common equity).
iv) It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth
rate and the extra dividend being set according to the residual policy.
b) Assume that investors expect Keenan to pay total dividends of $9,000,000 in 2012 and to have the dividend grow at
10% after 2012. The stock’s total market value is $180 million. What is the company’s cost of equity?
c) What is Keenan’s long-run average return on equity?

Problems for Assignment

1. Gamma Medical’s stock trades at $90 a share. The company is contemplating a 3-for-2 stock split. Assuming that the
stock split will have no effect on the market value of its equity, what will be the company’s stock price following the stock
split?

2. Beta Industries has net income of $2,000,000, and it has 1,000,000 shares of common stock outstanding. The
company’s stock currently trades at $32 a share. Beta is considering a plan in which it will use available cash to repurchase
20% of its shares in the open market. The repurchase is expected to have no effect on net income or the company’s P/E
ratio. What will be Beta’s stock price following the stock repurchase?

3. Rubenstein Bros. Clothing is expecting to pay an annual dividend per share of $0.75 out of annual earnings per share
of $2.25. Currently, Rubenstein Bros.’ stock is selling for $12.50 per share. Adhering to the company’s target capital
structure, the firm has $10 million in assets, of which 40% is funded by debt. Assume that the firm’s book value of equity
equals its market value. In past years, the firm has earned a return on equity (ROE) of 18%, which is expected to continue
this year and into the foreseeable future.
a) Based on that information, what long-run growth rate can the firm be expected to maintain?
b) What is the stock’s required return?
c) If the firm changed its dividend policy and paid an annual dividend of $1.50 per share, financial analysts would predict
that the change in policy will have no effect on the firm’s stock price or ROE. Therefore, what must be the firm’s new
expected long-run growth rate and required return?