Dividend Policies and Stock Repurchases

Exercise 1. Ace hardware has a target capital structure that consists of 70% debt and 30%
equity. The company anticipates that its capital budget for the upcoming year will be
P3,000,000. If Ace reports a net income of P2,000,000 and it follows a residual dividend payout
policy, what will be its dividend payout ratio?

Exercise 2. Gateway Corporation’s stock trade at P90 a share. The company is contemplating
a 3-for-2 stock split. Assuming 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?

Exercise 3. Eton House’s stock trade at P90 a share. The company is contemplating a 150%
stock dividend. Assuming the stock dividend will have no effect on the market value of its equity,
what will be the company’s stock price following the stock dividend?

Exercise 4. Bone Industries has net income of P2,000,000, and it has 1,000,000 shares of
common stock outstanding. The company’s stock currently trades at P32 a share. Bone 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. What will be Bone’s EPS
following the repurchase?

Exercise 5. In 2011, Keenan Company paid dividends totaling P3,600,000 on net income of
P10,800,000. 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
P14,400,000 and the firm expects to have profitable investment opportunities of P8,400,000. It
is predicted that Keenan will not be able to maintain the 2012 level of earnings growth because
the high 2012 earnings level is attributable to an exceptionally profitable new product line
introduced that year. After 2012, the company will return to its previous 10% growth rate.
Keenan’s target capital structure is 40% debt and 60% equity.
1. Calculate Keenan’s total dividends for 2012 assuming that it follows each of the following
policies:
a. Its 2012 dividend payment is set to force dividends to grow at the long-run growth rate in
earnings.
b. It continues the 2011 dividend pay-out ratio.
c. It uses a pure residual dividend policy.
d. 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
dividend policy.
2. Which of the preceding policies would you recommend?