CANDELARIA, YNA ISABELLE

DATUMULOK, NASHREN
DOMINGUEZ, CLARINE
MONANG, JUSTINE JOY
SAD-ANG, RUTH DENIELLE
7.5.1 Group Activity
PROBLEM 1
A firm has had the indicated earnings per share over the last three years:

Year EPS

2019 P   3.00

2020 2.00

2021 1.00

(a)   If the firm’s dividend policy was based on a constant payout ratio of 50 percent, determine the
annual dividend for each year.
Solution and Answer

Year EPS Payout ratio of Percent Annual Dividend

2019 P 3.00 50% 1.5

2020 2.00 50% 1

2021 1.00 50% 0.5

(b)   If the firm’s dividend policy was based on a fixed dollar payout policy of 50 cents per share plus
an extra dividend equal to 75 percent of earnings per share above P1.00, determine the annual dividend
for each year.
Solution and Answer

Year EPS Above 1 75% of Above Fixed 50 cents Annual

1 Dividend

2019 P 3.00 2 1.5 0.5 2

2020 2.00 1 0.75 0.5 1.25

2021 1.00 0 0 0.5 0.5

PROBLEM 2
BongBongBongGo Company has released the following information.

Earnings available to common stockholders P5,000,000

Number of shares of common stock outstanding 1,000,000

Market price per share P50

Retained earnings 11,600,000

A.   What are BongBongBongGo’s current earnings per share?

EPS = 5,000,000/1,000,000 = 5.00 per share

B. What is BongBongBongGo’s current P/E ratio?

P/E Ratio = 50.00/5.00 = 10

C. BongBongBongGo wants to use half of its earnings either to pay shareholders dividends or to
repurchase shares for inclusion in the firm’s employee stock ownership plan. If the firm pays a
cash dividend, what will be the dividend per share received by existing shareholders?

Dividends/Share = 2,500,000/1,000,000 = 2.50/share

D. Instead of paying the cash dividend, what if the firm uses half of its earnings to pay P55 per
share to repurchase the shares, what will be the firm’s new EPS? What should be the firm’s new
share price?

If the company paid 55 per share to repurchase stock, it could buy about 45,455 shares (2,500,000 / 55
per share). As a result, the company currently has 954,545 shares in circulation (1,000,000 shares -
45,455 shares). As a result, EPS would increase from 5.00 to 5.24 per share (5,000,000 / 954,545
shares).

If we assume the stock continues to trade at 10 times profits, we can estimate the new market price by
multiplying the new EPS by the PE ratio. Thus, the new price would be 52.40 per share,
representing a 2.40 rise in share price.

E. .Compare the impact of a stock dividend and stock repurchase on shareholder wealth.

A stock dividend and a stock repurchase have the same net impact. In this scenario, stockholders
would have enjoyed a net gain of roughly 2.50 per share in both circumstances.

PROBLEM 3
Tropa Company has entered into two lease arrangements. One lease is an operating lease on an office
copier requiring annual lease payments of P2,000 for the next three years. The other lease is a 15-year
financial lease on a building requiring annual lease payments of P150,000. If the firm’s discount rate is
10 percent, how should each lease be presented on the firm’s balance sheet?
Operating Lease : It should be disclosed in the footnote.

Financial Lease :

150,000 * 7.606 = 1,140,900

PV OF OA = [1 – [ (1 / 1+10%)^15] / 10%]  = 7.606

RUA 1,140,900

LEASE LIABILITY 1,140,900

PROBLEM 4

Ismo Inc. is considering leasing or purchasing a small aircraft to transport executives between
manufacturing facilities and the main administrative headquarters. The firm is in the 40 percent tax
bracket and its after-tax cost of debt is 7 percent. The estimated after-tax cash flows for the lease and
purchase alternatives are given below:

  Cash Flows (after-tax)

End of
 Year Lease Purchase

1 –64,329 –68,454

2 –64,329 –59,110

3 –64,329 –63,596

4 –64,329 –66,633

5   64,329   30,056

A.) Given the above cash outflows for each alternative, calculate the present value of the after-tax cash
flows using the after-tax cost of debt for each alternative.

PV of leasing

CFI - 4 (64,329) 3.387 (217,882)

CF5 64,329 0.713 45,867

 (172,015)

PV of Purchase

CF1 (68,454) 0.935 (64,004)

CF2 (59,110) 0.873 (51,603)

CF3 (63,596) 0.816 (51,894)

CF4 (66,633) 0.763 (50,841)

CF5 30,056 0.713 21,430

(196,912)

 B.)Which alternative do you recommend? Why?

The aircraft should be leased by the company. It is because the PV of lease is less than the PV of
purchase, so lease is cost effective than purchase.