UNIVERSITY OF DAR ES SALAAM

BUSINESS SCHOOL

DEPARTMENT OF FINANCE

COURSE: FN 202: Financial Management

Seminar Questions Set 4 Dividend Decision

1. AGC Investment Ltd. pays out 70 percent of its earnings in the form of
dividends.
a. Evaluate this policy assuming most stockholders are senior citizens in
low tax brackets.
b. Evaluate this policy assuming most stockholders are in high tax
brackets.

2. The Eve Milling Company practices a strict residual dividend policy and
maintains a capital structure of 60 percent debt, 40 percent equity. Earnings
for the year are Tsh. 5,000,000. What is maximum amount of capital spending
possible without selling new equity? Suppose that planned investment outlays
for the coming year are Tsh.12,000,000. Will Eve Milling Company be paying
a dividend? If so, how much?

3. The FCM Corporation has 4,500 shares of common stock having a par value
of Tsh. 240 outstanding. A 10 percent stock dividend is declared. The fair
market value of the stock is Tsh. 248 per share.
a. By how much will retained earnings be reduced?
b. What is the par value of the common stock to be issued?
c. What is the paid-in capital on common stock?

4. Nancy Company Ltd. has 50,000 shares of common stock having a par value
of Tsh. 120 per share. The board of directors decided on a 2-for-1 stock split.
The market price of the stock was Tsh. 200 before the split.
a. Record the stock split.
b. What will the market price per share be immediately after the
split?

5. BM Company’s net income for 2015 was Tsh. 300 million. Of this amount,
40 percent will be used to purchase treasury stock. Currently, there are 1
million shares outstanding and the market price per share is Tsh. 900.
a. How many shares can the company buy back through a tender offer of
Tsh. 1,200 a share?
b. What is the current earnings per share?
c. What is the current P/E ratio?
d. What will earnings per share be after the treasury stock acquisition?
e. What is the expected market price per share assuming the present P/E
ratio remains the same?

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6. The DM Company belongs to a risk class for which the appropriate discount
rate is 10%. DM currently has 100,000 outstanding shares selling at Tsh.100
each. The firm is contemplating the declaration of a Tsh. 5 dividend at the end
of the fiscal year that just began. Answer the following questions based on the
Miller and Modigliani model.
a. What will be the price of the stock on the ex-dividend date if the dividend
is declared?
b. What will be the price of the stock at the end of the year if the dividend is
not declared?
c. If DM makes Tsh. 2 million of new investments at the beginning of the
period, earns net income of Tsh. 1 million, and pays the dividend at the
end of the year, how many shares of new stock must the firm issue to
meet its funding needs?
d. Is it realistic to use the MM model in the real world to value stock? Why
or why not?

7. Zodiac, Inc., has declared a Tsh. 50 per share dividend. Suppose capital gains
are not taxed, but dividends are taxed at 30 percent. New IRS regulations
require that taxes be withheld at the time the dividend is paid. Zodiac sells for
Tsh. 800 per share, and the stock is about to go ex dividend. What do you
think the ex-dividend price will be?

8. The owners’ equity accounts for Octagon International are

shown here:
Common Stock (Tsh. 100 par value) 1,000,000
Capital Surplus 15,000,000
Retained Earnings 55,250,000
Total Owner’s Equity 71,250,000

a. If Octagon stock currently sells for Tsh. 2,000 per share and a 10 percent
stock dividend is declared, how many new shares will be distributed?
Show how the equity accounts would change.
b. If Octagon declared a 25 percent stock dividend, how would the accounts
change?

9. For the company in Question 8 above, show how the equity accounts
will change if:
a. Octagon declares a five-for-one stock split. How many shares are
outstanding now? What is the new par value per share?
b. Octagon declares a one-for-four reverse stock split. How many shares are
outstanding now? What is the new par value per share?

10. Rombo Rally Corporation (RRC) currently has 100,000 shares of stock
outstanding that sell for Tsh. 700 per share. Assuming no market
imperfections or tax effects exist, what will the share price be after:
a. RRC has a five-for-three stock split?
b. RRC has a 15 percent stock dividend?
c. RRC has a 42.5 percent stock dividend?
d. RRC has a four-for-seven reverse stock split?
e. Determine the new number of shares outstanding in parts (a) through (d).

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11. DSE Corporation follows a strict residual dividend policy. Its debt-equity ratio
is 3.
a. If earnings for the year are Tsh. 140,000, what is the maximum amount of
capital spending possible with no new equity?
b. If planned investment outlays for the coming year are Tsh. 770,000, will
DSE pay a dividend? If so, how much?
c. Does DSE maintain a constant dividend payout? Why or why not?

12. You own 1,000 shares of stock in Tanzania Cigarette Company (TCC). You
will receive a Tsh. 60 per share dividend in one year. In two years, TCC will
pay a liquidating dividend of Tsh. 3,000 per share. The required return on
TCC stock is 15 percent. What is the current share price of your stock
(ignoring taxes)? If you would rather have equal dividends in each of the next
two years, show how you can accomplish this by creating homemade
dividends.
Hint: Dividends will be in the form of an annuity.