16.1 Do Firms Distribute Cash to Their Shareholders?

45) XYZ Corporation has 400,000 shares of common stock outstanding, a P/E ratio of 8, and $500,000 available for
41) Kelly owns 10,000 shares in McCormick Spices, which currently has 500,000 shares common stockholders. The board of directors has just voted a 3-2 stock split.
outstanding. The stock sells for $86 on the open market. McCormick's management has decided a. If you had 100 shares of stock before the split, how many shares will you have after the split?
b. What was the total value of your investment in XYZ stock before the split?
on a 2-1 split.
c. What should be the total value of your investment in XYZ stock after the split?
a. Will Kelly's financial position alter after the split, assuming that the stocks will fall d. In view of your answers to (b) and (c) above, why would a firm's management want to have a stock split?
proportionately? Answer:
b. Assuming only a 35% fall on each stock, what will be Kelly's value after the split? a. Number of shares after split = 3/2 × 100 = 150
Answer: b. EPS before split = ($500,000/400,000) = $1.25
McCormick Spices Corporation - Stock Split Price per share before split = 8 × $1.25 = $10
Market price $86.00 Total value of investment = $10 × 100 = $1,000
Split multiple 2 c. Total number of shares after split = 3(400,000/2) = 600,000
EPS after split = ($500,000/600,000) = $.8333
Shares outstanding 500,000
Price per share after split = 8 × $.833 = $6.67
a. Total value of investment after split = $6.67 × 150 = $1,000
Investor's shares = 10,000 d. (1) Stock splits are believed to have favorable information content. Splits are often associated with growth
Position before split $860,000 = 10,000 shares × $86 per share companies.
Price after split $43.00 = $86/2 (2) Splits can conserve corporate cash if the firm has cash flow problems or needs additional funds for
Kelly's shares after split 20,000 = 10,000 × 2 attractive investment opportunities.
Position after split $860,000 = 20,000 shares × $43 per share
Net gain $0 45) XYZ Corporation has 400,000 shares of common stock outstanding, a P/E ratio of 8, and $500,000 available for
common stockholders. The board of directors has just voted a 3-2 stock split.
b. a. If you had 100 shares of stock before the split, how many shares will you have after the split?
Price fall 0.35 b. What was the total value of your investment in XYZ stock before the split?
Price after split $55.90 = $86.00(1 - .35) c. What should be the total value of your investment in XYZ stock after the split?
Position after split $1,118,000 = 20,000 shares × $55.90 per share d. In view of your answers to (b) and (c) above, why would a firm's management want to have a stock split?
Net gain $258,000 = $1,118,000 - $860,000

Your firm is planning a 2 for 1 stock split. The market price for the stock has been $84. The Answer:
table below presents the equity portion of your firm's balance sheet before the split. a. Number of shares after split = 3/2 × 100 = 150
b. EPS before split = ($500,000/400,000) = $1.25
Price per share before split = 8 × $1.25 = $10
Common stock Total value of investment = $10 × 100 = $1,000
Par value c. Total number of shares after split = 3(400,000/2) = 600,000
(1 million shares EPS after split = ($500,000/600,000) = $.8333
outstanding; $4 par value) $ 4,000,000 Price per share after split = 8 × $.833 = $6.67
Paid-in capital 16,000,000 Total value of investment after split = $6.67 × 150 = $1,000
Retained earnings 30,000,000 d. (1) Stock splits are believed to have favorable information content. Splits are often associated with growth
Total equity $50,000,000 companies.
(2) Splits can conserve corporate cash if the firm has cash flow problems or needs additional funds for
attractive investment opportunities.
23) After the stock split, the number of shares outstanding, their par value and the total
common stock account will stand at
C) 2,000,000; $2.00; $4,000,000.

24) Immediately after the stock split, the stock price will be approximately
A) $42.

25) Immediately after the stock split, an investor who owned 100 share before the split will own
B) 200 shares worth a total of $8400.
16.2 Does Dividend Policy Matter?
6) Millbury Gas and Oil's rate of return on equity is
12%. It can either pay a dividend of $5.00 today or
reinvest the money and pay a dividend of $5.60 at
the end of the year. From a shareholder's point of
view, the value of the dividend paid now is
________ and the value of the dividend paid a year
from now is ________.
B) $5.00, $5.00
47) Pettry, Inc. expects EPS this year to be
$5.25. If EPS grows at an average annual rate
of 10%, and if Pettry pays 60% of its earnings
as dividends, what will the expected dividend
per share be in 10 years?
Answer:
$5.25 (1 + 0.10)10 = 13.62 = EPS in 10 years
$13.62 × 0.6 = $8.17 = Expected dividends per
share
14) Chandler Corporation has 1 million shares outstanding. The
current price per share is $20. If the company decides to pay a $2
million dollar dividend, the company will have ________ shares
outstanding worth approximately ________.
D) 1,000,000, $18 per share
48) You are considering the stock of two firms to add to your portfolio.
The companies differ only with respect to their dividend policies. For
both firms, investors expect EPS for each of the next two years to be
$7 and dividends and ending price for each of the next two periods to
be:
D1 D2 P2
Firm A $2 $2 $60.70
Firm B 4 4 56.42
The required rate of return for the stock of Firm A is 14%. Ignore taxes
or transaction fees.
a. How much would investors pay for the stock of Firm A?
b. How much would investors pay for the stock of Firm B?
c. For a less-than-perfect world, provide an argument for each of the
following:
(1) Investors prefer the dividend policy of Firm A.
(2) Investors prefer the dividend policy of Firm B.
(3) Firms prefer the dividend policy of Firm A.
Answer:
a. Po = ($2.00/1.14) + [($2.00 + $60.72)/(1.14)2]
Po = $50
b. Exactly the same in the perfect capital market environment.
Po = ($4.00/1.14) + (($4.00 + $56.42)/(1.14)2)
Po = $50
c. (1) Investors can pay a lower capital gains tax on the growth.
(2) Investors in this firm may need current income.
(3) Firms need additional equity to finance growth.
15) Chandler Corporation has 1 million shares outstanding. The current price per 44) Georges Bizet owns 10,000 shares of Pearl Co.
share is $20. If the company decides to use $2 million dollars to repurchase purchased at an average price of $15 per share.
shares at the market price, the company will have ________ shares outstanding The tax rate on both dividends and capital gains is
worth approximately ________. Assume that the price does not change during the 15%. Would Bizet prefer a $2.00 per share dividend
repurchase period. or to sell 1,000 shares back to the company at $20
A) 900,000, $20 per share per share? Compute his after-tax income from each
option.
49) Noblesville Auto Supply Company's stock is trading ex-dividend Answer: If Bizet receives the dividend, his tax will
at $5 per share. The company just paid a 10% stock dividend. The be $20,000 × .15 = $3,000 and he would have
P/E ratio for the stock is 10. What was the price of the stock prior to $17,000 in after-tax income.
If the company repurchases the share, he will
trading ex-dividend?
have a capital gain of $20 - $15=$5 per share.
Answer:
EPS after stock dividend = ($5.00/10.00) = $.50 Of the $20,000 he receives by selling back the
EPS after stock dividend = (EPS before stock dividend)/(1.10) shares, only $5,000 would be taxable.
($.50)(1.10) = $.55 = EPS before stock dividend His tax would be $5,000 × .15 = $750, so his after-
Stock price prior to stock dividend = (10)($.55) = $5.50 tax income would be $20,000 - $750 = $19,250. He
would be better off by $2,250.
50) Trevor Co.'s future earnings for the next four 16.3 Cash Distribution Policies in Practice
years are predicted below. Assuming there are 19) Franklin Electric is presently generating
500,000 shares outstanding, what will the yearly earnings available to common shareholders of
dividend per share be if the dividend policy is as $7.25 per share. The firm's income tax rate is
follows? 40%. Franklin is paying a dividend to the
a. A constant payout ratio of 40% preferred shareholders of $2.10 per share. The
b. Stable dollar dividend targeted at 40% of the firm's dividend payout ratio on common stock is
average earnings over the four-year period 20%. What is the amount per share that
c. Small, regular dividend of $0.75 plus a year- Franklin will pay in dividends to common
end extra of 40% of profits exceeding $1 million shareholders?
Trevor Co. B) $1.45
Year 1 $ 900,000
Year 2 1,200,000
Year 3 850,000
Year 4 1,350,000
Answer:
a. .40($900,000)/500,000 = $0.72
.40($1,200,000)/500,000 = $0.96
.40($850,000)/500,000 = $0.68
.40($1,350,000)/500,000 = $1.08
b. .40($1,075,000) = $430,000/500,000 = $0.86
c. Year 1 $0.75 = $0.75
Year 2 $0.75 + $0.16 = $0.91
Year 3 $0.75 = $0.75
Year 4 $0.75 + $0.28 = $1.03
16.3 Cash Distribution Policies in Practice
19) Franklin Electric is presently generating earnings available to
common shareholders of $7.25 per share. The firm's income tax rate is
40%. Franklin is paying a dividend to the preferred shareholders of $2.10
per share. The firm's dividend payout ratio on common stock is 20%.
What is the amount per share that Franklin will pay in dividends to
common shareholders?
B) $1.45