Scribd
Upload
199 views5 pages

Dividend Policy - Problems For Class Discussion

The document discusses various dividend policies and their implications: 1) Under a residual dividend policy, Rackler Instruments should pay dividends of Rs. 500,000 if it has Rs. 1.5 million in high-return projects, Rs. 1 million if it has Rs. 2 million in such projects, and pay no dividends if it has Rs. 3 million in high-return projects and should retain earnings instead. 2) For Beta-Alpha Company, maintaining a constant dividend per share will require more external financing each year, while a 50% dividend payout ratio balances dividends and external financing needs best. 3) For factors affecting dividend payout ratios, growth companies and those with volatility

Uploaded by

chandel08
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
199 views5 pages

Dividend Policy - Problems For Class Discussion

The document discusses various dividend policies and their implications: 1) Under a residual dividend policy, Rackler Instruments should pay dividends of Rs. 500,000 if it has Rs. 1.5 million in high-return projects, Rs. 1 million if it has Rs. 2 million in such projects, and pay no dividends if it has Rs. 3 million in high-return projects and should retain earnings instead. 2) For Beta-Alpha Company, maintaining a constant dividend per share will require more external financing each year, while a 50% dividend payout ratio balances dividends and external financing needs best. 3) For factors affecting dividend payout ratios, growth companies and those with volatility

Uploaded by

chandel08
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 5

DIVIDEND POLICY – PROBLEMS FOR CLASS DISCUSSION

Residual Dividend Policy

1. Rackler Instruments Company treats dividends as a residual decision. It expects to generate


Rs. 2 million in net earnings after taxes in the coming year. The company has an all-equity
capital structure and its cost of equity capital is 15 percent. The company treats this cost as
opportunity cost of retained earnings. Because of floatation costs and underpricing, the cost of
common stock financing is higher. It is 16 percent.

a. How much in dividends (out of Rs.2 million in earnings) should be paid if the company has
Rs.1.5 million in projects whose expected return exceeds 15 percent?

b. How much in dividends should be paid if it has Rs.2 million in projects whose expected return

exceeds 15 percent?

c. How much in dividends should be paid if it has Rs. 3 million in projects whose expected return

exceeds 16 percent? What else should be done?

Alternative Dividend Policies

2. The Beta-Alpha Company expects with some degree of certainty to generate the following net
income and to have the following capital expenditures during the next 5 years (Rs.in thousands):

Year 1 2 3 4 5

Net Income 2,000 1,500 2,500 2,300 1,800


Capital expenditure 1,000 1,500 2,000 1,500 2,000

The company currently has one million shares of common stock outstanding and pays dividend
of Re.1 per share.
a. Determine dividends per share and external financing required in each year if dividend policy
is treated as a residual decision.
b. Determine the amounts of external financing in each year that will be necessary if the present
dividend per share is maintained.
c. Determine dividends per share and the amounts of external financing that will be necessary if
a dividend-payout ratio of 50 percent is maintained.
d. Under which of the three dividend policies are (1) aggregate dividends maximized? (2)
external financing minimized?

Residual Dividend Policy


3. A company predicts its earnings for the next year at Rs.56 million. It has 12 million shares and
it maintains a debt-equity ratio of 2.

(a) Calculate the maximum investment funds available without issuing new equity and increase
in borrowing that goes with it.

(b) Suppose that the company has a residual dividend policy. With a planned investment outlay
of Rs.72 million, what will the per share dividend be?

(c) In part (b), how much borrowing will take place? What is the addition to retained earnings?

(d) Suppose, the company does not plan any capital outlay in the coming year. What will the
dividend be under the residual dividend policy? What will new borrowings be?

Dividend Procedure
4. A company has just announced its regular quarterly cash dividend of Rs.1 per share.

(a) When will the stock price fall to reflect the dividend payment?
(b) Assume that there are no taxes. By how much is the price likely to fall?
(c) Now assume that all investors pay 30% tax on dividends and no tax on capital gains.. By how much is
the price likely to fall?

5. Lintern Limited declared a PAT of Rs. 300 Million. The share capital of the company consists of 15
Million equity shares of Rs.10 Each. During the year the company paid an interim dividend of Rs. 2 per
share and the directors proposed a final dividend @ Rs. 3 per shares. The dividend is subject to
distribution tax @ 20%. Calculate the Dividend Payout Ratio of the company.

Factors Affecting Dividend Payout

5. For each of the companies described below, would you expect it to have a medium/ high or a
low dividend-payout ratio? Explain why.

a. A company with a large proportion of inside ownership, all of whom are high-income
individuals.

b. A growth company with an abundance of good investment opportunities.

c. A company experiencing ordinary growth that has high liquidity and much unused borrowing
capacity.

d. A dividend-paying company that experiences an unexpected drop in earnings from a trend.

e. A company with volatile earnings and high business risk.

Factors Affecting Dividend Payout


6. Company A and Company B are in the Paper industry. Both are publicly held with a large
number of stockholders. They have the following characteristics (in thousands):

A B

Expected annual cash flow Rs.50,000 Rs.35,000


Standard deviation of cash flow 30,000 25,000
Annual capital expenditures 42,000 40,000
Cash and marketable securities 5,000 7,000
Existing long-term debt 1,00,000 85,000
Unused short-term line of credit 25,000 10,000
Floatation cost and under pricing
on common-stock issues as a
percent of proceeds 0.05 0.08

On the basis of this information, which company is likely to have the higher dividend-payout
ratio? Why/

Dividend Smoothing

8. The Xavier Industrial Coating Company has hired you as a financial consultant to advise the
company with respect to its dividend policy. The coating industry has been very stable for some
time, and the firm’s stock has not appreciated significantly in market value for some years. The
company has decided to undertake a vigorous expansion program to exploit new opportunities. It
plans to issue new shares in the near future and expects the new investments to yield a return of
25 percent. Data on earnings, dividends and common stock prices are given in the following
table.

2006 2007 2008 2009 2010


Expected

Earnings/share Rs.4.32 Rs.4.17 Rs.4.61 Rs.4.80 Rs.4.75


Cash available/share Rs.6.00 Rs.5.90 Rs.6.25 Rs.6.35 Rs.6.25
Dividend/share Rs.2.90 Rs.2.80 Rs.3.00 Rs.3.20 ?
Payout ratio 67% 67% 65% 67% ?
Average market price Rs.60.00 Rs.58.00 Rs.60.00 Rs.67.00 Rs.66.00
P/E ratio 14/1 14/1 13/1 14/1 14/1

What dividend policy recommendations would you make to the company? Specifically, what
payout would you recommend for 2010? Justify your position.

Stock Repurchases
10. The market-value based balance sheet of X Ltd. is given below. There are 5,000 shares of
stock outstanding

Equity Rs.8,750,000 Cash Rs.1,000,000


Fixed assets 7,750,000
--------------- -----------------
8,750,000 8,750,000
--------------- ------------------
(a) The company has declared a dividend of Rs.75 per share. The share will become ex-dividend
tomorrow. Ignoring any tax effects, what is the selling price of the stock today? What will it sell
for tomorrow? What will the balance sheet look like after the dividends are paid?

(b) Instead of paying dividend, the company has announced a share repurchase program of
Rs.375,000. What effect will this transaction have on the equity of the company? How many
shares will be outstanding? What will be the price per share after the repurchase? Ignore tax
effects.

11. The following information is available relating to a company:


Net Profit Rs.10 million
Number of shares before repurchase 1 million
Earnings per share Rs. 10
Price-earning ratio 20
Share price Rs. 200

The company now repurchases 200,000 shares at Rs.200 a share. The number of shares declines
to 800,000 shares and the earnings per share rises to Rs.12.50. Assuming the price-earning ratio
stays at 20, the share price rises to Rs.250. Discuss whether the repurchase increases the
shareholders’ wealth.

Stock Dividend

12. The shareholders’ funds of a company are as follows:


Rs.

Share capital (Rs.100 per share) 500,000


Securities premium 9,000,000
Retained earnings 29,325,000
--------------------
38,825,000
--------------------
The company’s share currently trades at Rs. 1,250. The company declares a stock dividend of
10%.. How many new shares will be distributed? Show how the shareholders’ equity will
change.

Stock Split
13. The shareholders’ funds of a company are as follows:
Rs.

Share capital (Rs.100 per share) 500,000


Securities premium 9,000,000
Retained earnings 29,325,000
--------------------
38,825,000
--------------------
(a) The company announces a four for one stock split. How many shares are outstanding now?
What is the new par value per share?

(b) The company announces a one for five reverse stock split. How many shares are outstanding
now? What is the new par value per share?

You might also like