Tutorial Chapter 19:

3, 7, 13, 14, 15
Common Stock ($1 par value) $25,000
Capital Surplus $135,000
Retained Earnings $ 487,600
Total owners’ equity $ 647,600

Answer:
a. To find the new shares outstanding, we multiply the current shares outstanding times the
ratio of new shares to old shares, so:

New shares outstanding = 25,000(4/1)

New shares outstanding = 100,000

The equity accounts are unchanged except that the par value of the stock is changed
by the ratio of new shares to old shares, so the new par value is:

New par value = $1(1/4)

New par value = $.25 per share

b. To find the new shares outstanding, we multiply the current shares outstanding times the
ratio of new shares to old shares, so:

New shares outstanding = 25,000(1/5)

New shares outstanding = 5,000

The equity accounts are unchanged except that the par value of the stock is changed by
the ratio of new shares to old shares, so the new par value is:

New par value = $1(5/1)

New par value = $5.00 per share

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Answer:

The stock price is the total market value of equity divided by the shares outstanding, so:
P0 = $695,000 equity/25,000 shares
P0 = $27.80 per share
The shares outstanding will increase by 25 percent, so:
New shares outstanding = 25,000(1.25)
New shares outstanding = 31,250
The new stock price is the market value of equity divided by the new shares outstanding,
so:
PX = $695,000/31,250 shares
PX = $22.24

Answer:

a. If the company makes a dividend payment, we can calculate the wealth of a

shareholder as:

Dividend per share = $6,675/1,500 shares

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 Dividend per share = $4.45

The stock price after the dividend payment will be:

PX = $67 – 4.45
PX = $62.55 per share

The shareholder will have a stock worth $62.55 and a $4.45 dividend for a total wealth
of $67. If the company makes a repurchase, the company will repurchase:
Shares repurchased = $6,675/$67
Shares repurchased = 99.63 shares

If the shareholder lets their shares be repurchased, they will have $67 in cash. If the
shareholder keeps their shares, they’re still worth $67.

b. If the company pays dividends, the current EPS is $2.80, and the PE ratio is:

PE = $62.55/$2.80
PE = 22.34

If the company repurchases stock, the number of shares will decrease. The total net
income is the EPS times the current number of shares outstanding. Dividing net
income by the new number of shares outstanding, we find the EPS under the
repurchase is:

EPS = $2.80(1,500)/(1,500 − 99.63)

EPS = $3.00

The stock price will remain at $67 per share, so the PE ratio is:
PE = $67/$3.00
PE = 22.34

c. A share repurchase would seem to be the preferred course of action. Only those
shareholders who wish to sell will do so, giving the shareholder a tax timing option
that he or she doesn’t get with a dividend payment.

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Answer:

a. Since the firm has a 100 percent payout policy, the entire net income, $135,000 will
be paid as a dividend. The current value of the firm is the discounted value one year
from now, plus the current income, which is:

Value = $135,000 + $1,985,000/1.12

Value = $1,907,321.43

b. The current stock price is the value of the firm, divided by the shares outstanding,
which is:

Stock price = $1,907,321.43/30,000

Stock price = $63.58

Since the company has a 100 percent payout policy, the current dividend per share
will be the company’s net income, divided by the shares outstanding, or:

Current dividend = $135,000/30,000

Current dividend = $4.50

The stock price will fall by the value of the dividend to:

Ex-dividend stock price = $63.58 – 4.50

Ex-dividend stock price = $59.08

c. i. According to MM, it cannot be true that the low dividend is depressing the price.
Since dividend policy is irrelevant, the level of the dividend should not matter.
Any funds not distributed as dividends add to the value of the firm, hence the
stock price. These directors merely want to change the timing of the dividends
(more now, less in the future). As the calculations below indicate, the value of
the firm is unchanged by their proposal. Therefore, the share price will be
unchanged.

To show this, consider what would happen if the dividend were increased to
$6.25. Since only the existing shareholders will get the dividend, the required
dollar amount to pay the dividends is:

Total dividends = $6.25(30,000)

Total dividends = $187,500

To fund this dividend payment, the company must raise:

Dollars raised = Required funds – Net income
Dollars raised = $187,500 – 135,000
Dollars raised = $52,500
This money can only be raised with the sale of new equity to maintain the all-
equity financing. Since those new shareholders must also earn 12 percent, their
share of the firm one year from now is:

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 New shareholder value in one year = $52,500(1.12)
New shareholder value in one year = $58,800
This means that the old shareholders' interest falls to:
Old shareholder value in one year = $1,985,000 – 58,800
Old shareholder value in one year = $1,926,200
Under this scenario, the current value of the firm is:
Value = $187,500 + $1,926,200/1.12
Value = $1,907,321.43
Since the firm value is the same as in part a, the change in dividend policy had
no effect.

ii. The new shareholders are not entitled to receive the current dividend. They will
receive only the value of the equity one year hence. The present value of those
flows is:
Present value = $1,926,200/1.12
Present value = $1,719,821.43

And the current share price will be:

Current share price = $1,719,821.43/30,000
Current share price = $57.33

So, the number of new shares the company must sell will be:
Shares sold = $52,500/$57.33
Shares sold = 915.79 shares

Answer:

a. The current price is the current cash flow of the company plus the present value of
the expected cash flows, divided by the number of shares outstanding. So, the current
stock price is:

Stock price = ($1,100,000 + 16,500,000)/525,000

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 Stock price = $33.52

b. To achieve a zero dividend payout policy, he can invest the dividends back into the
company’s stock. The dividends per share will be:

Dividends per share = [($1,100,000)(.50)]/525,000

Dividends per share = $1.05

And the stockholder in question will receive:

Dividends paid to shareholder = $1.05(1,000)

Dividends paid to shareholder = $1,047.62
The new stock price after the dividends are paid will be:
Ex-dividend stock price = $33.52 – 1.05
Ex-dividend stock price = $32.48

So, the number of shares the investor will buy is:

Number of shares to buy = $1,047.62/$32.48
Number of shares to buy = 32.26