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Tutorial 10 Solution

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16 views3 pages

Tutorial 10 Solution

Uploaded by

z7fc8mnkr2
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Tutorial 10

Question 1 (Handwritten)
Pinder Ltd is currently trading at $15 per share and is planning on a dividend of $2
per share. The capital gains tax and dividend income tax for Pinder Ltd’s shareholders
are 10% and 20% respectively. Based only on the information above, what is the
expected share price of Pinder Ltd on the ex-dividend date?

(15 – X) / 2 = (1 – 0.2) / (1 – 0.1)


X = 13.22

Question 2 (Handwritten)
If Demons Inc. is priced at $50.00 with a dividend of $5.00, and its price falls to
$46.50 on the ex-dividend date, what is the implied rate of personal income tax (at
which dividends are taxed) for its average stockholder? Assume that the personal tax
rate on capital gains is 40% of the personal income tax rate.

(Price before - Price After)/Dividend = (1- t) / (1-.4 t) where t is the personal income
tax rate.
Solving for the personal tax rate,
3.5/5 = (1-t)/(1-.4t)
The personal income tax rate = 0.30/0.72 = 41.67%
Question 3 (Handwritten)
Evaluate whether each of the following statements makes sense or not.
(a) “Dividends today are more certain than capital gains later. Hence dividends are
more valuable than capital gains. Stocks that pay dividends will therefore be more
highly valued than stocks that do not.”
(b) “Since the firm has excess cash on its hands this year and no investment projects
this year, it needs to give the money back to stockholders.”

(a) No. This argument is called “The Bird in the Hand” Fallacy which is about the
resolution of uncertainty. The popularity of this fallacy is based on the
intuition that investors would rather receive the cash than have managers
invest it into negative NPV projects. But note that any increase in value is
really caused by a change in investment policy (foregone negative NPV
projects) and not by a change in dividend policy. To see this, note that if
managers paid the dividend but raised funds for the bad projects through
new equity issues (which caused a price drop), then no value would be created
for shareholders. Dividends are less uncertain than capital gains, but investors
can resolve uncertainty associated with capital gain by selling shares
immediately.
(b) No. Excess cash might be a temporary phenomenon. So, the firm has to
consider future financing needs. The cost of raising new financing in future
years, especially by issuing new equity, can be staggering. In addition,
initiating dividends with the cash will create the expectation that the firm will
continue to pay those dividends, which might be unsustainable. Stock
buybacks provide more flexibility in terms of future actions. Another
alternative can be a special dividend.
Question 4 (Handwritten)
Under the imputation tax system, there is an optimal dividend policy for all Australian
companies: always pay the maximum possible franked dividend, given the balance in
the franking account. Discuss this statement.

Simply maximising the payout of franked dividends may not be an optimal dividend
policy for all Australian companies. Companies should also pay attention to non-
resident investors who do not benefit directly from tax credits. The possibility of
distributing additional cash through buying back shares should also be considered.
For other companies, the amount of cash available after paying dividends may serve
as a constraint on payment of cash dividends, but any such constraint may be
addressed by introducing a dividend reinvestment plan.

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