1 Questions and Exercises

CHAPTER 4
DIVIDENDS AND OTHER PAYOUTS
BASIC
1. Dividends and Taxes Lee Ann, Inc., has declared a $7.50 per-share dividend. Suppose capital
gains are not taxed, but dividends are taxed at 15 percent. New IRS regulations require that taxes be
withheld when the dividend is paid. The company’s stock sells for $93 per share, and is about to go
ex-dividend. What do you think the ex-dividend price will be?
2. Stock Dividends The owners’ equity accounts for Hexagon International are shown here:

a. If the company’s stock currently sells for $39 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 the company declared a 25 percent stock dividend, how would the accounts change?
c. Show how the equity accounts will change if the company declares a four-for-one stock split. How
many shares are outstanding now? What is the new par value per share?
3. Regular Dividends The balance sheet for Levy Corp. is shown here in market value
terms. There are 14,000 shares of stock outstanding.

The company has declared a dividend of $1.60 per share. The stock goes ex dividend tomorrow.
Ignoring any tax effects, what is the stock selling for today? What will it sell for tomorrow? What will
the balance sheet look like after the dividends are paid?
4. Share Repurchase In the previous problem, suppose the company has announced it is going to
repurchase $22,400 worth of stock. What effect will this transaction have on the equity of the
company? How many shares will be outstanding? What will the price
per share be after the repurchase? Ignoring tax effects, show how the share repurchase is effectively
the same as a cash dividend.
5. Stock Dividends The company with the common equity accounts shown here has declared a
stock dividend of 15 percent when the market value of its stock is $57 per share. What effects on the
equity accounts will the distribution of the stock dividend have?
 Corporate Finance 11th edition by Ross, Westerfield, Jaffe, and Jordan 2

6. Dividends and Stock Price The Mann Company belongs to a risk class for which the appropriate
discount rate is 10 percent. Mann currently has 240,000 outstanding shares selling at $105 each. The
firm is contemplating the declaration of a $4 dividend at the end of the fiscal year that just began.
Assume there are no taxes on dividends. Answer the following questions based on the Miller and
Modigliani model, which is discussed in the text.
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 Mann makes $4.3 million of new investments at the beginning of the period, earns net income of
$1.9 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?
INTERMEDIATE
7. Homemade Dividends You own 1,000 shares of stock in Avondale Corporation. You will receive a
dividend of $2.60 per share in one year. In two years, Avondale will pay a liquidating dividend of $53
per share. The required return on Avondale stock is 14 percent.
a. 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.)
b. Suppose you want only $500 total in dividends the first year. What will your homemade dividend be
in two years?
8. Stock Repurchase Flychucker Corporation is evaluating an extra dividend versus a share
repurchase. In either case $6,300 would be spent. Current earnings are $2.60 per share, and the
stock currently sells for $51 per share. There are 1,500 shares outstanding. Ignore taxes and other
imperfections in answering parts (a) and (b).
a. Evaluate the two alternatives in terms of the effect on the price per share of the stock and
shareholder wealth.
b. What will be the effect on the company’s EPS and PE ratio under the two different scenarios?
9. Dividend Policy Gibson Co. has a current period cash flow of $1.3 million and pays no dividends.
The present value of the company’s future cash flows is $18 million. The company is entirely financed
with equity and has 550,000 shares outstanding. Assume the dividend tax rate is zero.
a. What is the share price of the company’s stock?
b. Suppose the board of directors of the company announces its plan to pay out 50 percent of its
current cash flow as cash dividends to its shareholders. How can Jeff Miller, who owns 1,000 shares
of the company’s stock, achieve a zero payout policy on his own?
 3 Questions and Exercises

CHALLENGE
10. Dividends versus Reinvestment After completing its capital spending for the year, Carlson
Manufacturing has $1,000 extra cash. Carlson’s managers must choose between investing the cash
in Treasury bonds that yield 8 percent or paying the cash out to investors who would invest in the
bonds themselves.
a. If the corporate tax rate is 35 percent, what personal tax rate would make the investors equally
willing to receive the dividend or to let Carlson invest the money?
b. Is the answer to (a) reasonable? Why or why not?
c. Suppose the only investment choice is a preferred stock that yields 12 percent. The corporate
dividend exclusion of 70 percent applies. What personal tax rate will make the stockholders indifferent
to the outcome of Carlson’s dividend decision?
11. Expected Return, Dividends, and Taxes The Gecko Company and the Gordon Company are
two firms whose business risk is the same but that have different dividend policies. Gecko pays no
dividend, whereas Gordon has an expected dividend yield of 4.7 percent. Suppose the capital gains
tax rate is zero, whereas the dividend tax rate is 35 percent. Gecko has an expected earnings growth
rate of 13 percent annually, and its stock price is expected to grow at this same rate. If the aftertax
expected returns on the two stocks are equal (because they are in the same risk class), what is the
pretax required return on Gordon’s stock?