DIVIDEND POLICY
Multiple Choice: True/False
1.
The optimal distribution policy strikes that balance between current dividends and
capital gains that maximizes the firm's stock price.
ANS: True
PTS: 1
2.
Other things held constant, the higher a firm's target payout ratio, the higher its
expected growth rate should be.
ANS: False
PTS: 1
3.Miller
and Modigliani's dividend irrelevance theory says that the percentage of its
earnings a firm pays out in dividends has no effect on either its cost of capital or its
stock price.
ANS: True
PTS: 1
4.
Miller and Modigliani's dividend irrelevance theory says that the percentage of its
earnings a firm pays out in dividends has no effect on its cost of capital, but it does
affect its stock price.
ANS: False
PTS: 1
5.If
investors prefer firms that retain most of their earnings, then a firm that wants to
maximize its stock price should set a low payout ratio.
ANS: True
PTS: 1
6.
A 100% stock dividend and a 2:1 stock split should, at least conceptually, have the
same effect on the firm's stock price.
ANS: True
PTS: 1
7.
A “reverse split” reduces the number of shares outstanding.
ANS: True
PTS: 1
8.
The announcement of an increase in the cash dividend should, according to MM, lead
to an increase in the price of the firm's stock, other things held constant.
ANS: False
PTS: 1
9.
The federal government sometimes taxes dividends and capital gains at different
rates. Other things held constant, an increase in the tax rate on dividends relative to
that on capital gains would logically lead to an increase in dividend payout ratios.
ANS: False
PTS: 1
10.
The federal government sometimes taxes dividends and capital gains at different
rates. Other things held constant, if the tax rate on dividends is high relative to that on
capital gains, then individuals with low taxable incomes should favor stocks with low
payouts and high-income individuals should favor high-payout companies.
ANS: False
PTS: 1
11.
It has been argued that investors prefer high-payout companies because dividends
are more certain (less risky) than the capital gains that are supposed to come from
retained earnings. However, Miller and Modigliani say that this argument is incorrect,
and they call it the “bird-in-the-hand fallacy.” MM base their argument on the belief that
most dividends are reinvested in stocks, hence are exposed to the same risks as
reinvested earnings.
ANS: True
PTS: 1
12.
Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their
argument that the value of the firm is determined only by its basic earning power and its
business risk.
ANS: True
PTS: 1
13.
One implication of the bird-in-the-hand theory of dividends is that a given
reduction in dividend yield must be offset by a more than proportionate increase in
growth in order to keep a firm's required return constant, other things held constant.
ANS: True
PTS: 1
14.
If a retired individual lives on his or her investment income, then it would make
sense for this person to prefer stocks with high payouts so he or she could receive cash
without going to the trouble and expense of selling stocks. On the other hand, it would
make sense for an individual who would just reinvest any dividends received to prefer a
low-payout company because that would save him or her taxes and brokerage costs.
ANS: True
PTS: 1
15.Some
investors prefer dividends to retained earnings (and the capital gains retained
earnings bring), while others prefer retained earnings to dividends. Other things held
constant, it makes sense for a company to establish its dividend policy and stick to it,
and then it will attract a clientele of investors who like that policy.
ANS: True
PTS: 1
16.
Suppose a firm that has been earning P2 and paying a dividend of P1.00, or a 50%
dividend payout, announces that it is increasing the dividend to P1.50. The stock price
then jumps from P20 to P30. Some people would argue that this is proof that investors
prefer dividends to retained earnings. Miller and Modigliani would agree with this
argument.
ANS: False
PTS: 1
17.
If the information content, or signaling, hypothesis is correct, then a change in a
firm's dividend policy can have an important effect on its stock price and cost of equity.
ANS: True
PTS: 1
18.If
a firm uses the residual dividend model to set dividend policy, then dividends are
determined as a residual after providing for the equity required to fund the capital
budget. Under this model, the better the firm's investment opportunities, the lower its
payout ratio will be, other things held constant.
ANS: True
PTS: 1
19.If
a firm uses the residual dividend model to set dividend policy, then dividends are
determined as a residual after providing for the equity required to fund the capital
budget. Under this model, the higher the firm's debt ratio, the lower its payout ratio will
be, other things held constant.
ANS: False
PTS: 1
20.If
management wants to maximize its stock price, and if it believes that the dividend
irrelevance theory is correct, then it must adhere to the residual dividend policy.
ANS: False
PTS: 1
21.If
on January 3, 2012, a company declares a dividend of P1.50 per share, payable on
January 31, 2012, then the price of the stock should drop by approximate P1.50 on
January 31.
ANS: False
PTS: 1
22.If
on January 3, 2012, a company declares a dividend of $1.50 per share, payable on
January 31, 2012, to holders of record on January 19, then the price of the stock should
drop by approximately $1.50 on January 17, which is the ex-dividend date.
ANS: True
PTS: 1
ANS:
True
PTS: 1
23.
One advantage of dividend reinvestment plans is that they allow shareholders to
delay paying taxes on the dividends that they choose to reinvest.
ANS: False
PTS: 1
(15-4) Dividend reinvestment plans
F R Answer: a MEDIUM
There are two types of dividend reinvestment plans. Under one type of plan, the
firm uses the cash that would have been paid as dividends to buy stock on the open
market. Under the other type, the company issues new stock, keeps the cash that
would have been paid out, and in effect sells new stock to those investors who choose
to reinvest their dividends.
ANS: True
PTS: 1
24.
a.
b.
True
False
(15-4) Dividend reinvestment plans
F R Answer: a MEDIUM
25.
If a firm pays out all of its earnings as dividends and its stockholders then elect to
have all of their dividends reinvested, the company should reconsider its dividend policy
and possibly move to a lower dividend payout ratio.
ANS: True
PTS: 1
a.
b.
True
False
(15-6) Stock split
F R Answer: a MEDIUM
26.
If a firm declares a 20:1 stock split, and the pre-split price was $500, then we
might expect the post-split price to be $25. However, it often turns out that the post-split
price will be higher than $25. This higher price could be due to signaling effects-investors believe that management split the stock because they think the firm is going to
do better in the future. The higher price could also be because investors like lowerpriced shares.
ANS: True
PTS: 1
a.
b.
True
False
(15-3) Residual dividend model F R Answer: a HARD
27.
Your firm uses the residual dividend model to set dividend policy. Market interest
rates suddenly rise, and stock prices decline. Your firm's earnings, investment
opportunities, and capital structure do not change. If the firm follows the residual
dividend model, then its dividend payout ratio would increase.
ANS: True
PTS: 1
a.
b.
True
False
(15-5) WACC and dividend policy F R Answer: b HARD
28.
Suppose you plotted a curve which showed a Firm U's WACC on the vertical axis
and its debt ratio on the horizontal axis. Then you plotted a similar curve for Firm V.
The curve for firm U resembled a shallow “U,” while that for Firm V resembled a sharp
“V.” Both firms have debt ratios that cause their WACCs to be minimized. Other things
held constant, it would be easier for Firm V than for Firm U to maintain a steady
dividend in the face of varying investment opportunities and earnings from year to year.
ANS: True
PTS: 1
a.
b.
True
False
Multiple Choice: Conceptual
(15-3) Dividend payout
C R Answer: a EASY
29.
In the real world, dividends
a.
are usually more stable than earnings.
b.
fluctuate more widely than earnings.
c.
tend to be a lower percentage of earnings for mature firms.
d.
are usually changed every year to reflect earnings changes, and these changes
are randomly higher to lower, depending on whether earnings increased or decreased.
e.
are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if
EPS = $2.00, then DPS would equal $0.80. Once the percentage is set, then dividend
policy is on “automatic pilot” and the dividend actually paid depends strictly on earnings.
(15-6) Stock split
C R Answer: b EASY
30.
You own 100 shares of Troll Brothers' stock, which currently sells for $120 a
share. The company is about to declare a 2-for-1 stock split. Which of the following
best describes your likely position after the split?
a.
You will have 200 shares of stock, and the stock will trade at or near $120 a
share.
b.
You will have 200 shares of stock, and the stock will trade at or near $60 a share.
c.
You will have 100 shares of stock, and the stock will trade at or near $60 a share.
d.
You will have 50 shares of stock, and the stock will trade at or near $120 a share.
e.
You will have 50 shares of stock, and the stock will trade at or near $600 a share.
(15-1) Investors' div. preferences C R Answer: d MEDIUM
31.
Myron Gordon and John Lintner believe that the required return on equity
increases as the dividend payout ratio is lowered. Their argument is based on the
assumption that
a.
investors are indifferent between dividends and capital gains.
b.
investors require that the dividend yield plus the capital gains yield equal a
constant.
c.
capital gains are taxed at a higher rate than dividends.
d.
investors view dividends as being less risky than potential future capital gains.
e.
investors prefer a dollar of expected capital gains to a dollar of expected
dividends because of the lower tax rate on capital gains.
(15-3) Residual dividend model C R Answer: a MEDIUM
32.
Your firm adheres strictly to the residual dividend model. All else equal, which of
the following factors would be most likely to lead to an increase in the firm's dividend per
share?
a.
The firm's net income increases.
b.
The company increases the percentage of equity in its target capital structure.
c.
The number of profitable potential projects increases.
d.
Congress lowers the tax rate on capital gains, leaving the rest of the tax code
unchanged.
e.
Earnings are unchanged, but the firm issues new shares of common stock.
(15-3) Residual dividend model C R Answer: b MEDIUM
33.
If a firm adheres strictly to the residual dividend policy, and if its optimal capital
budget requires the use of all earnings for a given year (along with new debt according
to the optimal debt/assets ratio), then the firm should pay
a.
b.
c.
d.
e.
the same dividend as it paid the prior year.
no dividends to common stockholders.
dividends only out of funds raised by the sale of new common stock.
dividends only out of funds raised by borrowing money (i.e., issuing debt).
dividends only out of funds raised by selling off fixed assets.
(15-3) Residual dividend model C R Answer: c MEDIUM
34.
If a firm adheres strictly to the residual dividend model, the issuance of new
common stock would suggest that
a.
b.
c.
d.
e.
the dividend payout ratio has remained constant.
the dividend payout ratio is increasing.
no dividends will be paid during the year.
the dividend payout ratio is decreasing.
the dollar amount of capital investments had decreased.
(15-5) Factors in div. policy
C R Answer: d MEDIUM
35.
Which of the following does NOT normally influence a firm's dividend policy
decision?
a.
The firm's ability to accelerate or delay investment projects without adverse
consequences.
b.
A strong preference by most of its shareholders for current cash income versus
potential future capital gains.
c.
Constraints imposed by the firm's bond indenture.
d.
The fact that much of the firm's equipment is leased rather than bought and
owned.
e.
The fact that Congress is considering changes in the tax law regarding the
taxation of dividends versus capital gains.
(15-5) Factors in div. policy
C R Answer: c MEDIUM
36.
Which of the following would be most likely to lead to a decrease in a firm's
dividend payout ratio?
a.
Its earnings become more stable.
b.
Its access to the capital markets increases.
c.
Its research and development efforts pay off, and it now has more high-return
investment opportunities.
d.
Its accounts receivable decrease due to a change in its credit policy.
e.
Its stock price has increased over the last year by a greater percentage than the
increase in the broad stock market averages.
(15-6) Stock dividends and splits C R Answer: e MEDIUM
37.
Which of the following statements is CORRECT?
a.
When firms are deciding on the size of stock splits--say whether to declare a 2for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1
split, because then the after-split price will be higher than if the 3-for-1 split had been
used.
b.
Back before the SEC was created in the 1930s, companies would declare
reverse splits in order to boost their stock prices. However, this was determined to be a
deceptive practice, and reverse splits are illegal today.
c.
Stock splits create more administrative problems for investors than stock
dividends, especially determining the tax basis of their shares when they decide to sell
them, so today stock dividends are used far more often than stock splits.
d.
When a company declares a stock split, the price of the stock typically declines-for example, by about 50% after a 2-for-1 split--and this necessarily reduces the total
market value of the firm's equity.
e.
If a firm's stock price is quite high relative to most stocks--say $500 per share-then it can declare a stock split of say 20-for-1 so as to bring the price down to
something close to $25. Moreover, if the price is relatively low--say $2 per share--then
it can declare a “reverse split” of say 1-for-10 so as to bring the price up to somewhere
around $20 per share.
(Comp.) Dividend theories C R Answer: e MEDIUM
38.
Which of the following statements about dividend policies is CORRECT?
a.
Miller and Modigliani argued that investors prefer dividends to capital gains
because dividends are more certain than capital gains. They call this the “bird-in-thehand” effect.
b.
One reason that companies tend to favor distributing excess cash as dividends
rather than by repurchasing stock is that dividends are normally taxed at a lower rate
than gains on repurchased stock.
c.
One advantage of dividend reinvestment plans is that they allow shareholders to
delay paying taxes on the dividends that they choose to reinvest.
d.
One key advantage of the residual dividend model is that it enables a company
to follow a stable dividend policy.
e.
The clientele effect suggests that companies should follow a stable dividend
policy.
(Comp.) Repurchases and DRIPS
C R Answer: c MEDIUM
39.
Which of the following statements is CORRECT?
a.
One disadvantage of dividend reinvestment plans is that they increase
transactions costs for investors who want to increase their investment in the company.
b.
One advantage of dividend reinvestment plans is that they enable investors to
postpone paying taxes on the dividends credited to their account.
c.
Stock repurchases can be used by a firm that wants to increase its debt ratio.
d.
Stock repurchases make sense if a company expects to have a lot of profitable
new projects to fund over the next few years, provided investors are aware of these
investment opportunities.
e.
One advantage of an open market dividend reinvestment plan is that it provides
new equity capital and increases the shares outstanding.
(Comp.) Divs., DRIPs, and repurch.
C R Answer: d MEDIUM
40.
Which of the following statements is CORRECT?
a.
Under the tax laws as they existed in 2011, a dollar received by an individual
taxpayer as interest income is taxed at the same rate as a dollar received as dividends.
b.
One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the
taxes investors would have to pay if they received cash dividends.
c.
Empirical research indicates that, in general, companies send a negative signal
to the marketplace when they announce an increase in the dividend. As a result, share
prices fall when dividend increases are announced because investors interpret the
increase as a signal that the firm expects fewer good investment opportunities in the
future.
d.
If a company needs to raise new equity capital, a new-stock dividend
reinvestment plan would make sense. However, if the firm does not need new equity,
then an open market purchase dividend reinvestment plan would probably make more
sense.
e.
Dividend reinvestment plans have not caught on in most industries, and today
over 99% of all DRIPs are offered by utilities.
(Comp.) Div. policy and repurchases
C R Answer: d MEDIUM
41.
Which of the following statements is CORRECT?
a.
Historically, the tax code has encouraged companies to pay dividends rather
than retain earnings.
b.
If a company uses the residual dividend model to determine its dividend
payments, dividend payout will tend to increase whenever its profitable investment
opportunities increase relatively rapidly.
c.
The more a firm's management believes in the clientele effect, the more likely the
firm is to adhere strictly to the residual dividend model.
d.
Large stock repurchases financed by debt tend to increase expected earnings
per share, but they also tend to increase the firm's financial risk.
e.
A dollar paid out to repurchase stock has the same tax benefit as a dollar paid
out in dividends. Thus, both companies and investors should be indifferent between
distributing cash through dividends and stock repurchase programs.
(Comp.) Dividend concepts
C R Answer: c MEDIUM
42.
Which of the following statements is CORRECT?
a.
If a company has a 2-for-1 stock split, its stock price should roughly double.
b.
Capital gains earned on shares repurchased are taxed less favorably than
dividends, which is why companies typically pay dividends and avoid share
repurchases.
c.
Very often, a company's stock price will rise when it announces that it plans to
commence a share repurchase program. Such an announcement could lead to a stock
price decline, but this does not normally happen.
d.
Stock repurchases increase the number of outstanding shares.
e.
The clientele effect is the best explanation for why companies tend to vary their
dividend payments from quarter to quarter.
(Comp.) Dividend concepts
C R Answer: e MEDIUM
43.
Which of the following statements is CORRECT?
a.
Firms with a lot of good investment opportunities and a relatively small amount of
cash tend to have above-average dividend payout ratios.
b.
One advantage of the residual dividend model is that it leads to a stable dividend
payout, which investors like.
c.
An increase in the stock price when a company cuts its dividend is consistent
with signaling theory as postulated by MM.
d.
If the “clientele effect” is correct, then for a company whose earnings fluctuate, a
policy of paying a constant percentage of net income will probably maximize its stock
price.
e.
Stock repurchases make the most sense at times when a company believes its
stock is undervalued.
(Comp.) Dividend concepts
C R Answer: b MEDIUM
44.
Which of the following statements is CORRECT?
a.
One advantage of dividend reinvestment plans is that they enable investors to
avoid paying taxes on the dividends they receive.
b.
If a company has an established clientele of investors who prefer a high dividend
payout, and if management wants to keep stockholders happy, it should not adhere
strictly to the residual dividend model.
c.
If a firm adheres strictly to the residual dividend model, then, holding all else
constant, its dividend payout ratio will tend to rise whenever its investment opportunities
improve.
d.
If Congress eliminates taxes on capital gains but leaves the personal tax rate on
dividends unchanged, this would motivate companies to increase their dividend payout
ratios.
e.
Despite its drawbacks, following the residual dividend model will tend to stabilize
actual cash dividends, and this will make it easier for firms to attract a clientele that
prefers high dividends, such as retirees.
(Comp.) Dividend concepts
C R Answer: b MEDIUM
45.
Firm M is a mature company in a mature industry. Its annual net income and
cash flows are consistently high and stable. However, M's growth prospects are quite
limited, so its capital budget is small relative to its net income. Firm N is a relatively new
company in a new and growing industry. Its markets and products have not stabilized,
so its annual operating income fluctuates considerably. However, N has substantial
growth opportunities, and its capital budget is expected to be large relative to its net
income for the foreseeable future. Which of the following statements is CORRECT?
a.
Firm M probably has a lower target debt ratio than Firm N.
b.
Firm M probably has a higher target dividend payout ratio than Firm N.
c.
If the corporate tax rate increases, the debt ratio of both firms is likely to decline.
d.
The two firms are equally likely to pay high dividends.
e.
Firm N is likely to have a clientele of shareholders who want a consistent, stable
dividend income.
(Comp.) Dividend concepts
C R Answer: a MEDIUM
46.
Which of the following statements is CORRECT?
a.
If a firm repurchases some of its stock in the open market, then shareholders
who sell their stock for more than they paid for it will be subject to capital gains taxes.
b.
An open-market dividend reinvestment plan will be most attractive to companies
that need new equity and would otherwise have to issue additional shares of common
stock through investment bankers.
c.
Stock repurchases tend to reduce financial leverage.
d.
If a company declares a 2-for-1 stock split, its stock price should roughly double.
e.
One advantage of adopting the residual dividend model is that this makes it
easier for corporations to meet the requirements of Modigliani and Miller's dividend
clientele theory.
(Comp.) Dividend concepts
C R Answer: e MEDIUM
47.
Which of the following actions will best enable a company to raise additional
equity capital, other things held constant?
a.
b.
c.
d.
e.
Refund long-term debt with lower cost short-term debt.
Declare a stock split.
Begin an open-market purchase dividend reinvestment plan.
Initiate a stock repurchase program.
Begin a new-stock dividend reinvestment plan.
(Comp.) Repurchases and splits C R Answer: e MEDIUM
48.
Which of the following statements is NOT CORRECT?
a.
Stock repurchases can be used by a firm as part of a plan to change its capital
structure.
b.
After a 3-for-1 stock split, a company's price per share should fall, but the number
of shares outstanding will rise.
c.
Investors may interpret a stock repurchase program as a signal that the firm's
managers believe the stock is undervalued, or, alternatively, as a signal that the firm
does not have many good investment opportunities.
d.
A company can repurchase stock to distribute a large one-time cash inflow, say
from the sale of a division, to stockholders without having to increase its regular
dividend.
e.
Stockholders pay no income tax on dividends if the dividends are used to
purchase stock through a dividend reinvestment plan.
(Comp.) Dividend concepts
C R Answer: a MEDIUM/HARD
49.
Which of the following statements is CORRECT?
a.
If a firm follows the residual dividend model, then a sudden increase in the
number of profitable projects would be likely to lead to a reduction of the firm's dividend
payout ratio.
b.
The clientele effect explains why so many firms change their dividend policies so
often.
c.
One advantage of adopting the residual dividend model is that this policy makes
it easier for a corporation to attract a specific and well-identified dividend clientele.
d.
New-stock dividend reinvestment plans are similar to stock dividends because
they both increase the number of shares outstanding but don't change the firm's total
amount of book equity.
e.
Investors who receive stock dividends must pay taxes on the value of the new
shares in the year the stock dividends are received.
(Comp.) Dividend concepts
C R Answer: d MEDIUM/HARD
50.
Which of the following statements is CORRECT?
a.
Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a
50% dividend payout, announces that it is increasing the dividend to $1.50. The stock
price then jumps from $20 to $30. Some people would argue that this is proof that
investors prefer dividends to retained earnings. Miller and Modigliani would agree with
this argument.
b.
Other things held constant, the higher a firm's target dividend payout ratio, the
higher its expected growth rate should be.
c.
Miller and Modigliani's dividend irrelevance theory says that the percentage of its
earnings that a firm pays out in dividends has no effect on its cost of capital, but it does
affect its stock price.
d.
The federal government sometimes taxes dividends and capital gains at different
rates. Other things held constant, an increase in the tax rate on dividends relative to
that on capital gains would logically lead to a decrease in dividend payout ratios.
e.
If investors prefer firms that retain most of their earnings, then a firm that wants
to maximize its stock price should set a high dividend payout ratio.
Multiple Choice: Problems
These problems can be changed algorithmically, and the computer can, at times,
produce combinations of variables where the residual policy results in zero dividends
and a zero payout ratio. We sometimes constrain the input variables to prevent this
from occurring, but we sometimes permit it. When this possibility exists, we so indicate.
(15-3) Residual dividend model C R Answer: d EASY
51.
Portland Plastics Inc. has the following data. If it follows the residual dividend
model, what is its forecasted dividend payout ratio?
Capital budget
% Debt 40%
Net income (NI)
a.
b.
c.
d.
e.
$12,500
$11,500
25.36%
28.17%
31.30%
34.78%
38.26%
(15-6) Stock split
C R Answer: c EASY
52.
Becker Financial recently declared a 2-for-1 stock split. Prior to the split, the
stock sold for $80 per share. If the firm's total market value is unchanged by the split,
what will the stock price be following the split?
a.
b.
c.
d.
e.
$36.10
$38.00
$40.00
$42.00
$44.10
(15-6) Stock split
C R Answer: a EASY
53.
Toombs Media Corp. recently completed a 3-for-1 stock split. Prior to the split,
its stock sold for $90 per share. The firm's total market value was unchanged by the
split. Other things held constant, what is the best estimate of the stock's post-split
price?
a.
b.
c.
d.
e.
$30.00
$31.50
$33.08
$34.73
$36.47
(15-6) Stock split
C R Answer: c EASY
54.
Mid-State BankCorp recently declared a 7-for-2 stock split. Prior to the split, the
stock sold for $80 per share. If the firm's total market value is unchanged by the split,
what will the stock price be following the split?
a.
b.
c.
d.
e.
$20.63
$21.71
$22.86
$24.00
$25.20
(15-3) Residual dividend model C R Answer: b EASY/MEDIUM
55.
Fauver Industries plans to have a capital budget of $650,000. It wants to
maintain a target capital structure of 40% debt and 60% equity, and it also wants to pay
a dividend of $225,000. If the company follows the residual dividend model, how much
net income must it earn to meet its investment requirements, pay the dividend, and
keep the capital structure in balance?
a.
b.
c.
d.
e.
$584,250
$615,000
$645,750
$678,038
$711,939
(15-3) Residual dividend model C R Answer: b MEDIUM
56.
Ring Technology has a capital budget of $850,000, it wants to maintain a target
capital structure of 35% debt and 65% equity, and it also wants to pay a dividend of
$400,000. If the company follows the residual dividend model, how much net income
must it earn to meet its capital budgeting requirements and pay the dividend, all while
keeping its capital structure in balance?
a.
b.
c.
d.
e.
$ 904,875
$ 952,500
$1,000,125
$1,050,131
$1,102,638
(15-3) Residual dividend model C R Answer: a MEDIUM
57.
D. Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain
a target capital structure of 45% debt and 55% equity, and she also wants to pay a
dividend of $500,000. If the company follows the residual dividend model, how much
income must it earn, and what will its dividend payout ratio be?
a.
b.
c.
d.
e.
$ 898,750; 55.63%
$ 943,688; 58.41%
$ 990,872; 61.34%
$1,040,415; 64.40%
$1,092,436; 67.62%
(15-3) Residual dividend model C R Answer: d MEDIUM
58.
Banerjee Inc. wants to maintain a target capital structure with 30% debt and 70%
equity. Its forecasted net income is $550,000, and its board of directors has decreed
that no new stock can be issued during the coming year. If the firm follows the residual
dividend model, what is the maximum capital budget that is consistent with maintaining
the target capital structure?
a.
b.
c.
d.
e.
$673,652
$709,107
$746,429
$785,714
$825,000
(15-3) Residual dividend model C R Answer: d MEDIUM
59.
Dentaltech Inc. projects the following data for the coming year. If the firm follows
the residual dividend model and also maintains its target capital structure, what will its
dividend payout ratio be?
EBIT $2,000,000
Interest rate 10%
Debt outstanding
Shares outstanding
a.
b.
c.
d.
e.
Capital budget
$850,000
% Debt
40%
$5,000,000 % Equity
60%
5,000,000
Tax rate
40%
37.2%
39.1%
41.2%
43.3%
45.5%
(15-3) Residual dividend model C R Answer: c MEDIUM
60.
Mortal Inc. expects to have a capital budget of $500,000 next year. The
company wants to maintain a target capital structure with 30% debt and 70% equity,
and its forecasted net income is $400,000. If the company follows the residual dividend
model, how much in dividends, if any, will it pay?
a.
b.
c.
d.
e.
$45,125
$47,500
$50,000
$52,500
$55,125
(15-3) Residual dividend model C R Answer: e MEDIUM
61.
Torrence Inc. has the following data. If it uses the residual dividend model, how
much total dividends, if any, will it pay out?
Capital budget
% Debt 60%
Net income (NI)
a.
b.
c.
d.
e.
$1,000,000
$625,000
$183,264
$192,909
$203,063
$213,750
$225,000
(15-3) Residual dividend model C R Answer: e MEDIUM
62.
NY Fashions has the following data. If it follows the residual dividend model,
how much total dividends, if any, will it pay out?
Capital budget
% Debt 65%
Net income (NI)
a.
b.
c.
d.
$20,363
$21,434
$22,563
$23,750
$1,500,000
$550,000
e.
$25,000
(15-3) Residual dividend model C R Answer: a MEDIUM
63.
Chicago Brewing has the following data, dollars in thousands. If it follows the
residual dividend model, what will its dividend payout ratio be?
Capital budget
% Debt 45%
Net income (NI)
a.
b.
c.
d.
e.
$5,000
$5,300
48.11%
50.52%
55.57%
61.13%
67.24%
(15-3) Residual dividend model C R Answer: a MEDIUM
64.
LA Moving Company has the following data, dollars in thousands. If it follows the
residual dividend model, what will its dividend payout ratio be?
Capital budget
% Debt 45%
Net income (NI)
a.
b.
c.
d.
e.
$5,000
$7,000
60.71%
63.75%
70.13%
77.14%
84.85%
(15-3) Residual dividend model C R Answer: d MEDIUM
65.
New Orleans Builders Inc. has the following data. If it follows the residual
dividend model, what is its forecasted dividend payout ratio?
Capital budget
% Debt 35%
Net income (NI)
a.
b.
c.
d.
e.
$7,500
$6,500
18.23%
20.25%
22.50%
25.00%
27.50%
(15-6) Stock split
C R Answer: c MEDIUM
66.
Ross-Jordan Financial has suffered losses in recent years, and its stock currently
sells for only $0.50 per share. Management wants to use a reverse split to get the price
up to a more “reasonable” level, which it thinks is $25 per share. How many of the old
shares must be given up for one new share to achieve the $25 price, assuming this
transaction has no effect on total market value?
a.
b.
c.
d.
47.50
49.88
50.00
52.50
e.
55.13
(15-6) Stock split
C R Answer: b MEDIUM
67.
Keys Financial has done extremely well in recent years, and its stock now sells
for $175 per share. Management wants to get the price down to a more typical level,
which it thinks is $25 per share. What stock split would be required to get to this price,
assuming the transaction has no effect on the total market value? Put another way,
how many new shares should be given per one old share?
a.
b.
c.
d.
e.
6.98
7.00
7.35
7.72
8.10
(15-6) Stock split
C R Answer: b MEDIUM
68.
Whited Products recently completed a 4-for-1 stock split. Prior to the split, its
stock sold for $120 per share. If the firm's total market value increased by 5% as a
result of increased liquidity and favorable signaling effects, what was the stock price
following the split?
a.
b.
c.
d.
e.
$29.93
$31.50
$33.08
$34.73
$36.47
(15-3) Residual dividend model C R Answer: c MEDIUM/HARD
69.
Clark Farms Inc. has the following data, and it follows the residual dividend
model. Currently, it finances with 15% debt. Some Clark family members would like for
the dividends to be increased. If Clark increased its debt ratio, which the firm's
treasurer thinks is feasible, by how much could the dividend be increased, holding other
things constant?
Capital budget
$3,000,000
Net income (NI)
$3,500,000
% Debt now 15%
% Debt after change
60%
a.
b.
c.
d.
e.
$1,093,500
$1,215,000
$1,350,000
$1,485,000
$1,633,500
(15-3) Residual dividend model C R Answer: a MEDIUM/HARD
70.
Purcell Farms Inc. has the following data, and it follows the residual dividend
model. Currently, it finances with 15% debt. Some Purcell family members would like
for the dividend payout ratio to be increased. If Purcell increased its debt ratio, which
the firm's treasurer thinks is feasible, by how much could the dividend payout ratio be
increased, holding other things constant?
Capital budget
$3,000,000
Net income (NI)
$3,500,000
% Debt now 15%
% Debt after change
60%
a.
b.
c.
d.
e.
38.6%
40.5%
42.5%
44.7%
46.9%
(15-3) Residual dividend model C R Answer: c MEDIUM/HARD
71.
Whitman Antique Cars Inc. has the following data, and it follows the residual
dividend model. Some Whitman family members would like more dividends, and they
also think that the firm's capital budget includes too many projects whose NPVs are
close to zero. If Whitman reduced its capital budget to the indicated level, by how much
could dividends be increased, holding other things constant?
Original capital budget
$3,000,000
New capital budget $2,000,000
Net income $3,500,000
% Debt 40%
a.
b.
c.
d.
e.
$486,000
$540,000
$600,000
$660,000
$726,000
(15-3) Residual dividend model C R Answer: e MEDIUM/HARD
72.
Pavlin Corp.'s projected capital budget is $2,000,000, its target capital structure
is 40% debt and 60% equity, and its forecasted net income is $900,000. If the company
follows the residual dividend model, how much dividends will it pay or, alternatively, how
much new stock must it issue?
a.
b.
c.
d.
e.
$462,983; $244,352
$487,350; $257,213
$513,000; $270,750
$540,000; $285,000
$
0; $300,000
(15-6) Stock split
C R Answer: b MEDIUM/HARD
73.
Grullon Co. is considering a 7-for-3 stock split. The current stock price is $75.00
per share, and the firm believes that its total market value would increase by 5% as a
result of the improved liquidity that should follow the split. What is the stock's expected
price following the split?
a.
b.
c.
d.
e.
$32.06
$33.75
$35.44
$37.21
$39.07
(15-3) Residual dividend model C R Answer: c HARD
74.
Walter Industries is a family owned concern. It has been using the residual
dividend model, but family members who hold a majority of the stock want more cash
dividends, even if that means a slower future growth rate. Neither the net income nor
the capital structure will change during the coming year as a result of a dividend policy
change to the indicated target payout ratio. By how much would the capital budget
have to be cut to enable the firm to achieve the new target dividend payout ratio?
% Debt 35%
% Equity = 1.0 – % Debt 65%
Capital budget under the residual dividend model
$5,000,000
Net
income;
it
will
not
change
this
year
dividends increase $3,500,000
Equity
to
support
the
capital
= % Equity × Capital budget
$3,250,000
Dividends paid = NI − Equity needed
$250,000
Currently projected dividend payout ratio7.1%
Target dividend payout ratio
70.0%
a.
b.
c.
d.
e.
even
if
budget
-$2,741,538
-$3,046,154
-$3,384,615
-$3,723,077
-$4,095,385
(15-3) Residual dividend model C R Answer: e HARD
75.
Sheehan Corp. is forecasting an EPS of $3.00 for the coming year on its 500,000
outstanding shares of stock. Its capital budget is forecasted at $800,000, and it is
committed to maintaining a $2.00 dividend per share. It finances with debt and common
equity, but it wants to avoid issuing any new common stock during the coming year.
Given these constraints, what percentage of the capital budget must be financed with
debt?
a.
b.
c.
d.
e.
30.54%
32.15%
33.84%
35.63%
37.50%
(15-3) Residual dividend model C R Answer: e HARD
76.
Del Grasso Fruit Company has more positive NPV projects than it can finance
under its current policies without issuing new stock, but its board of directors had
decreed that it cannot issue any new shares in the foreseeable future. Your boss, the
CFO, wants to know how the capital budget would be affected by changes in capital
structure policy and/or the target dividend payout policy. You obtained the following
data, which shows the firm's projected net income (NI), its current capital structure and
dividend payout policies, and three possible new policies. Projected net income for the
coming year will not be affected by a policy change. How much larger could the capital
budget be if (1) the target debt ratio were raised to the indicated amount, other things
held constant, (2) the target payout ratio were lowered to the indicated amount, other
things held constant, or (3) the debt ratio and dividend payout were both changed by the
indicated amounts?
Current
Policy Changes
Policy
Increase Debt
Lower Payout
Projected NI $175.0
$175.0
$175.0
$175.0
% Debt 25.0%
75.0% 25.0% 75.0%
% Equity 75.0%
25.0% 75.0% 25.0%
% Payout 65.0%
65.0% 20.0% 20.0%
a.
b.
c.
d.
e.
$133.0; $ 85.5; $389.6
$140.0; $ 90.0; $410.1
$147.4; $ 94.8; $431.7
$155.2; $ 99.8; $454.4
$163.3; $105.0; $478.3
Do Both
CHAPTER 15
ANSWERS AND SOLUTIONS
1.
(15-1) Optimal distribution policy F R
Answer: a
EASY
2.
(15-1) Target payout ratio
Answer: b
EASY
F R
The higher the payout ratio, the less of its earnings the firm reinvests in the business, and the lower the
reinvestment rate, the lower the firm’s growth rate.
3.
(15-1) Dividend irrelevance
F R
Answer: a
EASY
4.
(15-1) Dividend irrelevance
F R
Answer: b
EASY
5.
(15-1) Investors' div. preferences
F R
Answer: a
EASY
6.
(15-6) Stock dividends and splits F R
Answer: a
EASY
7.
(15-6) Reverse split
Answer: a
EASY
8.
(15-1) Dividends and stock prices F R
Answer: b
MEDIUM
9.
(15-1) Dividends and stock prices F R
Answer: b
MEDIUM
10.
(15-1) Dividends and stock prices F R
Answer: b
MEDIUM
11.
(15-1) Dividends and stock prices F R
Answer: a
MEDIUM
12.
(15-1) Dividend irrelevance
F R
Answer: a
MEDIUM
13.
(15-1) Dividend-growth tradeoff
F R
Answer: a
MEDIUM
14.
(15-2) Dividends and stock prices F R
Answer: a
MEDIUM
15.
(15-2) Dividends and stock prices F R
Answer: a
MEDIUM
16.
(15-2) Dividends and stock prices F R
Answer: b
MEDIUM
F R
MM would disagree. They would say that investors took the dividend increase as a signal that the firm's
management expected higher future earnings. MM say dividends have information content regarding future
earnings.
17.
(15-2) Signaling hypothesis
F R
Answer: a
MEDIUM
18.
(15-3) Residual dividend model
F R
Answer: a
MEDIUM
19.
(15-3) Residual dividend model
F R
Answer: b
MEDIUM
The higher the debt ratio, the more dollars of debt will be used to fund a given capital budget. So, the higher
the debt ratio, the less equity will be needed, and this results in a higher dividend payout ratio according to
the residual dividend model.
20.
(15-3) Residual dividend model
F R
Answer: b
MEDIUM
21.
(15-3) Dividend payment procedures F R
Answer: b
MEDIUM
This is false. The stock price will drop on the ex-dividend date, which is two days prior to the holder of
record date, which is well before the actual January 31 payment date. Also, because the dividend is taxable,
the price decline is generally somewhat less than the full amount of the dividend.
22.
(15-3) Dividend payment procedures F R
Answer: a
MEDIUM
This is true. The stock price will drop on the ex-dividend date, which is two days prior to the holder of
record date, which is well before the actual January 31 payment date. Note, though, that because the dividend
is taxable, the price decline may be somewhat less than the full amount of the dividend.
23.
(15-4) Dividend reinvestment plans F R
Answer: b
MEDIUM
24.
(15-4) Dividend reinvestment plans F R
Answer: a
MEDIUM
25.
(15-4) Dividend reinvestment plans F R
Answer: a
MEDIUM
This is true, because if the company retains its earnings rather than paying them out, investors should receive
capital gains rather than dividend income, and the taxes on those gains will be deferred until the stock is sold.
Note that the money will be reinvested by the company in either case, so the risk to stockholders under
dividend reinvestment and retained earnings should be the same.
26.
(15-6) Stock split
F R
27.
(15-3) Residual dividend model
F R
Answer: a
Answer: a
MEDIUM
HARD
(1) The firm's WACC would increase, (2) this would cause fewer projects to be accepted, (3) this would lead
to a smaller capital budget, (4) thus less money would be needed to fund the capital budget, (5) thus less
equity would be needed, so (6) the dividend payout ratio would increase.
28.
(15-5) WACC and dividend policy
F R
Answer: b
HARD
Firm U could fund its capital budget with varying amounts of debt without causing large changes in its
WACC and thus in its value and stock price. Firm V could not vary its debt ratio without increasing its
WACC. Thus, Firm V would have to raise and lower its dividend payout in order to obtain the equity it
needed to support its capital budget. Firm U, on the other hand, could maintain a stable, steady dividend, and
let the debt ratio vary without causing much harm to its stock price.
29.
(15-3) Dividend payout
C R
Answer: a
EASY
30.
(15-6) Stock split
C R
Answer: b
EASY
31.
(15-1) Investors' div. preferences
C R
Answer: d
MEDIUM
32.
(15-3) Residual dividend model
C R
Answer: a
MEDIUM
33.
(15-3) Residual dividend model
C R
Answer: b
MEDIUM
34.
(15-3) Residual dividend model
C R
Answer: c
MEDIUM
35.
(15-5) Factors in div. policy
C R
Answer: d
MEDIUM
36.
(15-5) Factors in div. policy
C R
Answer: c
MEDIUM
37.
(15-6) Stock dividends and splits C R
Answer: e
MEDIUM
38.
(Comp.) Dividend theories
C R
Answer: e
MEDIUM
39.
(Comp.) Repurchases and DRIPS
C R
Answer: c
MEDIUM
40.
(Comp.) Divs., DRIPs, and repurch.
C R
Answer: d
MEDIUM
41.
(Comp.) Div. policy and repurchases
C R
Answer: d
MEDIUM
42.
(Comp.) Dividend concepts
C R
Answer: c
MEDIUM
c is correct, but perhaps the easiest way to answer this question is to eliminate the other choices, which are
obviously wrong.
43.
(Comp.) Dividend concepts
C R
Answer: e
MEDIUM
44.
(Comp.) Dividend concepts
C R
Answer: b
MEDIUM
45.
(Comp.) Dividend concepts
C R
Answer: b
MEDIUM
46.
(Comp.) Dividend concepts
C R
Answer: a
MEDIUM
47.
(Comp.) Dividend concepts
C R
Answer: e
MEDIUM
48.
(Comp.) Repurchases and splits
C R
Answer: e
MEDIUM
49.
(Comp.) Dividend concepts
C R
Answer: a
MEDIUM/HARD
50.
(Comp.) Dividend concepts
C R
Answer: d
MEDIUM/HARD
51.
(15-3) Residual dividend model
C R
Capital budget
Net income (NI)
% Debt
% Equity = 1.0 – %Debt =
Equity needed to support the capital budget = % Equity × Capital budget
Dividends paid = NI − Equity needed if positive, otherwise $0.0.
Answer: d
EASY
$12,500
$11,500
40%
60%
$7,500
$4,000
Payout ratio = Dividends paid/NI = 34.78%
52.
(15-6) Stock split
Number of new shares
Number of old shares
Old (pre-split) price
C R
Answer: c
EASY
C R
Answer: a
EASY
C R
Answer: c
EASY
2
1
$80
New price = Old price × (Old shares/New shares) = $40.00
53.
(15-6) Stock split
Number of new shares
Number of old shares
Pre-split stock price
3
1
$90.00
Post-split stock price: P0/New per old = $30.00
54.
(15-6) Stock split
Number of new shares
Number of old shares
Old (pre-split) price
7
2
$80.00
New price = Old price × (Old shares/New shares) = $22.86
55.
(15-3) Residual dividend model
Capital budget
$650,000
C R
Answer: b
EASY/MEDIUM
% Equity
Dividends to be paid
60%
$225,000
Required net income = Dividends + (Capital budget × % Equity) = $615,000
56.
(15-3) Residual dividend model
Capital budget
Equity ratio
Dividends to be paid
C R
Answer: b
MEDIUM
Answer: a
MEDIUM
Answer: d
MEDIUM
$850,000
65%
$400,000
Required net income = Dividends + (Capital budget × % Equity) = $952,500
57.
(15-3) Residual dividend model
Capital budget
Equity ratio
Dividends paid
C R
$725,000
55%
$500,000
NI = Dividends + (Equity % × Capital budget) = $898,750
Payout = Dividends/NI = 55.63%
58.
(15-3) Residual dividend model
% Debt
% Equity
Net income
Max. capital budget = NI/% Equity
C R
30%
70%
$550,000
$785,714
Check: Is calculated Max. capital budget × % Equity = NI? $550,000 = Net income
59.
(15-3) Residual dividend model
EBIT
Interest rate
Debt outstanding
Shares outstanding
$2,000,000
10%
$5,000,000
5,000,000
C R
Answer: d
Capital budget
% Debt
% Equity
Tax rate
EBIT
− Interest expense = Interest rate × Debt
Taxable income
− Taxes = Tax rate × Income
Net income (NI)
− Equity needed for capital budget = % Equity(Capital budget)
MEDIUM
$850,000
40%
60%
40%
$2,000,000
500,000
$1,500,000
600,000
$ 900,000
510,000
Dividends = NI − Equity needed
$ 390,000
Payout ratio = Dividends/NI = 43.33%
60.
(15-3) Residual dividend model
% Debt
% Equity
Capital budget
Net income
Equity requirement = Capital budget × % Equity
C R
Answer: c
MEDIUM
Answer: e
MEDIUM
30%
70%
$500,000
$400,000
$350,000
Dividends = NI − Equity requirement = $50,000
61.
(15-3) Residual dividend model
C R
Capital budget
Net income (NI)
% Debt
% Equity = 1.0 – % Debt
Equity needed to support the capital budget = % Equity × Capital budget
$1,000,000
$625,000
60%
40%
$400,000
Dividends paid = NI − Equity needed if positive (otherwise, $0.0) = $225,000
62.
(15-3) Residual dividend model
C R
Capital budget
Net income (NI)
% Debt
% Equity = 1.0 – % Debt
Equity needed to support the capital budget = % Equity × Capital budget
Answer: e
MEDIUM
$1,500,000
$550,000
65%
35%
$525,000
Dividends paid = NI − Equity needed if positive (otherwise, $0.0) = $25,000
63.
64.
(15-3) Residual dividend model
C R
Answer: a
Capital budget
Net income (NI)
% Debt
% Equity = 1.0 – % Debt
Equity needed to support the capital budget = % Equity × Capital budget
Dividends paid = NI − Equity needed if positive (otherwise, $0.0)
$5,000
$5,300
45%
55%
$2,750
$2,550
Payout ratio = Dividends paid/NI = 48.11%
(15-3) Residual dividend model
Answer: a
C R
Capital budget
Net income (NI)
% Debt
% Equity = 1.0 – % Debt
Equity needed to support the capital budget = % Equity × Capital budget
Dividends paid = NI − Equity needed if positive (otherwise, $0.0)
MEDIUM
MEDIUM
$5,000
$7,000
45%
55%
$2,750
$4,250
Payout ratio = Dividends paid/NI = 60.71%
65.
(15-3) Residual dividend model
Capital budget
Net income (NI)
C R
Answer: d
$7,500
$6,500
MEDIUM
% Debt
% Equity = 1.0 – % Debt
Equity needed to support the capital budget = % Equity × Capital budget
Dividends paid = NI − Equity needed if positive (otherwise, $0.0)
35%
65%
$4,875
$1,625
Payout ratio = Dividends paid/NI = 25.00%
66.
(15-6) Stock split
Current price
Target price
C R
Answer: c
MEDIUM
Answer: b
MEDIUM
Answer: b
MEDIUM
$0.50
$25.00
Old shares surrendered per 1 new share = Target price/Old price = 50.00
67.
(15-6) Stock split
Current price
Target price
C R
$175.00
$25.00
No. of new shares per 1 old share = Current price/Target price = 7.00
68.
(15-6) Stock split
New shares per 1 old share
Pre-split stock price
% value increase
C R
4
$120
5%
Post-split stock price = (P0/[New shares per old shares) × (1 + % Value increase)] = $31.50
69.
(15-3) Residual dividend model
C R
% Debt
% Equity = 1.0 – % Debt
Capital budget
Net income (NI)
Equity needed to support the capital budget = % Equity × Capital budget
Dividends paid = NI − Equity needed if positive (otherwise, $0.0)
Answer: c
Old
15%
85%
$3,000,000
$3,500,000
$2,550,000
$950,000
MEDIUM/HARD
New
60%
40%
$3,000,000
$3,500,000
$1,200,000
$2,300,000
Increase in dividends paid = $1,350,000
70.
(15-3) Residual dividend model
C R
% Debt
% Equity = 1.0 – % Debt
Capital budget
Net income (NI)
Equity needed to support the capital budget = % Equity × Capital budget
Dividends paid = NI − Equity needed if positive (otherwise, $0.0)
Dividend payout ratio
Answer: a
Old
15%
85%
$3,000,000
$3,500,000
$2,550,000
$950,000
27.1%
MEDIUM/HARD
New
60%
40%
$3,000,000
$3,500,000
$1,200,000
$2,300,000
65.7%
Increase in dividend payout ratio = 38.6%
71.
(15-3) Residual dividend model
% Debt
% Equity = 1.0 – % Debt
C R
Answer: c
Old
40%
60%
MEDIUM/HARD
New
40%
60%
Capital budget
Net income (NI)
Equity needed to support the capital budget = % Equity × Capital budget
Dividends paid = NI − Equity needed if positive (otherwise, $0.0)
$3,000,000
$3,500,000
$1,800,000
$1,700,000
$2,000,000
$3,500,000
$1,200,000
$2,300,000
Increase in dividends paid = $600,000
72.
(15-3) Residual dividend model
C R
Answer: e
Capital budget
% Equity
Net income (NI)
Equity required for capital budget = % Equity × Capital budget
Dividends = NI – Equity required if > 0 (otherwise, 0) =
Required new stock = NI – Equity required if < 0 (otherwise, 0) =
$2,000,000
60%
$900,000
$1,200,000
$0
$300,000
Dividends:
Dividends paid = NI − [% Equity(Cap. bud.)], stock issued if dividends zero or neg. $0
73.
(15-6) Stock split
C R
Answer: b
Number of new shares
Number of old shares
Old (pre-split) price
% Increase in value
New price before value increase = Old price/(New shares/Old shares)
MEDIUM/HARD
or new stock:
$300,000
MEDIUM/HARD
7
3
$75.00
5%
$32.14
New price after value increase = Prior × (1 + % Value increase) = $33.75
74.
(15-3) Residual dividend model
C R
Answer: c
Net income (NI)
% Debt
% Equity = 1.0 – % Debt
Old
$3,500,000
35%
65%
New target dividend payout ratio
Target dividend = Target dividend payout × NI
Target retained earnings (RE) = NI – Dividends
Max. capital budget = RE/% Equity
Check: % Equity × Capital budget consistent = Calculated RE? Yes
70%
$2,450,000
$1,050,000
$1,615,385
$1,050,000
HARD
New
$3,500,000
35%
65%
New capital budget – Old capital budget = $1,615,385 – $5,000,000 = -$3,384,615
75.
(15-3) Residual dividend model
EPS
Shares outstanding
DPS
C R
Answer: e
$3.00
500,000
$2.00
HARD
Capital budget
Net income = EPS × Shares outstanding
Dividends paid = DPS × Shares outstanding
Retained earnings available
Capital budget − Retained earnings = Debt needed
$800,000
$1,500,000
$1,000,000
$500,000
$300,000
Debt needed/Capital budget = % Debt financing = 37.5%
76.
(15-3) Residual dividend model
NI
% Debt
% Equity
% Payout
Dividends
Ret. earnings, RE
Max. cap. budget
Found as:
Given
“
“
“
Payout % × NI
NI – Dividends
RE/% Equity
C R
Current
Maximum
$175.0
25.0%
75.0%
65.0%
$113.8
$61.3
$81.7
Increase: New max. − Current max. =
Percentage increase: New max./Current max. – 1.0 =
Answer: e
If Increase
Debt
$175.0
75.0%
25.0%
65.0%
$113.8
$61.3
$245.0
$163.3
200.0%
New Maximums:
If Lower
Payout
$175.0
25.0%
75.0%
20.0%
$35.0
$140.0
HARD
$186.7
If Do
Both
$175.0
75.0%
25.0%
20.0%
$35.0
$140.0
$560.0
$105.0
128.6%
$478.3
585.7%