Exam 11: Developing a Dividend Policy

Lenders interested in ensuring a large cushion of cash to mitigate the risks of the loan may include restrictions in the contract to preclude the company from paying out dividends to common shareholders. Shareholders may have to vote in a block to oust a Board who has undertaken these loans. What is this situation is consistent with?

What does the traditional view of dividend policy say about a higher payout ratio?

RAJ Industries earned an income of $4,000,000 and distributed $850,000 as dividends. A year later, earnings had risen by 5% and RAJ distributed earnings of $700,000. What may investors have concluded about RAJ?

Merrick Manufacturing has been in a court battle over alleged patent infringement for several years. If Merrick has had generally paid out a consistent level of dividends and increases its dividend payout by 50%, how investors may interpret this move by Merrick?

A company has 21 million common shares outstanding at a price of $63.00 each and an EPS of $12.00 per share. If the company wishes to provide a stock dividend of 30%, how many shares will shareholders receive for every ten shares currently held?

LaGuerre Computer Animation Ltd. has a tax rate of 30%, has been trading around $44.50 for three years and has a consistent dividend payout of 35%. Last year, it had common shares outstanding of 4.2 million, no preferred shares, interest payments of $8 million and an EBIT of $29 million. Over the following year, the company repurchased 1.2 million shares with a bond issue that increased its interest payments by $2.7 million. If its EBIT rose to $32 million, what is the degree of financial leverage for LaGuerre?

At a time when the corporate tax rate is 22%, the government has raised taxes on individuals to 43% to meet its fiscal needs. The dividend tax rate is 32%. Interest rates are 8%. Which of the following applies to LED Ltd.'s dividend policy?

At REL Ltd., earnings per share over a five year period were (from earliest to latest) $2.00, $0.50, $1.20, $2.40, $1.75. In the same period, dividends per share were $0.50, $0,50, $0,50, $0.75, $0.75. What best describes this result?

Michael can choose to hold 500 shares trading for $62.50 in Company A or 1,000 shares trading in Company B trading for $31.25 each. Both companies announced their earnings on December 31st at $5.00 per share and $2.50 per share, respectively. Company A's payout ratio is 100%. Company B will retain 100% of its earnings this year. Next year it will return to its usual 100% payout ratio. (Company B's common share dividend is not cumulative). Both companies return 8% to their common shareholders. Michael will by bonds with any cash received from dividends, providing an interest income at 8%. He faces a marginal income tax rate of 40% and a dividend tax rate of 37%. Assuming Michael does not liquidate his investments, which company will provide him the higher after tax income at the end of the second year?

Which of these actions is an illustration of the residual theory of dividends?

Using a Fair Value Balance Sheet, a company's financial position is as follows: cash of $30,000, total assets, net of cash, of $330,000, total debt of $200,000 and $160,000 worth of owners' equity, comprised of 100,000 common shares and $60,000 of retained earnings. If the company pays out its total cash in dividends, what happens to a shareholder's financial position?

How is a dividend is paid out?

Felicity Trust has a dividend cover ratio of 5.0 on net income of $6.3 million. The company's EPS is $2.10 and its cum dividend price is $22.50. What is the expected ex dividend price of the shares?

ABC is selling for $45.60 and is expected to continue its 5.5% growth rate in dividends. Using the Dividend Growth model, what is its expected dividend if its target return to investors is 18%?

A major forest products company with a cost of capital of 12% has raised $15 million in financing and is considering three projects that are divisible, are not mutually exclusive and will have no residual value at the end of their 10 year term. Project A will cost a company $12 million providing $2.45 million in annual income before depreciation. Project B, costing $10.8 million, has annual projected savings before depreciation of $1.8 million. Project C costs $7.3 million and will bring in $1.7 million annually before depreciation. Assuming markets operate in the theoretical Modernist manner, if the company expects to earn a 12% return on their investments, in which project(s) should the company invest?

What does the Modernist (Modigliani and Miller) view of dividend policy say about a higher payout ratio if taxes are ignored?

Which of the following is the most important factor influencing the level of dividends?

Beryl Corporation has 15 million common shares outstanding trading on October 1 at a cum dividend price of $22.15 a share. Its EPS at that time, the end of the third quarter, is $1.80 per share. If the ex dividend price drops to $21.95 on Oct. 2, what dividend was declared?

Kaylea Co. Ltd. has perpetual debt with a face value of $20 million at 5% and a market value of $18 million. It has no preferred shares. Ten million common shares were issued at $12.50 and are now trading for $15.00 each from a high three years ago of $24.00. Common shareholders are demanding a 9% return from companies of equal risk. The company has a tax rate of 35%. It wishes to repurchase four million common shares to reduce the threat of a hostile take-over. Kaylea Co. will use all of its retained earnings of $32 million and fund the balance with perpetual debt at 7% where the market value will equal face value. Assume the cost of Kaylea's old debt will remain unchanged and that share price remains the same. If the repurchase goes through, in absolute terms, what will be the change in the company's cost of capital?

Which of the following will tend to increase the proportion of earnings that are distributed as dividends?