Chapter 17 – Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts
CHAPTER 17 – SHARING FIRM WEALTH: DIVIDENDS, SHARE REPURCHASES,
AND OTHER PAYOUTS
questions
LG1 1. Why might a firm’s investors wish to delay receiving cash from the firm?
LG2 2. Why might the government actually want the capital gains tax rate to be lower than the
LG2 3. What condition would have to be necessary in order for the riskiness of the firm’s cash
flows to investors to be affected by the firm’s dividend payout policy?
LG3 4. Explain how an announced increase in a firm’s dividend payout might be perceived as
either a good or a bad information signal.
LG3 5. We talked about how a firm might attract a different clientele by switching dividend
payout policies: Might a particular clientele change its preference for dividends versus
17-1
LG4 6. Suppose that federal banking regulators in the United States announced that they are
going to allow banks to take on significant equity investments in firms to which they
have lent. What would you expect, on average, to happen to those firms’ dividend payout
LG4 7. If a firm follows the modified residual dividend model discussed in this chapter, are
extraordinary dividends paid out of residual net income?
LG4 8. Suppose a firm announces a new dividend amount every year with the first quarterly
dividend declaration, but never explicitly states that the dividend will be continued for the
other three quarters of the year. However, in the past the firm has always continued the
first quarter’s dividend into the other three quarters of the year. How much would you
expect this firm’s share price to react when it announced the new, first-quarter dividend at
the beginning of a new year?
LG5 9. Could the record date ever be before the ex-dividend date? Why or why not?
LG5 10. Suppose a firm managed to consistently lower the length of time between the ex-dividend
LG5 11. If a firm announces a dividend decrease, would you expect the stock price to go down
more or less than the present value of that decrease? Why?
17-2
Chapter 17 – Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts
LG6 12. How big of a stock dividend would a firm have to announce for the stock price to be
LG6 13. Why might a firm announce a reverse stock split?
LG6 14. Would it be possible for a firm to announce a “reverse stock dividend”?
LG7 15. Why might firms prefer to conduct stock repurchases through open-market operations
rather than through fixed-price tender offers?
problems
basic problems
LG2 17-1 Payout Ratio Suppose a firm pays total dividends of $500,000 out of net income of $2
million. What would the firm’s payout ratio be?
LG2 17-2 Payout Ratio Suppose a firm pays total dividends of $750,000 out of net income of $5
LG2 17-3 Total Dividend Amount Suppose a firm has a retention ratio of 35 percent and net
income of $5 million. How much does it pay out in dividends?
If the firm retains 35 percent of net income, then it pays out:
17-3
LG2 17-4 Total Dividend Amount Suppose a firm has a retention ratio of 56 percent and net
income of $9 million. How much does it pay out in dividends?
If the firm retains 56 percent of net income, then it pays out:
LG2 17-5 Dividend per Share Suppose a firm has a retention ratio of 40 percent, net income of
$17 million, and 10 million shares outstanding. What would be the dividend per share
paid out on the firm’s stock?
If the firm retains 40 percent of net income, then it pays out:
LG2 17-6 Dividend per Share Suppose a firm has a retention ratio of 60 percent, net income of
$35 million, and 140 million shares outstanding. What would be the dividend per share
paid out on the firm’s stock?
If the firm retains 60 percent of net income, then it pays out:
LG6 17-7 Stock Dividend Effects If a firm has retained earnings of $3 million, a common shares
account of $5 million, and additional paid-in-capital of $10 million, how would these
accounts change in response to a 10 percent stock dividend? Assume market value of
equity is equal to book value of equity.
17-4
17-5
LG6 17-8 Stock Dividend Effects If a firm has retained earnings of $23 million, a common shares
account of $275 million, and additional paid-in-capital of $100 million, how would these
accounts change in response to a 20 percent stock dividend? Assume market value of
equity is equal to book value of equity.
intermediate problems
LG4 17-9 Extraordinary Dividend JBK, Inc., normally pays an annual dividend. The last such
dividend paid was $2.50, all future dividends are expected to grow at 5 percent, and the
firm faces a required rate of return on equity of 11 percent. If the firm just announced
that the next dividend will be an extraordinary dividend of $17 per share that is not
expected to affect any other future dividends, what should the stock price be?
Using equation 8-6, the price if only the ordinary dividend were paid would be:
( )
1
0
$2.50 1.05
0.11 0.05
$2.625
0.11 0.05
$43.75
D
Pi g
=–
=–
=–
=
However, the next dividend will be $17 – $2.625 = $14.375 higher than the model
accounts for, so we would need to add the present value of this difference to get the actual
stock price:
0
$14.375
$43.75 1.11
$56.70
P= +
=
LG4 17-10 Extraordinary Dividend MMK Cos. Normally pays an annual dividend. The last such
dividend paid was $2.25, all future dividends are expected to grow at a rate of 7 percent
per year, and the firm faces a required rate of return on equity of 13 percent. If the firm
just announced that the next dividend will be an extraordinary dividend of $25 per share
that is not expected to affect any other future dividends, what should the stock price be?
Using equation 8-6, the price if only the ordinary dividend were paid would be:
Chapter 17 – Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts
( )
1
0
$2.25 1.07
0.13 0.07
$2.4075
0.13 0.07
$40.13
D
Pi g
=–
=–
=–
=
However, the next dividend will be $25 – $2.4075 = $22.5925 higher than the model
accounts for, so we would need to add the present value of this difference to get the actual
stock price:
0
$22.5925
$40.13 1.13
$60.12
P= +
=
LG5 17-11 Effects of Dividends on Stock Prices Gen Corp. is expected to pay a dividend of $3.50
per year indefinitely. If the appropriate rate of return on this stock is 11 percent per year,
and the stock consistently goes ex-dividend 35 days before dividend payment date, what
will be the expected minimum and maximum prices in light of the dividend payment
logistics?
The daily interest rate will be equal to:
365 1.11 1
0.000286
daily
i= –
=
So the maximum stock price, which will occur right before the stock goes ex-dividend,
will be:
( ) ( )
036 36
$3.50 $3.50 1 $34.96
0.11
1 0.000286 1 0.000286
P
æ ö
= + ´ =
ç ÷
ç ÷
+ +
è ø
And the minimum stock price, which will occur right after the stock goes ex-dividend,
will be:
( )
035
$3.50 1 $31.50
0.11 1 0.000286
P
æ ö
= ´ =
ç ÷
ç ÷
+
è ø
LG5 17-12 Effects of Dividends on Stock Prices Kenzie Cos. is expected to pay a dividend of $2.75
per year indefinitely. If the appropriate rate of return on this stock is 16 percent per year,
and the stock consistently goes ex-dividend 40 days before dividend payment date, what
will be the expected minimum and maximum prices in light of the dividend payment
logistics?
Chapter 17 – Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts
LG4 17-15 Dividends Set Annually Suppose that a firm always announces a yearly dividend at the
end of the first quarter of the year, but then pays the dividend out as four equal quarterly
payments. If the next such “annual” dividend has been announced as $4, it is exactly one
quarter until the first quarterly dividend from that $4, the effective annual required rate of
return on the company’s stock is 13 percent, and all future “annual” dividends are
expected to grow at 3 percent per year indefinitely, how much will this stock be worth?
LG5 17-18 Change in Lead Time of Dividend Announcement Everything else held constant, if a
firm announces that it will halve the length of time between its ex-dividend date and its
payment date, what should be the effect on the stock price?