978-1259277160 Chapter 18 Solution Manual Part 3

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Chapter 18: Dividend Policy and Retained Earnings

18-18. Solution:

Ace Products

*240,000 shares × ($20 market price – $5 par value)

= 240,000 × $15 = $3,600,000

18-18. (Continued)

**$23,000,000 Beginning retained earnings account

b. EPS after stock dividend = $4,800,000/$2,640,000 = $1.82

d. Before After

19. Stock dividend and cash dividend (LO18-4) Health Systems Inc. is considering a 15

percent stock dividend. The capital accounts are as follows:

Common stock (6,000,000 shares at $10 par)……. $60,000,000

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Chapter 18: Dividend Policy and Retained Earnings

Capital in excess of par*………………..….……….….. 35,000,000

Retained earnings………………………………….………. 75,000,000

Net worth……………………………………………………

$170,000,00

*The increase in capital in excess of par as a result of a stock dividend

is equal to the shares created times (Market price – Par value).

The company’s stock is selling for $32 per share. The company had total earnings of

$19,200,000 with 6,000,000 shares outstanding and earnings per share were $3.20. The

firm has a P/E ratio of 10.

a. What adjustments would have to be made to the capital accounts for a 15 percent stock

dividend? Show the new capital accounts.

b. What adjustments would be made to EPS and the stock price? (Assume the P/E ratio

remains constant.)

c. How many shares would an investor have if he or she originally had 80?

d. What is the investor’s total investment worth before and after the stock dividend if the

P/E ratio remains constant? (There may be a slight difference due to rounding.)

e. Assume Mr. Heart, the president of Health Systems, wishes to benefit stockholders by

keeping the cash dividend at a previous level of $1.25 in spite of the fact that the

stockholders now have 15 percent more shares. Because the cash dividend is not

reduced, the stock price is assumed to remain at $32.

What is an investor’s total investment worth after the stock dividend if he/she had

80 shares before the stock dividend?

f. Under the scenario described in part e, is the investor better off?

g. As a final question, what is the dividend yield on this stock under the scenario

described in part e?

18-19. Solution:

Health Systems Inc.

18-19. (Continued)

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Chapter 18: Dividend Policy and Retained Earnings

b. EPS after the stock dividend = $19,200,000/6,900,000 = $2.78

d. Before After

e. After

f. Yes. As a result of keeping the cash dividend constant, the

Divided Cash dividend $1.25 3.91%

Yield Market price $32.00

= = =

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Chapter 18: Dividend Policy and Retained Earnings

20. Reverse stock split (LO18-4) Worst Buy Company has had a lot of complaints from

customers of late and its stock price is now only $2 per share. It is going to employ a

one-for-five reverse stock split to increase the stock value. Assume Dean Smith owns 140

shares.

a. How many shares will he own after the reverse stock split?

b. What is the anticipated price of the stock after the reverse stock split?

c. Because investors often have a negative reaction to a revere stock split, assume the

stock only goes up to 80 percent of the value computed in part b. What will the stock’s

price be?

d. How has the total value of Dean Smith’s holdings changed from before the reverse

stock split to after the reverse stock split (based on the stock value computed in part c)?

To get the total value before and after the split, multiply the shares held times the

stock price.

18-20. Solution:

Worst Buy Company

a. Number of shares after reverse stock split

b. Anticipated stock price

c. Actual stock price based on the 80 percent assumption

d. Dean Smith’s total holdings

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Chapter 18: Dividend Policy and Retained Earnings

21. Cash dividend versus stock repurchase (LO18-5) The Carlton Corporation has $5

million in earnings after taxes and 2 million shares outstanding. The stock trades at a P/E of

20. The firm has $4 million in excess cash.

a. Compute the current price of the stock.

b. If the $4 million is used to pay dividends, how much will dividends per share be?

c. If the $4 million is used to repurchase shares in the market at a price of $54 per share,

how many shares will be acquired? (Round to the nearest share.)

d. What will the new earnings per share be? (Round to two places to the right of the

decimal.)

e. If the P/E ratio remains constant, what will the price of the securities be? By how much,

in terms of dollars, did the repurchase increase the stock price?

f. Has the stockholder’s total wealth changed as a result of the stock repurchase as

opposed to receiving the cash dividend?

g. What are some reasons a corporation may wish to repurchase its own shares in the

market?

18-21. Solution:

Carlton Corporation

d. Shares outstanding after repurchase

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Chapter 18: Dividend Policy and Retained Earnings

18-21. (Continued)

f. No. With the cash dividend:

g. The (potential) appreciation in value associated with a stock

repurchase defers the capital gains tax until the stock is

Also, the corporation may think its shares are underpriced

in the market. The purchase may stave off further decline

and perhaps even trigger a rally. Reacquired shares may

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Chapter 18: Dividend Policy and Retained Earnings

22. Retaining funds versus paying them out (LO18-1) The Hastings Sugar Corporation has

the following pattern of net income each year, and associated capital expenditure projects.

The firm can earn a higher return on the projects than the stockholders could earn if the

funds were paid out in the form of dividends.

Year Net Income

Profitable Capital

Expenditure

1……… $14 million $ 7 million

2……… 16 million 11 million

3……… 12 million 6 million

4……… 16 million 8 million

5……… 16 million 9 million

The Hastings Corporation has 3 million shares outstanding (the following questions are

separate from each other).

a. If the marginal principle of retained earnings is applied, how much in total cash

dividends will be paid over the five years?

b. If the firm simply uses a payout ratio of 30 percent of net income, how much in total

cash dividends will be paid?

c. If the firm pays a 10 percent stock dividend in years 2 through 5, and also pays a cash

dividend of $3.40 per share for each of the five years, how much in total dividends will

be paid?

d. Assume the payout ratio in each year is to be 20 percent of net income and the firm will

pay a 10 percent stock dividend in years 2 through 5. How much will dividends per

share for each year be? (Assume cash dividend is paid after the stock dividend).

18-22. Solution:

Hastings Sugar Corporation

a. Dividends represent what is left over after profitable capital

expenditures are undertaken.

Year

Net

Income –

Profitable

Capital

Expenditures Dividends

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Chapter 18: Dividend Policy and Retained Earnings

18-22. (Continued)

Year Net Income ×Payout Ratio Dividends

Year

Outstanding ×

Dividends

per Share Dividends

Year

Net

Income

Payout

Ratio Dividends Shares

Dividends

per Share

COMPREHENSIVE PROBLEM

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Chapter 18: Dividend Policy and Retained Earnings

Modern Furniture Company (Dividend payments versus stock repurchases) (LO18-5)

Modern Furniture Company had finally arrived at the point where it had a sufficient excess cash

flow of $4.8 million to consider paying a dividend. It had 3 million shares of stock outstanding

and was considering paying a cash dividend of $1.60 per share. The firm’s total earnings were

$12 million, providing $4.00 in earnings per share. The stock traded in the market at $88.00 per

share.

However, Al Rosen, the chief financial officer, was not sure that paying a cash dividend was the

best route to go. He had recently read a number of articles in The Wall Street Journal about the

advantages of stock repurchases and before he made a recommendation to the CEO and board of

directors, he decided to do a number of calculations.

a. What is the firm’s P/E ratio?

b. If the firm paid the cash dividend, what would be its dividend yield and dividend payout ratio

per share?

c. If a stockholder held 100 shares of stock and received the cash dividend, what would

be the total value of his portfolio (stock plus dividends)?

d. Assume instead of paying the cash dividend, the firm used the $4.8 million of excess funds to

purchase shares at slightly over the current market value of $88 at a price of $89.60. How

many shares could be repurchased? (Round to the nearest share.)

e. What would the new earnings per share be under the stock repurchase alternative? (Round to

three places to the right of the decimal point.)

f. If the P/E ratio stayed the same under the stock repurchase alternative, what would be the

stock value per share? If a stockholder owned 100 shares, what would now be the total value

of his portfolio? (This answer should be approximately the same as the answer to part c.)

CP18-1. Solution:

Modern Furniture Company

b. Dividend yield = Dividend per share/price

Dividend payout ratio =

c. Portfolio value

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Chapter 18: Dividend Policy and Retained Earnings

e. EPS = Total earnings/Total shares

Portfolio value

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