Montgomery Corporation
Case 28
Dividend Policy
Purpose: The key issue is whether the firm’s cash dividend should be considered an active or residual
variable in setting the actual payment. There is enough bickering between directors and officers of the
firm to give the student plenty of insight into this issue. Though Montgomery Corporation is a fictitious
firm in the retail industry, the student is given enough information to compare its dividend policy to
Dillard’s, J.C. Penney, Wal–Mart, and others. The student is also asked to use the dividend valuation
model, to consider capital structure issues, and also evaluate the suitability of a stock dividend versus a
cash dividend.
Relation to Text: The case should follow Chapter 18. It is also assumed that the student is familiar with
capital structure considerations (Chapter 11) and common stock (Chapter 17).
Complexity: The case is moderately complex. It should require 1 hour.
Solutions
1. a. From Figure 1, we note that dividends per share for the years 2009-2015 were:
2009
2010
2011
2012
2013
2014
2015
$1.36
$1.36
$1.48
$1.70
$1.76
$1.76
$1.96
The firm is following a constant dividend policy with increases as the company grows. Note that
the total amount committed to common dividends has increased each year, but it’s the dividend
per share figure that counts. Given the increasing number of shares outstanding each year, the
directors have been sure that DPS has remained constant or increased slightly on an annual basis.
b. In Figure 2, we see that all of Montgomery’s competitors are either following the same policy
that Montgomery is, or they are striving to increase the dividend every year. Dollar General held
2. a. Given that D1 = $2.10, g = 7.1%, and P0 = $35, Ke, the expected return to the common
stockholder is:
%1.13
%1.7%6
%1.7
35$
10.2$
=
+=
+=
e
K
b. If Don’s proposal is adopted, and next year’s dividend is zero, but g rises to 14%, the expected
return to the stockholders is:
%14
%140
%14
35$
0
=
+=
+=
e
K
It appears that if Montgomery adopted Don’s suggestion, the stockholders would realize a 0.9%
increase in their expected return. By this calculation alone, then, we might conclude that Don’s
3. Don’s argument rests on the principle that the capital budget, as well as the dividend, must be paid for
solely out of net income for the current year, and, of course, this is not so. It is the amount of cash
available that is the limiting factor. Referring to Figure 1, we see that Montgomery’s cash balance for
4. a. The cost of internal equity financing is, of course, 13.1%, which was computed in question 2a,
above. The cost of external equity financing would be slightly higher due to flotation costs.
5. Mr. Autry’s comments strike at the heart of the residual dividend policy. That policy presumes that
the stockholders have no preferences about the form of repayment they receive from their
6. The firm could pay a stock dividend in place of the cash dividend, and some stockholders might be
satisfied with that. However, the majority would probably recognize that they had not received
7. As we mentioned in question 5, there is no universal agreement on this question. Some would argue
that dividends do not matter and some would argue that they do. Most would agree, however, that if