Banking Chapter 17 Homework Payout Policy What Options Does Firm Have Spend Its Free Cash

Chapter 17

Payout Policy

17–1. What options does a firm have to spend its free cash flow (after it has satisfied all interest

obligations)?

17–2. ABC Corporation announced that it will pay a dividend to all shareholders of record as of

Monday, April 2, 2012. It takes three business days of a purchase for the new owners of a share

of stock to be registered.

a. When is the last day an investor can purchase ABC stock and still get the dividend payment?

b. When is the ex-dividend day?

17–3. Describe the different mechanisms available to a firm to use to repurchase shares

There are three mechanisms. 1) In an open-market repurchase, the firm repurchases the shares in the

17–4. RFC Corp. has announced a $1.32 dividend. If RFC’s price last price cum-dividend is $13.21,

what should its first ex-dividend price be (assuming perfect capital markets)?

17–5. EJH Company has a market capitalization of $1.3 billion and 10 million shares outstanding. It

plans to distribute $120 million through an open market repurchase. Assuming perfect capital

markets:

a. What will the price per share of EJH be right before the repurchase?

b. How many shares will be repurchased?

c. What will the price per share of EJH be right after the repurchase?

17–6. KMS Corporation has assets with a market value of $422 million, $36 million of which are cash.

It has debt of $186 million and 18 million shares outstanding. Assume perfect capital markets.

a. What is its current stock price?

b. If KMS distributes $36 million as a dividend, what will its share price be after the dividend

is paid?

c. If instead, KMS distributes $36 million as a share repurchase, what will its share price be

once the shares are repurchased?

d. What will its new market debt-equity ratio be after either transaction?

17–7. Natsam Corporation has $150 million of excess cash. The firm has no debt and 350 million

shares outstanding with a current market price of $11 per share. Natsam’s board has decided to

pay out this cash as a one-time dividend.

a. What is the ex-dividend price of a share in a perfect capital market?

b. If the board instead decided to use the cash to do a one-time share repurchase, in a perfect

capital market what is the price of the shares once the repurchase is complete?

c. In a perfect capital market, which policy, in part (a) or (b), makes investors in the firm

better off?

17–8. Suppose the board of Natsam Corporation decided to do the share repurchase in Problem 7 part

(b), but you, as an investor, would have preferred to receive a dividend payment. How can you

leave yourself in the same position as if the board had elected to make the dividend payment

instead?

17–9. Suppose you work for Oracle Corporation, and part of your compensation takes the form of

stock options. The value of the stock option is equal to the difference between Oracle’s stock

price and an exercise price of $10 per share at the time that you exercise the option. As an option

holder, would you prefer that Oracle use dividends or share repurchases to pay out cash to

shareholders? Explain.

17-20. A stock that you know is held by long-term individual investors paid a large one-time dividend.

You notice that the price drop on the ex–dividend date is about the size of the dividend payment.

You find this relationship puzzling given the tax disadvantage of dividends. Explain how the

dividend-capture theory might account for this behavior.

17-21. Clovix Corporation has $43 million in cash, 11 million shares outstanding, and a current share

price of $25. Clovix is deciding whether to use the $43 million to pay an immediate special

dividend of $3.91 per share, or to retain and invest it at the risk-free rate of 10% and use the

$4.30 million in interest earned to increase its regular annual dividend of $0.39 per share.

Assume perfect capital markets.

a. Suppose Clovix pays the special dividend. How can a shareholder who would prefer an

increase in the regular dividend create it on her own?

b. Suppose Clovix increases its regular dividend. How can a shareholder who would prefer the

special dividend create it on her own?

17-22. Assume capital markets are perfect. Kay Industries currently has $100 million invested in short

term Treasury securities paying 7%, and it pays out the interest payments on these securities

each year as a dividend. The board is considering selling the Treasury securities and paying out

the proceeds as a one-time dividend payment.

a. If the board went ahead with this plan, what would happen to the value of Kay stock upon

the announcement of a change in policy?

b. What would happen to the value of Kay stock on the ex-dividend date of the one-time

dividend?

c. Given these price reactions, will this decision benefit investors?

17-23. Redo Problem 21, but assume that Kay must pay a corporate tax rate of 35%, and investors pay

no taxes.

17-24. Harris Corporation has $243 million in cash and 147 million shares outstanding. Suppose the

corporate tax rate is 35% and investors pay no taxes on dividends, capital gains, or interest

income. Investors had expected Harris to pay out the $243 million through a share repurchase.

Suppose instead that Harris announces it will permanently retain the cash and use the interest

238 Berk/DeMarzo, Corporate Finance, Fourth Edition, Global Edition

on the cash to pay a regular dividend. If there are no other benefits of retaining the cash, how

will Harris’ stock price change upon this announcement?

17-25. Redo Problem 21, but assume the following:

a. Investors pay a 15% tax on dividends but no capital gains taxes or taxes on interest income,

and Kay does not pay corporate taxes.

b. Investors pay a 15% tax on dividends and capital gains, and a 35% tax on interest income,

while Kay pays a 35% corporate tax rate.

a. Assuming investors pay a 15% tax on dividends but no capital gains taxes nor taxes on interest

income, and Kay does not pay corporate taxes:

17-26. Raviv Industries has $97 million in cash that it can use for a share repurchase. Suppose instead

Raviv invests the funds in an account paying 8% interest for one year.

a. If the corporate tax rate is 38%, how much additional cash will Raviv have at the end of the

year net of corporate taxes?

b. If investors pay a 18% tax rate on capital gains, by how much will the value of their shares

have increased, net of capital gains taxes?

c. If investors pay a 28% tax rate on interest income, how much would they have had if they

invested the $97 million on their own?

d. Suppose Raviv retained the cash so that it would not need to raise new funds from outside

investors for an expansion it has planned for next year. If it did raise new funds, it would

have to pay issuance fees. How much does Raviv need to save in issuance fees to make

retaining the cash beneficial for its investors? (Assume fees can be expensed for corporate

tax purposes.)

17-31. Berkshire Hathaway’s A shares are trading at $120,000. What split ratio would it need to bring

its stock price down to $50?

17-32. Suppose the stock of Host Hotels & Resorts is currently trading for $25 per share.

a. If Host issued a 20% stock dividend, what will its new share price be?

b. If Host does a 3:2 stock split, what will its new share price be?

c. If Host does a 1:3 reverse split, what will its new share price be?

17-33. Explain why most companies choose to pay stock dividends (split their stock).

17-34. When might it be advantageous to undertake a reverse stock split?