Economics Chapter 15 Homework Which appears at the end of this chapter solution

Chapter 15: Distributions to Shareholders

Learning Objectives

407

Chapter 15

Distributions to Shareholders: Dividends and

Share Repurchases

Learning Objectives

After reading this chapter, students should be able to:

◆ Explain why some investors like the firm to pay more dividends while other investors prefer

reinvestment and the resulting capital gains.

◆ Discuss the various trade-offs that companies face when trying to establish their optimal dividend

policy.

◆ Differentiate between stock splits and stock dividends.

◆ List the advantages and disadvantages of stock repurchases vis-à-vis dividends from both investors’

and companies’ perspectives.

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Lecture Suggestions

Chapter 15: Distributions to Shareholders

Lecture Suggestions

We like this chapter and generally cover it in its entirety, but it could be omitted in the introductory

course without loss of continuity. Or, sections such as stock dividends or stock repurchases could be

omitted.

DAYS ON CHAPTER: 3 OF 56 DAYS (50-minute periods)

Chapter 15: Distributions to Shareholders

Answers and Solutions

409

Answers to End-of-Chapter Questions

15-1 The biggest advantage of having an announced dividend policy is that it would reduce investor

uncertainty, and reductions in uncertainty are generally associated with lower capital costs and

15-2 While it is true that the cost of outside equity is higher than that of retained earnings, it is not

necessarily irrational for a firm to pay dividends and sell stock in the same year. If the firm has

15-3 Logic suggests that stockholders like stable dividends—many of them depend on dividend

15-5 a. From the stockholders’ point of view, an increase in the personal income tax rate would make

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Answers and Solutions

Chapter 15: Distributions to Shareholders

c. If interest rates were to increase, the increase would make retained earnings a relatively

15-6 a. The residual dividend policy is based on the premise that, since new common stock is more

15-7 It is true that executives’ salaries are more highly correlated with the size of the firm than with

Chapter 15: Distributions to Shareholders

Answers and Solutions

411

15-9 It is sometimes argued that there is an optimum price for a stock; that is, a price at which WACC

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Answers and Solutions

Chapter 15: Distributions to Shareholders

Solutions to End-of-Chapter Problems

15-1 70% Debt; 30% Equity; Capital budget = $3,000,000; NI = $2,000,000; PO = ?

15-3 NI = $2,000,000; Shares outstanding = 1,000,000; P0 = $32; Repurchase = 20%; New EPS = ?

15-4 DPS after split = $0.75.

Chapter 15: Distributions to Shareholders

Answers and Solutions

413

15-6 Step 1: Determine the capital budget by selecting those projects whose returns are greater

than the project’s risk-adjusted cost of capital.

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Answers and Solutions

Chapter 15: Distributions to Shareholders

d. Payout ratio = Dividends/Net income

e. Since the company would like to avoid transactions costs involved in issuing new equity, it

would be best for the firm to maintain the same per-share dividend. This will provide a

15-8 a. Before finding the long-run growth rate, the dividend payout ratio must be determined.

b. The required return can be calculated using the DCF approach.

c. The new payout ratio can be calculated as:

d. The firm’s original plan was to issue a dividend equal to $0.75 per share, which equates to a

Chapter 15: Distributions to Shareholders

Answers and Solutions

415

e. If the total amount of value to be distributed to shareholders is $360,000, at a price of

$12.50 per share, then the number of new shares issued would be:

15-9 a. 1. 2015 Dividends = (1.10)(2014 Dividends)

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Answers and Solutions

Chapter 15: Distributions to Shareholders

Comprehensive/Spreadsheet Problem

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Comprehensive/Spreadsheet Problem

Note to Instructors:

The solution to this problem is not provided to students at the back of their text. Instructors

can access the

Excel

file on the textbook’s website.

b. According to the residual dividend model, only $2 million is available for dividends.

Payout ratio = $2,000,000/$8,000,000 = 25%.

e. Capital budget = $10 million; Dividends = $3 million; NI = $8 million;

Capital structure = ?

f. Dividends = $3 million; Capital budget = $10 million; 60% equity, 40% debt; NI = $8

million.

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Comprehensive/Spreadsheet Problem

Chapter 15: Distributions to Shareholders

g. Dividends = $3 million; NI = $8 million; Capital structure = 60% equity, 40% debt.

h. The firm can do one of four things:

(1) Cut dividends.

Chapter 15: Distributions to Shareholders

Integrated Case

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Integrated Case

15–11

Southeastern Steel Company

Dividend Policy

Southeastern Steel Company (SSC) was formed 5 years ago to exploit a new

continuous casting process. SSC’s founders, Donald Brown and Margo Valencia,

had been employed in the research department of a major integrated-steel

A. (1) What is meant by the term dividend policy?