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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.
408
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
410
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
Chapter 15: Distributions to Shareholders
Comprehensive/Spreadsheet Problem
417
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
419
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?
