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Introduction
Corporate Finance - Aubrey Yachts
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Question
1 of 6
The dividend policy that was used by Aubrey Yacht until the strike occurred is best described as a:

constant dividend payout ratio policy.

stable dividend policy.
residual dividend policy.

Question not answered

Jack Aubrey and his brother Charles are co-founders of Aubrey Yacht Manufacturers in Miami, Florida. The company specializes in
the production of yachts in the $500,000 to $1,200,000 price range. The Aubrey brothers took the company public in 1998 and its
shares are now traded on NASDAQ under the symbol AYM. Jack is the President and Charles is the chief executive officer (CEO)
and chairman of the board.

Demand for yachts in AYMs price range was strong during 2007, but a six-month strike that started in June
of that year allowed the company to reduce its finished goods inventory substantially by year end. During the
2008 recession, demand fell. The company responded by reducing inventory and modifying its capital
structure from its long run average of 25% long-term debt-to-equity until all of its outstanding long-term debt
was finally repaid in 2009.

Earnings and dividends had been growing strongly until the strike occurred. The company paid its first
dividend in 2003 but discontinued it soon after the strike began. Exhibit 1 shows the history of the companys
earnings per share (EPS) and dividends per share (DPS) since 2003.

Exhibit 1
 Aubrey Yacht Manufacturers Earnings and Dividend History, 31 December 2003 to 31 December

2013

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

EPS ($) 4.18 4.52 4.77 5.05 5.18 2.6 2.4 3.5 4.8 5.2 5.5

DPS ($) 2.17 2.31 2.48 2.58 2.64

During 2012, sales of yachts in the companys price range had recovered and Jack Aubrey is confident that
the company will be able to reinstate its dividend in 2014. He also wants to ensure that future dividends are
not cut as occurred in 2008 and has plans to determine dividends with a target payout adjustment model
that uses a five-year period to adjust toward the target.

His estimates and proposed payout plan are provided in Exhibit 2.

Exhibit 2

Jack Aubreys Estimates of Future Earnings and Dividends and Proposed

Long- Policy Run Dividend

Earnings Dividends

For 2014 $6.60/share $3.42/share

For 2015 $8.05/share

Proposed long-run dividend policy beginning in 2014

Long-run target payout 35%

Adjustment factor toward five-year target 0.20 per year

Steve Maturin is the CEO of Standard Marine Containers, a manufacturer of plastic pallets and crates used
in marine shipping. He is one of the four independent directors on the board of AYM; the board consists of
eight directors with only the Aubreys having had an employment relationship with the company. Maturin has
been a close friend of Charles Aubrey since childhood and Jack Aubrey is a director of Standard Marine
Containers.

Charles, Maturin, and their families have just returned from a two week cruise to Bermuda on one of the
companys best yachts. Maturin informed Jack that the weather on this years trip was much better than last
year, that he was well rested, and ready to tackle some thorny issues in AYMs first board meeting of the
year.

Maturin started: In particular, alternatives to paying dividends, moving to a staggered board of directors, and
the companys financing mix are items of great interest to me.
Maturin said that after reviewing the companys share price behavior during 2003-2007, he found that when
the shares went ex-dividend, they normally fell by about $0.68 per $1.00 of dividend paid.
 Jack Aubrey reminded everyone about the results of a survey that was conducted last year on a large
sample of the companys investors. It had indicated that, on average, the investors tax rate on capital gains
was 23%, but their tax rates on dividends varied widely across the sample.

Jack asked Maturin:

"If these tax results had also applied to the time period for which you reviewed the ex-dividend share
price behavior, what would have been the marginal tax rate on dividend income for those trading the
companys shares around the ex-dividend date?"

Maturin said he would answer Jacks question later and continued:

Ive been thinking that our current annual election of the board is not in the best interests of our
shareholders. I believe we should be moving to a staggered board for the following reasons:

1. The company would be less likely to resist hostile takeover attempts with a staggered board;
2. It would ensure the continuity of the knowledge and experience in the company that is so essential for
good corporate governance; and
3. It would provide board members more time to learn and understand the needs of shareholders and to
be in a better position to align their interests with them.

Maturin concluded his remarks by saying:

"Although the company has not used any long-term debt since 2009, I would like to see the company
use long-term debt again. It should issue long-term debt and repurchase shares to return to its
historical level of 25% debt-to-equity. We should be able to issue long-term debt at a before tax cost
of 5%, and this should not materially increase the costs of financial distress, agency costs, or
asymmetrical information. With our current cost of equity at 12% and a 30% tax rate, our weighted
average cost of capital should drop, thus enhancing shareholder value."

Question not anwered.

Exhibit 1 shows that from 2003 to 2007, the company annually paid out approximately 51%-52% of earnings, which indicates a
constant dividend payout ratio policy.

Year EPS ($) DPS ($) DPS/EPS 100

2003 4.18 2.17 51.9%
2004 4.52 2.31 51.1%
2005 4.77 2.48 51.9%
2006 5.05 2.58 51.0%
2007 5.18 2.64 50.9%

CFA Level II
Dividends and Share Repurchases: Analysis, Gregory Noronha and George H. Troughton
Sections 4.1.1, 4.1.3

Question
2 of 6
Using Jack Aubreys estimates in Exhibit 2, and assuming that the company adopts his suggested dividend policy, the companys
2015 dividends per share will be closest to:

$3.49.
$4.17.
$3.52.

Question not answered

 Incorrect.

Aubrey is proposing a stable dividend policyone that reflects long-run expected earnings.
Following Example 9 fromDividends and Share Repurchases: Analysis,

.
=0.20

Expected Dividend:

= Last dividend + Increase in earnings Target payout ratio Adjustment factor

For 2015, Expected dividend = 3.42 + (8.05 6.60) 0.35 0.20 = $3.52

CFA Level II
Dividends and Share Repurchases: Analysis, Gregory Noronha and George H. Troughton
Section 4.1.1, Example 9

Question
3 of 6
Which of the following factors best supports Maturins classification as an independent director of AYM?

Jack Aubreys membership on the board of Standard Marine Containers

Personal relationships between Maturin and Charles Aubrey
Maturins employment history with the company

Question not answered

Personal relationships, having a past employment history with the firm, and interlocking directorships all indicate a lack of board
independence. Maturin was never employed by AYM, which is appropriate for an independent director. But Maturin was a childhood
friend of Charles and has been on vacation with Charles. Furthermore, Maturin and Jack have interlocking directorships on their
respective boards.

CFA Level II
Corporate Governance, Rebecca Todd McEnally and Kenneth Kim
Section 5.1.1

Question
4 of 6
The best response that Maturin could give to Jack Aubreys question about the marginal tax rate on dividend income is that it was
closest to:

47.6%.
32.0%.
15.6%.

Question not answered

Given the survey results and ex-dividend price behavior. Apply equation (1) in a similar manner as solution 2 from example 1 in
Dividends and Share Repurchases: Analysis,

Pw = stock price prior to dividend and eligible for dividend

Px = stock price after dividend
Pw Px = $0.68

D = amount of dividend ($1.00)

 TCG = marginal capital gains tax (23%)
TD = marginal dividend tax (?)

Pw Px = D [(1 TD)/(1 TCG)]

$0.68 = $1.00 [(1 TD)/(1 23%)]
Solve for TD = 1 [$0.63 (1 23%)] = 47.64%

CFA Level II
Dividends and Share Repurchases: Analysis, Gregory Noronha and George H. Troughton
Section 2.4.1, Equation 1 and Solution 2 of Example 1

Question
5 of 6
Which of Maturins reasons for adopting a staggered board is most supported by best practices of corporate governance?

2
3
1

Question not answered

Staggered boards do allow for continuity of the knowledge and experience in the company, which is essential for good corporate
governance.

CFA Level II
Corporate Governance, Rebecca Todd McEnally and Kenneth Kim
Section 5.1.4

Question
6 of 6
Using Maturins assumptions, the companys weighted average cost of capital (WACC) under his proposed financing plan would
be closest to:

10.3%.
11.3%.
9.8%.

Question not answered

Use equations 8 and 9 from the reading Capital Structure, implement Maturins suggested debt structure:

1. Determine the cost of equity at the proposed debt level

According to ModiglianiMiller Proposition II, in the presence of taxes
re = r0 + (r0 rd) (1 t) D/E (Equation 9)
re = 0.12 + (0.12 0.05) (1 0.30) 0.25 = 13.2%
The company is currently unlevered so its r0 = 12%.

2. Determine the WACC using the levered cost of equity

A D/E of 0.25 corresponds to D/V of 0.25/1.25 = 20%.
rWACC = D/V rd (1 t) + E/V re (Equation 8)
rWACC = [0.20 0.05 (1 0.30)] + [0.80 0.132] = 11.3%

where
re = marginal cost of equity capital for levered firm
r0 = cost of equity capital for unlevered firm
t = corporate tax rate
 rd = marginal cost of debt, before tax
D, E, V = market value of debt, equity, and value of firm, respectively
rWACC = weighted average cost of capital for firm

CFA Level II
Capital Structure, Raj Aggarwal, Pamela Peterson Drake, Adam Kobor, and Gregory Noronha
Sections 2.2, 2.3, Equations 8 and 9