BUSINESS

FINANCE
FINS1613
Tutorial
Week13
DividendPolicy

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 CONTACT DETAILS
YourTutor:
PeterAndersen
peter.andersen@unsw.edu.au

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 1
DIVIDENDS AND SHARE PRICE
Q. Yourportfolioconsistsof200sharesofJCSLtd.Thecurrentsharepriceis
$96.Thecompanyhasannouncedadividendof$2.50persharewithanex
dividenddateofApril19.Assumingnotaxes,howmuchwillyoursharebe
worthonApril19?
A. Withnotaxeswewouldexpectthesharepricetodropbyexactlytheamount
ofthedividend,sothenewsharepricewillbe:
Newshareprice=$96.00 2.50
Newshareprice=$93.50
Yourtotalshareinvestmentwillbeworth:
Sharevalue=200 $93.50
Sharevalue=$18,700

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 2
DIVIDENDS AND SHARE PRICE
Q. ItisApril19.Usingtheinformationinthepreviousquestion,whatisyour
totalportfoliovalue?
A. Yourtotalportfoliovaluewillbethetotalsharevalueplusthedividends
received,so:
Portfoliovalue=$18,700+(200 $2.50)
Portfoliovalue=$19,200

Thisisthesameasifyoutookthecumdividendsharepriceof$96and
multiplieditbyyour200sharesowned.Thepointisthatyourwealthdoesnot
decreasewhenthesharepricedropsontheexdividenddate.Rather,someof
thatwealthistransferredfromsharestocash(dividends).

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 4
SHARE DIVIDENDS/BONUS ISSUE
TheownersequityaccountsforFigJamInternationalareshownhere:
Ordinaryshares ($1subscriptionprice) $25,000
Capitalsurplus $170,000
Retainedearnings $530,000
Totalownersequity $725,000
Q. IfFigJamssharescurrentlysellfor$35pershareanda10%bonusissueis
declared,howmanynewshareswillbedistributed?Showhowtheequity
accountswouldchange.
A. Thesharesoutstandingincreasesby10percent,so:
Newsharesoutstanding=25,000(1.10)
Newsharesoutstanding=27,500
Newsharesissued=2,500

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 4
SHARE DIVIDENDS/BONUS ISSUE
TheownersequityaccountsforFigJamInternationalareshownhere:
Ordinaryshares ($1subscriptionprice) $25,000
Capitalsurplus $170,000
Retainedearnings $530,000
Totalownersequity $725,000
Q. IfFigJamssharescurrentlysellfor$35pershareanda10%bonusissueis
declared,howmanynewshareswillbedistributed?Showhowtheequity
accountswouldchange.
A. Sincetheparvalueofthenewsharesis$1,thecapitalsurpluspershareis
$34.Thetotalcapitalsurplusistherefore:
Capitalsurplusonnewshares=2,500($34)
Capitalsurplusonnewshares=$85,000

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 4
SHARE DIVIDENDS/BONUS ISSUE
A. Thenewequityaccountbalanceswillbe:
Changes
Ordinaryshares ($1subscriptionprice) $27,500 +$2,500
Capitalsurplus $255,000 +$85,000
Retainedearnings $442,500 $87,500
Totalownersequity $725,000 =$0

Thepointofthisproblemistoshowthatwhenthecompanyissuesshare
dividendsorhasabonusissue,theretainedearningsdecreaselikethey
wouldwithacashdividend.However,theseretainedearningsjustget
transferredtootherequityaccountsandoverallownersequitystaysconstant.
$1outofthe$35marketprice(pershare)atthetimeofissuegetsaddedto
theOrdinarySharesaccount.
Theremaining$34outofthe$35getsaddedtotheCapitalSurplusaccount.
Overallshareholderwealthdoesntthechange.Theyjusthavethatsame
wealthdividedupamongmoreshares.
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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 4
SHARE DIVIDENDS/BONUS ISSUE
A. Thenewequityaccountbalanceswillbe:
Ordinaryshares ($1subscriptionprice) $27,500
Capitalsurplus $255,000
Retainedearnings $442,500
Totalownersequity $725,000
Q. AfterFigJamcarriesoutthebonusissue,whatisthenewshareprice?
A. Sincenonewequityfundsarereceivedbythefirmitmeansthattheshare
pricewillbereducedbytheeffectofthenewissue.Thesharepriceistheold
marketvaluedividedbythetotalamountofsharesonissue,therefore:
Marketvalue=originalnumberofsharesissuedxshareprice
Marketvalue=25,000($35)=$875,000
Newshareprice=Marketvalue/numberofsharesissued
NewShareprice=$875,000/27,500=$31.82
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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 5
SHARE SPLITS
ForthecompanyinProblem4,calculatethesharepriceif:
Q. FigJamdeclaresatwoforonesharesplit.Howmanysharesareoutstanding
now?
A. Tofindthenewsharesoutstanding,wemultiplythecurrentshares
outstandingtimestheratioofnewsharestooldshares,so:
Newsharesoutstanding=25,000(2/1)
Newsharesoutstanding=50,000
Thevalueoftheshareischangedbytheratioofnewsharestooldshares,so
thenewvalueofashareis:
Newsharevalue=35(1/2)
Newsharevalue=$17.50pershare

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 5
SHARE SPLITS
ForthecompanyinProblem4,calculatethesharepriceif:
Q. FigJamdeclaresa1forfivesharesplit.Howmanysharesareoutstanding
now?
A. Tofindthenewsharesoutstanding,wemultiplythecurrentshares
outstandingtimestheratioofnewsharestooldshares,so:
Newsharesoutstanding=25,000(1/5)
Newsharesoutstanding=5,000
Thevalueoftheshareischangedbytheratioofnewsharestooldshares,so
thenewvalueofashareis:
Newsharevalue=$35(5/1)
Newsharevalue=$175.00pershare

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 6
SHARE SPLITS, DIVIDENDS & BONUS ISSUE
BermudaTriangleCorporationcurrentlyhas400,000sharesoutstanding,
whichsellfor$92pershare.Assumingnomarketimperfectionsortax
effectsexist,whatwillthesharepricebeafter:
Q. BTChasafiveforthreesharesplit?
A. $92(3/5)=$55.20
Q. BTChasa15%bonusissue?
A. $92(1/1.15)=$80.00
Q. BTChasa42.5%bonusissue?
A. $92(1/1.425)=$64.56
Q. BTChasafourforsevenreversesharesplit?
A. $92(7/4)=$161.00

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 6
SHARE SPLITS, DIVIDENDS & BONUS ISSUE
BermudaTriangleCorporationcurrentlyhas400,000sharesoutstanding,
whichsellfor$92pershare.Assumingnomarketimperfectionsortax
effectsexist,whatwillthesharepricebeafter:
Q. Determinethenewnumberofsharesoutstandinginthepreviousfour
questions.
A. 400,000(5/3)=666,667
400,000(1.15)=460,000
400,000(1.425)=570,000
400,000(4/7)=228,571

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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 16
HOMEMADE DIVIDENDS
Q. Youown1,000sharesinChristinaCommunications.Youwillreceivea$3.50
persharedividendinoneyear.Intwoyears,Christinawillpayaliquidating
dividendof$45pershare.TherequiredreturnonChristinassharesis15%.
Whatisthecurrentshareprice(ignoringtaxes)?Ifyouwouldratherhave
equaldividendsineachofthenexttwoyears,showhowyoucanaccomplish
thisbycreatinghomemadedividends.(Hint:dividendswillbeintheformof
anannuity).
A. ThepriceofthesharetodayisthePVofthedividends,so:
P0 =$3.50/(1+0.15)+$45/(1+0.15)2 =$37.07
Tofindtheequaltwoyeardividendswiththesamepresentvalueastheprice
oftheshare,wesetupthefollowingequationandsolveforthedividend
(Note:Thedividendisatwoyearannuity,sowecouldsolvewiththeannuity
factoraswell):
$37.07=D/(1+0.15)2 +D/(1+0.15)2 >D=$22.80
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FINS1613 PeterKjeldAndersen(2012S2)
 CHAPTER 14: PROBLEM 16
A. Wenowknowthecashflowpersharewewanteachofthenexttwoyears.
Wecanfindthepriceofshareinoneyear,whichwillbe:
P1=$45/(1+0.15)=$39.13
Sinceyouown1,000shares,inoneyearyouwant1,000($22.80) =$22,802.33
Butyoullonlyget:Dividendsreceivedinoneyear=1,000($3.50)=$3,500.00
Thus,inoneyearyouwillneedtoselladditionalsharesinordertoincrease
yourcashflow.Thenumberofsharestosellinyearoneis:
Sharestosellattimeone=($22,802.33 $3,500)/$39.13 =493.28shares
AtYear2,youcashflowwillbethedividendpaymenttimesthenumberof
sharesyoustillown,sotheYear2cashflowis:
Year2cashflow=$45(1,000 493.28)=$22,802.33

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FINS1613 PeterKjeldAndersen(2012S2)
 MULTIPLE CHOICE QUESTION 1
ArdenManufacturingfollowsastrictresidualdividendpolicy.Thecompanyisforecasting
thatitsnetincomewillbe$500millionthisyear.Thecompanyanticipatesthatitscapital
budgetwillbe$250million.Thecompanyhasatargetcapitalstructurethatconsistsof50
percentequityand50percentlongtermdebt.Whatisthecompany'santicipateddividend
payoutratio?
A. 75%
B. 55%
C. 50% Underaresidualdividendpolicy,thecompanypaysoutwhatever
fractionofitsnetincomethatitdoesntneedforitscapitalbudget
D. 25% (i.e.investmentinstufflikeplant,property,machinery)
E. 47%
Total Dividends
Dividend Payout Ratio
Net Income

Total Dividends Net Income amount of capital budget funded through equity
Total Dividends $500m $250m 50% $375m

Total Dividends $375m

Dividend Payout Ratio 75%
Net Income $500m
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FINS1613 PeterKjeldAndersen(2012S2)
 MULTIPLE CHOICE QUESTION 2
Whichofthefollowingstatementsbestdescribesthetheoriesofinvestors'preferencesfor
dividends?
A. ModiglianiandMillerarguethatinvestorspreferdividendstocapitalgains.
B. Thebirdinhandtheorysuggeststhatacompanycanreduceitscostofequitycapital
byreducingitsdividendpayoutratio.
C. Thetaxpreferencetheorysuggeststhatacompanycanincreaseitsstockpriceby
increasingitsdividendpayoutratio.
D. Onekeyadvantageofaresidualdividendpolicyisthatitenablesacompanytofollowa
stabledividendpolicy.
E. Theclienteleeffectsuggeststhatcompaniesshouldfollowastabledividendpolicy.

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FINS1613 PeterKjeldAndersen(2012S2)
 MULTIPLE CHOICE QUESTION 3
FirmMisamaturefirminamatureindustry.Itsannualnetincomeandnetcashfloware
bothconsistentlyhighandverystable.Thecompany'sgrowthprospectsarequitelimited;
therefore,thecompany'scapitalbudgetissmallrelativetoitsnetincome.FirmNisa
relativelynewfirminanewindustry.Itsannualoperatingincomefluctuatesconsiderably,
butthecompanyhassubstantialgrowthopportunities.Itscapitalbudgetisexpectedtobe
largerelativetoitsnetincomefortheforeseeablefuture.Whichofthefollowingstatements
ismostcorrect?
A. FirmMprobablyhasalowerdebtratiothanFirmN.
B. FirmMprobablyhasahigherdividendpayoutratiothanFirmN.
C. Ifthecorporatetaxrateincreases,thedebtratioofbothfirmsislikelytofall.
D. Statementsaandbarecorrect.
E. Statementsbandcarecorrect.

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FINS1613 PeterKjeldAndersen(2012S2)
 MULTIPLE CHOICE QUESTION 4
Whichofthefollowingwouldnothaveaninfluenceontheoptimaldividendpolicy?
A. Thepossibilityofacceleratingordelayinginvestmentprojects.
B. Astrongshareholders'preferenceforcurrentincomeversuscapitalgains.
C. Bondindentureconstraints.
D. Thecostsassociatedwithsellingnewcommonstock.
E. Allofthestatementsabovecanhaveaneffectondividendpolicy.

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FINS1613 PeterKjeldAndersen(2012S2)
 MULTIPLE CHOICE QUESTION 5
Whichofthefollowingactionswillenableacompanytoraiseadditionalequitycapital(that
is,whichofthefollowingwillraisethetotalbookvalueofequity)?
A. Theestablishmentofanewstockdividendreinvestmentplan.
B. Astocksplit.
C. Theestablishmentofanopenmarketpurchasedividendreinvestmentplan.
D. Astockrepurchase.
E. Statementsaanddarecorrect.

UnderanopenmarketpurchaseDRIP,thedividendsgetpaidouttoatrusteebank,who
thenbuysnewsharesonthesecondarymarket(i.e.stockmarket)andallocatedthem
amongtheDRIPparticipants.

UnderanewstockDRIP,thecompanyissuesnewsharesandthedividendsthatwouldhave
beenpaidouttoinvestorsareinsteadusedtopurchasethosesharesontheirbehalf.

Itincreasesthebookvalueofequityrelativetothesituationwherethecompaniesjustpaid
outdividendsortheywerereinvestedonthesecondarymarket.

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FINS1613 PeterKjeldAndersen(2012S2)
 MULTIPLE CHOICE QUESTION 6
AlbanyMotorsrecentlycompleteda3for1stocksplit.Priortothesplit,thecompanyhad
10millionsharesoutstandinganditsstockpricewas$150pershare.Afterthesplit,thetotal
marketvalueofthecompany'sstockequalled$1.5billion.Whatwasthepriceofthe
company'sstockfollowingthestocksplit?
A. $15
B. $45
C. $50
D. $150
E. $450

Newsharesoutstanding=10,000,000x(3/1)=30,000,000shares
Ifmarketvalue=$1.5bor$1,500,000,000,then:
Marketprice=$1,5000,000,000/30,000,000shares=$50pershare.

Dontjustdividethestockpriceof$150/shareby(3/1).Usethemarketvalueoftheoverall
companyasabovejustincasethestocksplitledtosomeincreaseintheoverallvalueofthe
companybeyondthetheoreticalsharepriceof$150/3=$50duetolatentdemand(inthis
questionitdoesntmatter).
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FINS1613 PeterKjeldAndersen(2012S2)
 MULTIPLE CHOICE QUESTION 7
Whichofthefollowingstatementsismostcorrect?
A. Ingeneral,stockrepurchasesaretaxedthesamewayasdividends.
B. Onenicefeatureofdividendreinvestmentplansisthattheyenableinvestorstoreduce
thetaxespaidontheirdividends.
C. Onaverage,companiessendanegativesignaltothemarketplacewhentheyannounce
anincreaseintheirdividend.
D. Ifacompanyisinterestedinissuingnewequitycapital,anewstockdividend
reinvestmentplanprobablymakesmoresensethananopenmarketdividend
reinvestmentplan.
E. Statementsbanddarecorrect.

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FINS1613 PeterKjeldAndersen(2012S2)
 MULTIPLE CHOICE QUESTION 8
Theadvantagesofastockrepurchasecomparedtoadividendinclude:
A. Investorsseearepurchaseasagoodsignal
B. Shareholdershavemorechoice
C. Anylargeblocksofsharesthataredepressingthemarketpricecanberemoved
D. Managerscanissueexcessearningstoshareholderswithoutalteringdividends
E. Allofthestatementsabove

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FINS1613 PeterKjeldAndersen(2012S2)
CEST FINI

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FINS1613 PeterKjeldAndersen(2012S2)