Stock Splits Nathan Detroit

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a. If the firm's dividend policy were based on a constant payout ratio of 40% for all years with positive earnings and 0% otherwise, what would be the annual dividend for each year?

b. If the firm had a dividend payout of $1.00 per share, increasing by $0.10 per share whenever the dividend payout fell below 50% for two consecutive years, what annual dividend would the firm pay each year?

c. If the firm's policy were to pay $0.50 per share each period except when earnings per share exceed $3.00, when an extra dividend equal to 80% of earnings beyond '$3.00 would be paid, what annual dividend would the firm pay each year?

d. Discuss the pros and cons of each dividend policy described in parts a through c.

lUHS-li Alternative dividend policies Given the earnings per share over the period

2002-2009 shown in the following table, determine the annual dividend per share under each of the policies set forth in parts a through d.

2008 1.56

2007 1.20

2004 0.60

2003 1.00

2002 0.44

a. Pay out 50% of earnings in all years with positive earnings.

b. Pay $0.50 per share and increase to $0.60 per share whenever earnings per share rise above $0.90 per share for two consecutive years.

c. Pay $0.50 per share except when earnings exceed $1.00 per share, in which case pay an extra dividend of 60% of earnings above $1.00 per share.

d. Combine the policies described in parts b and c. When the dividend is raised (in part b), raise the excess dividend base (in part c) from $1.00 to $1.10 per share.

e. Compare and contrast each of the dividend policies described in parts a through d.

baifr&J Stock dividend—Firm Columbia Paper has the following stockholders' equity account. The firm's common stock has a current market price of $30 per share.

Preferred stock $100,000

Common stock (10,000 shares at $2 par) 20,000

Paid-in capital in excess of par 280,000

Retained earnings 100,000

Total stockholders' equity $500,000

a. Show the effects on Columbia of a 5% stock dividend.

b. Show the effects of (1) a 10% and (2) a 20% stock dividend.

c. In light of your answers to parts a and b, discuss the effects of stock dividends on stockholders' equity.

Cash versus stock dividend Milwaukee Tool has the following stockholders' equity account. The firm's common stock currendy sells for $4 per share.

Preferred stock

Common stock (400,000 shares at $1 par) Paid-in capital in excess of par Retained earnings Total stockholders' equity

$ 100,000 400,000 200,000 320,000 $1,020,000

a. Show the effects on the firm of a cash dividend of $0.01, $0.05, $0.10, and $0.20 per share.

Show the effects on the firm of a 1%, 5%, 10%, and 20% stock dividend. Compare the effects in parts a and b. What are the significant differences between the two methods of paying dividends?

Personal Finance Problem

Stock dividend—Investor Sarah Warren currently holds 400 shares of Nutri-Foods. The firm has 40,000 shares outstanding. The firm most recently had earnings available for common stockholders of $80,000, and its stock has been selling for $22 per share. The firm intends to retain its earnings and pay a 10% stock dividend, a. How much does the firm currently earn per share?

What proportion of the firm does Warren currently own? What proportion of the firm will Warren own after the stock dividend? Explain your answer:

At what market price would you expect the stock to sell after the stock dividend?

Discuss what effect, if any, the payment of stock dividends will have on Warren's share of the ownership and earnings of Nutri-Foods.

Personal Finance Problem

Stock dividend—Investor Security Data Company has outstanding 50,000 shares of common stock currently selling at $40 per share. The firm-most recently had earnings available for common stockholders of $120,000, but it has decided to retain these funds and is considering either a5%oral0% stock dividend in lieu of a cash dividend.

a. Determine the firm's current earnings per share.

b. If Sam Waller currently owns 500 shares of the firm's stock, determine his proportion of ownership currently and under each of the proposed stock dividend plans. Explain your findings.

c. Calculate and explain the market price per share under each of the stock dividend plans.

For each of the proposed stock dividends, calculate the earnings per share after payment of the stock dividend.

What is the value of Waller's holdings under each of the plans? Explain. Should Waller have any preference with respect to the proposed stock dividends? Why or why not?

Stock split—Firm Growth Industries' current stockholders' equity account is as follows at the top of page 627:

Common stock (600,000 shares at $3 par) 1,800,000

Paid-in capital in excess of par 200,000

Retained earnings 800,000

Total stockholders' equity $3,200,000

a. Indicate the change, if any, expected if the firm declares a 2-for-l stock split.

b.. Indicate the change, if any, expected if the firm declares a 1-for-lVi reverse stock split.

c. Indicate the change, if any, expected if the firm declares a 3-for-l stock split.

d. Indicate the change, if any, expected if the firm declares a 6-for-l stock split.

e. Indicate the change, if any, expected if the firm declares a l-for-4 reverse stock split.

Personal Finance Problem

Stock splits Nathan Detroit owns 400 shares of Apple Inc., which he purchased in September 2006 for $18 per share. Apple is regarded as a high-tech computer stock and has introduced new innovations in the electronics field over the past 3 years. As of May 2009, the price of the stock was at $121 per share. Nathan read in the Wall Street Journal that Apple's board of directors believed that the stock may be priced too high and would trade more actively in a lower price range. The board announced a 4-for-l stock split.

Answer the following questions about the impact of the stock split on his holdings and taxes. Nathan is in the 28% federal income tax bracket.

a. How many shares of Apple will Nathan own after the stock split?

b. Immediately after the split, what do you expect the value of Apple to be?

c. Compare the total value of Nathan's stock holdings before and after the split. What do you find?

d. Does Nathan experience a gain or loss on the stock as a result of the 4-for-l split?

e. What is Nathan's tax liability from the event?

Stock split versus stock dividend—Firm Mammoth Corporation is considering a 3-for-2 stock split. It currently has the stockholders* equity position shown. The current stock price is $120 per share. The most recent period's earnings available for common stock is included in retained earnings.

Preferred stock $ 1,000,000

Common stock (100,000 shares at $3 par) 300,000

Paid-in capital in excess of par 1,700,000

Retained earnings 10,000,000

Total stockholders' equity $13,000,000

a. What effects on Mammoth would result from the stock split?

b. What change in stock price would you expect to result from the stock split?

c. What is the maximum cash dividend per share that the firm could pay on common stock before and after the stock split? (Assume that legal capital includes all paid-in capital.)

d. Contrast your answers to parts a through c with the circumstances surrounding a 50% stock dividend.

e. Explain the differences between stock splits and stock dividends.

M Ijjjtgyjj Stock dividend versus stock split—Firm The board of Wicker Home Health Care, Inc., is exploring ways to expand the number of shares outstanding in an effort to reduce the market price per share to a level that the firm considers more appealing to investors. The options under consideration are a 20% stock dividend and, alternatively, a 5-for-4 stock split. At the present time, the firm's equity account and other per-share information are as follows:

Preferred stock $ 0

Common stock (100,000 shares at $1 par) 100,000

Paid-in capital in excess of par 900,000

Retained earnings 700,000

Total stockholders' equity $1,700,000

Price per share $30.00

Earnings per share $3.60

Dividend per share $1.08

a. Show the effect on the equity accounts and per-share data of a 20% stock dividend.

b. Show the effect on the equity accounts and per-share data of a 5-for-4 stock split.

c. Which option will accomplish Wicker's goal of reducing the current stock price while maintaining a stable level of retained earnings?

d. What legal constraints might encourage the firm to choose a stock split over a stock dividend?

laflBJm Stock repurchase The following financial data on the Bond Recording Company

6 j are available:

Earnings available for common stockholders $800,000

Number of shares of common stock outstanding 400,000

Market price per share $20

The firm is currently considering whether it should use $400,000 of its earnings to pay cash dividends of $1 per share or to repurchase stock at $21 per share.

a. Approximately how many shares of stock can the firm repurchase at the $21-per-share price, using the funds that would have gone to pay the cash dividend?

b. Calculate the EPS after the repurchase. Explain your calculations.

c. If the stock still sells at 10 times earnings, what will the market price be after the repurchase?

d. Compare the pre- and post-repurchase earnings per share.

e. Compare and contrast the stockholders' positions under the dividend and repurchase alternatives. What are the tax implications under each alternative?

Stock repurchase Harte Textiles, Inc., a maker of custom upholstery fabrics, is concerned about preserving the wealth of its stockholders during a cyclic downturn in the home furnishings business. The company has maintained a constant dividend payout of $2.00 tied to a target payout ratio of 40%. Management is preparing a share repurchase recommendation to present to the firm's board of directors. The following data have been gathered from the last two years:

Earnings available for common stockholders $1,260,000 $1,200,000

Number of shares outstanding 300,000 300,000

Earnings per share S4.20 $4.00

Market price per share $23.50 $20.00

Price/earnings ratio 5.6 5.0

a. How many shares should the company have outstanding in 2009 if its earnings available for common stockholders in that year is $1,200,000 and it pays a dividend of $2.00, given that its desired payout ratio is 40%?

b. How many shares would Harte have to repurchase to have the level of shares outstanding calculated in part a?

ra PI 3-19 ETHICS PROBLEM Assume that you are the CFO of a company contemplating 6 j a stock repurchase next quartet. You know that there are several methods of reducing the current quarterly earnings, which may cause the stock price to fall prior to the announcement of the proposed stock repurchase. What course of action would you recommend to your CEO? If your CEO came to you first and recommended reducing the current quarter's earnings, what would be your response?

Chapter 13 Case

Establishing General Access Company's Dividend Policy and Initial Dividend

General Access Company (GAC) is a fast-growing Internet access provider that initially went public in early 2003. Its revenue growth and profitability have steadily risen since the firm's inception in late 2001. GAC's growth has been financed through the initial common stock offering, the sale of bonds in 2006, and the retention of all earnings. Because of its rapid growth in revenue and profits, with only short-term earnings declines, GAC's common stockholders have been content to let the firm reinvest earnings as part of its plan to expand capacity to meet the growing demand for its services. This strategy has benefited most stockholders in terms of stock splits and capital gains. Since the company's initial public offering in 2003, GAC's stock twice has been split 2-for-l. In terms of total growth, the market price of GAC's stock, after adjustment for stock splits, has increased by 800% during the 7-year period 2003-2009.

Because GAC's rapid growth is beginning to slow, the firm's CEO, Marilyn McNeeiy, believes that its shares are becoming less attractive to investors. McNeely has had discussions with her CFO, Bobby Joe Rook, who believes that the firm must begin to pay cash dividends. He argues that many investors value regular dividends and that by beginning to pay them, GAC would increase the demand—and therefore the price—for its shares. McNeely decided that at the next board meeting she would propose that the firm begin to pay dividends on a regular basis.

McNeeiy realized that if the board approved her recommendation, it would have to (1) establish a dividend policy and (2) set the amount of the initial annual dividend.

She had Rook prepare a summary of the firm's annual EPS. It is given in the following table.

- * j-8-

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