The following companies have different financial statistics. What dividend policies would you recommend for them? Explain your reasons Matthews Co. Aaron Corp Growth rate in sales and earnings 20% Cash as a percentage of total assets 15% Solution: Mathews is not growing very fast so it doesn't need cash for growth unless it desires to change its policies. Assuming it doesn't, Mathews should have a high payout ratio Aaron is growing very fast and needs its cash for reinvestment in assets. For this reason, aaron should have a low dividend payout 18-6 A financial analyst is attempting to assess the future dividend policy of Interactive Technology by examining its life cycle. She anticipates no payout of earnings in the form of cash dividends during the development stage(). During the growth stage (II), she anticipates 10 percent of earnings will be distribut as dividends. As the firm progresses to the expansion stage (IIf), the payout ratio will go up to 40 percent, and eventually reach 60 percent during the maturity stage (IV a. Assuming earnings per share will be the following during each of the four stages, ind icate the cash dividend per share(if any) during each stage Stage I $.20 Stage Ill 22 StageⅣV 3.00 b. Assume in Stage IV that an investor owns 425 shares and is in a 15 percent tax bracket for dividends what will be his or her total aftertax income from the cash d ividend? In what two stages is the firm most likely to utilize stock dividends or stock CopyrightC 2005 by The McGran-Hill Companies, Inc. S-632
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-632 18-5. The following companies have different financial statistics. What dividend policies would you recommend for them? Explain your reasons. Matthews Co. Aaron Corp. Growth rate in sales and earnings .................. 5% 20% Cash as a percentage of total assets ............... 15% 2% Solution: Mathews is not growing very fast so it doesn't need cash for growth unless it desires to change its policies. Assuming it doesn't, Mathews should have a high payout ratio. Aaron is growing very fast and needs its cash for reinvestment in assets. For this reason, Aaron should have a low dividend payout. 18-6. A financial analyst is attempting to assess the future dividend policy of Interactive Technology by examining its life cycle. She anticipates no payout of earnings in the form of cash dividends during the development stage (I). During the growth stage (II), she anticipates 10 percent of earnings will be distributed as dividends. As the firm progresses to the expansion stage (III), the payout ratio will go up to 40 percent, and eventually reach 60 percent during the maturity stage (IV). a. Assuming earnings per share will be the following during each of the four stages, indicate the cash dividend per share (if any) during each stage. Stage I $ .20 Stage II 2.00 Stage III 2.80 Stage IV 3.00 b. Assume in Stage IV that an investor owns 425 shares and is in a 15 percent tax bracket for dividends; what will be his or her total aftertax income from the cash dividend? c. In what two stages is the firm most likely to utilize stock dividends or stock splits?
18-6. Continued Solution: Interactive Technology Earnings Payout Ratio Dividends Stage $.20 Stage 2.00 10% $20 Stage Ill 2.80 40% $l.12 Stage Iv 3.00 60% $l.80 b. Total dividends shares x dividends per share 425x1.80=$765 Aftertax income total dividends x(1-t) $765X 15 $765X(85)=$650.25 c. Stock dividends or stock splits are most likely to be utilized during stage II(growth or stage Ill(expansion) Squash Delight, Inc has the following balance sheet Assets $100,000 Accounts receivable 300.000 Fixed assets 600000 Total assets l.000.000 Liabilities Accounts payabl 150.000 50,000 Capital Common stock(50,000 shares @ $2 par) 100,000 Accounts Capital in excess of par 200.000 Retained earnings 500.000 S-633 Copyright o 2005 by The McGraw-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-633 18-6. Continued Solution: Interactive Technology a. Earnings Payout Ratio Dividends Stage I $ .20 0 0 Stage II 2.00 10% $ .20 Stage III 2.80 40% $1.12 Stage IV 3.00 60% $1.80 b. Total Dividends = shares x dividends per share = 425 x 1.80 = $765 Aftertax income = total dividends x (1 – T) = $765 x (1 – .15) = $765 x (.85) = $650.25 c. Stock dividends or stock splits are most likely to be utilized during stage II (growth) or stage III (expansion). 18-7. Squash Delight, Inc. has the following balance sheet: Assets Cash........................................................................................ $ 100,000 Accounts receivable................................................................ 300,000 Fixed Assets........................................................................... 600,000 Total Assets...................................................................... $1,000,000 Liabilities Accounts payable ........................................... $ 150,000 Notes payable ................................................. 50,000 Capital Common stock (50,000 shares @ $2 par)...... 100,000 Accounts Capital in excess of par.................................. 200,000 Retained earnings........................................... 500,000 $1,000,000
18-7. Continued The firms stock sells for $10 a share a. Show the effect on the capital account(s)of a two-for-one stock split b. Show the effect capital accounts of a 10 percent stock divided Part b is separate from part a. In part b do not assume the stock split has taken place c. Based on the balance in retained earnings, which of the two dividend plans is more restrictive on future cash dividends? Solution: Squash delight, Inc. a. 2 for l stock split Common stock(100,000 shares $l par)$100,000 Capital ex cess of par 200000 Retained earnings 500.000 The only account affected b. 10% stock dividend Common stock(55,000 shares @$2 par)$110,000 Capital in excess of par 245000 Retained earning 445000 *$20000+500($10-$1)=$200,000+$45000 $245000 *$500,000-10,000-45,000=$500000-55,000 =$445000 c. The stock dividend Cash dividends cannot exceed the balance in retained earnings and the balance is lower with the stock dividend ($445,000 versus$500,000) CopyrightC 2005 by The McGran-Hill Companies, Inc. S-634
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-634 18-7. Continued The firm's stock sells for $10 a share. a. Show the effect on the capital account(s) of a two-for-one stock split. b. Show the effect on the capital accounts of a 10 percent stock divided. Part b is separate from part a. In part b do not assume the stock split has taken place. c. Based on the balance in retained earnings, which of the two dividend plans is more restrictive on future cash dividends? Solution: Squash Delight, Inc. a. 2 for 1 stock split * Common stock (100,000 shares @ $1 par)$100,000 Capital excess of par 200,000 Retained earnings 500,000 * The only account affected b. 10% stock dividend Common stock (55,000 shares @ $2 par) $110,000 * Capital in excess of par 245,000 ** Retained earnings 445,000 * $200,000 + 5,000 ($10 – $1) = $200,000 + $45,000 = $245,000 ** $500,000 – 10,000 – 45,000 = $500,000 – 55,000 = $445,000 c. The stock dividend. Cash dividends cannot exceed the balance in retained earnings and the balance is lower with the stock dividend ($445,000 versus $500,000)
18-8 In doing a five-year analysis of future dividends, Newell Labs, Inc, is considering the following two plans. The values represent dividends per share Year Plan a Plan b 1 $2.50 2 2. 3.30 2.50 35 2.65 2.80 2.65 a. How much in total dividends per share will be paid under each plan over the b. Ms. Carter, the vice president of finance, suggests that stockholders often prefer a stable dividend policy to a highly variable one. She will assume that stockholders apply a lower discount rate to dividends that are stable The discount rate to be used for Plan a is 10 percent; the discount rate for Plan B is 12 percent. Which plan will provide the higher present value for the future dividends? (Round to two places to the right of the decima Solution: Newell labs Inc a. Plan a($250+255+250+265+265)=$1285 PanB($80+3.30+35+280+660)=$1385 b. plan a Dividend Per share PⅤIF(10%) PⅤ $2.50 909 $227 2.55 826 2.11 2.50 188 2.65 683 1.8 2.65 621 Present Value of future dividends $9.72 S-635 Copyright o 2005 by The McGraw-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-635 18-8. In doing a five-year analysis of future dividends, Newell Labs, Inc., is considering the following two plans. The values represent dividends per share. Year Plan A Plan B 1.......... $2.50 $ .80 2.......... 2.55 3.30 3.......... 2.50 .35 4.......... 2.65 2.80 5.......... 2.65 6.60 a. How much in total dividends per share will be paid under each plan over the five years? b. Ms. Carter, the vice president of finance, suggests that stockholders often prefer a stable dividend policy to a highly variable one. She will assume that stockholders apply a lower discount rate to dividends that are stable. The discount rate to be used for Plan A is 10 percent; the discount rate for Plan B is 12 percent. Which plan will provide the higher present value for the future dividends? (Round to two places to the right of the decimal point.) Solution: Newell Labs, Inc. a. Plan A ($2.50 + 2.55 + 2.50 + 2.65 + 2.65) = $12.85 Plan B ($.80 + 3.30 + .35 + 2.80 + 6.60) = $13.85 b. Plan A Dividend Per Share x PVIF (10%) PV 1 $2.50 .909 $2.27 2 2.55 .826 2.11 3 2.50 .751 1.88 4 2.65 .683 1.81 5 2.65 .621 1.65 Present Value of future dividends $9.72
18-8. Continued Plan b Dividend Per share PVIF 2%) PⅤ $.80 893 $71 3.30 797 2.63 712 25 4 2.80 636 6.60 567 3.74 Present Value of future dividends $9.11 Plan a will provide the higher present value of future dividends 18-9 The stock of Pills Berry Company is selling at $60 per share. The firm pays a dividend of $1. 80 per share a. What is the annual dividend yield? b. If the firm has a payout rate of 50 percent, what is the firms P/E ratio? Solution: Pills Berry Company a. annual dividend yield cash dividend/price =$180/s60=3.00% b. Earnings per share cash dividends/5 $l80/.5=$3 P/E ratio Price/earnings per share $60/$3.60=1667X CopyrightC 2005 by The McGran-Hill Companies, Inc. S-636
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-636 18-8. Continued Plan B Dividend Per Share x PVIF (12%) PV 1 $ .80 .893 $ .71 2 3.30 .797 2.63 3 .35 .712 .25 4 2.80 .636 1.78 5 6.60 .567 3.74 Present Value of future dividends $9.11 Plan A will provide the higher present value of future dividends. 18-9. The stock of Pills Berry Company is selling at $60 per share. The firm pays a dividend of $1.80 per share. a. What is the annual dividend yield? b. If the firm has a payout rate of 50 percent, what is the firm's P/E ratio? Solution: Pills Berry Company a. Annual dividend yield = cash dividend/price = $1.80/$60 = 3.00% b. Earnings per share = cash dividends/.5 = $1.80/.5 = $3.60 P/E ratio = Price/earnings per share = $60/$3.60 = 16.67x