chap018 - Chapter 18 Dividend Policy Why Does It Matter...

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8 * Chapter 18: Dividend Policy: Why Does It Matter? 18.1 February 16: Declaration date - the board of directors declares a dividend payment that will be made on March 14. February 24: Ex-dividend date - the shares trade ex dividend on and after this date. Sellers before this date receive the dividend. Purchasers on or after this date do not receive the dividend. February 26: Record date - the declared dividends are distributable to shareholders of record on this date. March 14: Payable date - the checks are mailed. 18.2 Based on Miller and Modigliani reasoning, the stock will sell for $8.75. This is the same price you purchased the stock. When the stock goes ex-dividend the stock is expected to fall $0.75 a share. 18.3 a. If the dividend is declared, the price of the stock will drop on the ex-dividend date by the value of the dividend, $5. It will then trade for $95. b. If it is not declared, the price will remain at $100. c. Mann’s outflows for investments are $2,000,000. These outflows occur immediately. One year from now, the firm will realize $1,000,000 in net income and it will pay $500,000 in dividends. Since the only immediate financing need is for the investments, Mann must finance $2,000,000 through the sale of shares worth $100. It must sell $2,000,000 / $100 = 20,000 shares. d. The MM model is not realistic since it does not account for taxes, brokerage fees, uncertainty over future cash flows, investors’ preferences, signaling effects, and agency costs. 18.4 a. The ex-dividend date is Feb. 27, which is two business days before the record date. b. The stock price should drop by $1.25 on the ex-dividend date. 18.5 Knowing that share price can be expressed as the present value of expected future dividends does not make dividend policy relevant. Under the growing perpetuity model, if overall corporate cash flows are unchanged, then a change in dividend policy only changes the timing of the dividends. The PV of those dividends is the same. This is true because, given that future earnings are held constant, dividend policy simply represents a transfer between current and future stockholders. In a more realistic context and assuming a finite holding period, the value of the shares should represent the future stock price as well as the dividends. Any cash flow not paid as a dividend will be reflected in the future stock price. As such the PV of the flows will not change with shifts in dividend policy; dividend policy is still irrelevant. 18.6 a. The price is the PV of the dividends, $2 . $17. . $15 115 5375 115 2 + = b. The current value of your shares is ($15)(500) = $7,500. The annuity you receive must solve $7,500 X 1.15 X 1.15 2 = + ; Answers to End-of-Chapter Problems B-173
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You desire $4,613.3721 each year. You will receive $1,000 in dividends in the first year, so you must sell enough shares to generate $3,613.3721. The end-of-year price at which you will sell your shares is the PV of the liquidating dividend, $17.5375 / 1.15 = $15.25, so you must sell 236.942 shares. The remaining shares will each earn the liquidating dividend. At the end of the second year, you will receive $4,613.38 [= (500 - 236.942) x $17.5375]. (Rounding causes the discrepancies).
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