CHAPTER 16
The Dividend Controversy
Answers to Practice Questions
1.
Newspaper exercise; answers will vary depending on the stocks chosen.
2.
The available evidence is consistent with the observation that managers believe
shareholders prefer a steady progression of dividends.
For managers of risky
companies whose earnings have high variability, it is easy to show, using the
Lintner model, that a lower target payout (e.g., zero) and a lower adjustment rate
(e.g., zero) reduce the variance of dividend changes.
3.
a.
Distributes a relatively low proportion of current earnings to offset
fluctuations in operational cash flow; lower P/E ratio.
b.
Distributes a relatively high proportion of current earnings since the
decline is unexpected; higher P/E ratio.
c.
Distributes a relatively low proportion of current earnings in order to offset
anticipated declines in earnings; lower P/E ratio.
d.
Distributes a relatively low proportion of current earnings in order to fund
expected growth; higher P/E ratio.
4.
a.
A t = 0 each share is worth $20.
This value is based on the expected
stream of dividends: $1 at t = 1, and increasing by 5% in each subsequent
year.
Thus, we can find the appropriate discount rate for this company as
follows:
g
r
DIV
P
1
0

=
g
r
1
20

=
⇒
r = 0.10 = 10.0%
Beginning at t = 2, each share in the company will enjoy a perpetual
stream of growing dividends: $1.05 at t = 2, and increasing by 5% in each
subsequent year.
Thus, the total value of the shares at t = 1 (after the
t = 1 dividend is paid and after N new shares have been issued) is given
by:
million
$21
.05
0
0.10
million
1.05
V
1
=

=
141
This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentIf P
1
is the price per share at t = 1, then:
V
1
= P
1
×
(1,000,000 + N) = $21,000,000
and:
P
1
×
N = $1,000,000
From the first equation:
(1,000,000
×
P
1
) + (N
×
P
1
) = 21,000,000
Substituting from the second equation:
(1,000,000
×
P
1
) + 1,000,000 = 21,000,000
so that P
1
= $20.00
b.
With P
1
equal to $20, and $1,000,000 to raise, the firm will sell 50,000 new
shares.
c.
The expected dividends paid at t = 2 are $1,050,000, increasing by 5% in
each subsequent year.
With 1,050,000 shares outstanding, dividends per
share are: $1 at t = 2, increasing by 5% in each subsequent year.
Thus,
total dividends paid to old shareholders are: $1,000,000 at t = 2,
increasing by 5% in each subsequent year.
d.
For the current shareholders:
5.
From Question 4, the fair issue price is $20 per share.
If these shares are
instead issued at $10 per share, then the new shareholders are getting a
bargain, i.e., the new shareholders win and the old shareholders lose.
As pointed out in the text, any increase in cash dividend must be offset by a
stock issue if the firm’s investment and borrowing policies are to be held
constant.
If this stock issue cannot be made at a fair price, then shareholders
are clearly not indifferent to dividend policy.
This is the end of the preview.
Sign up
to
access the rest of the document.
 Dividends, Dividend, Dividend yield

Click to edit the document details