Unformatted text preview: , the firm pays a fixed percentage of
earnings to the owners each period; dividends move
up and down with earnings, and no dividend is paid
when a loss occurs. Under a regular dividend policy,
the firm pays a fixed-dollar dividend each period; it
increases the amount of dividends only after a
proven increase in earnings has occurred. The lowLG4 SELF-TEST PROBLEM
LG6 ST 13–1 Dividend Policy 579 regular-and-extra dividend policy is similar to the
regular dividend policy, except that it pays an
“extra dividend” in periods when the firm’s earnings are higher than normal. The regular and the
low-regular-and-extra dividend policies are generally preferred because their stable patterns of dividends reduce uncertainty.
Evaluate stock dividends from accounting,
shareholder, and company points of view.
Occasionally, firms pay stock dividends as a
replacement for or supplement to cash dividends.
The payment of stock dividends involves a shifting
of funds between capital accounts rather than a use
of funds. Shareholders receiving stock dividends
receive nothing of value; the market value of their
holdings, their proportion of ownership, and their
share of total earnings remain unchanged. However, the firm may use stock dividends to satisfy
owners and preserve its market value without having to use cash.
LG5 Explain stock splits and stock repurchases and
the firm’s motivation for undertaking each of
them. Stock splits are used to enhance trading activity of a firm’s shares by lowering or raising their
market price. A stock split merely involves accounting adjustments; it has no effect on the firm’s cash
or on its capital structure. Stock repurchases can be
made in lieu of cash dividend payments to retire
outstanding shares. They reduce the number of outstanding shares and thereby increase earnings per
share and the market price per share. They also
delay the tax burden of shareholders.
LG6 (Solution in Appendix B)
Stock repurchase The Off-Shore Steel Company has earnings available for
common stockholders of $2 million and has 500,000 shares of common stock
outstanding at $60 per share. The firm is currently contemplating the payment
of $2 per share in cash dividends.
a. Calculate the firm’s current earnings per share (EPS) and price/earnings (P/E)
b. If the firm can repurchase stock at $62 per share, how many shares can be
purchased in lieu of making the proposed cash dividend payment?
c. How much will the EPS be after the proposed repurchase? Why?
d. If the stock sells at the old P/E ratio, what will the market price be after
repurchase? 580 PART 4 Long-Term Financial Decisions e. Compare and contrast the earnings per share before and after the proposed
f. Compare and contrast the stockholders’ position under the dividend and
repurchase alternatives. PROBLEMS
LG1 13–1 Dividend payment procedures At the quarterly dividend meeting, Wood Shoes
declared a cash dividend of $1.10 per share for holders of record on Monday,
July 10. The firm has 300,000 shares of common stock outst...
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