CHAPTER 26 - Answer
April 29, 2021 | Author: Anonymous | Category: N/A
Short Description
Download CHAPTER 26 - Answer...
Description
Solutions Manual
CHAPTER 26 SHARING FIRM WEALTH: DIVIDENDS, SHARE REPURCHASES AND OTHER PAYOUTS EVIEW QUESTIONS AND PROBLEMS SUGGESTED ANSWERS TO THE R EVIEW
I.
Questions
1. The marginal principle of retained earnings suggests that the corporation must do an analysis of whether the corporation or the shareholders can earn the most on funds associated with retained earnings. Thus, we must consider what the shareholders can earn on other investments. 2. The The shar shareh ehol old der woul would d appe appear ar to con conside siderr divi divide dend ndss as rele releva vant nt.. Dividends do resolve uncertainty in the minds of investors and provide information content. Some shareholders may say that the dividends are relevant, but in a different sense. Perhaps they prefer to receive little or no dividends because of the immediate income tax and higher tax rate imposed on cash dividends. . The The rela relati tion onsh ship ip betw betwee een n a comp compan any! y!ss grow growth th poss possib ibil ilit itie iess and and its its dividend policy is that, the greater a company!s growth possibilities, the more funds that can be "ustified for profitable internal reinvestment. #. $anage $anagemen ment! t!ss desire desire for control control could could imply that that a closel closely y held firm should avoid dividends to minimi%e the need for outside financing. &or a larger firm, management may have to pay dividends in order to maintain their current position through 'eeping shareholders happy. (. The asset asset base remains remains the same and the shareho sharehold lders ers!! propor proportio tionat natee interest is unchanged )everyone got the same new share*. +arnings per share will go down by the exact proportion that the number of shares increa increases ses.. f the P-+ ratio remain remainss consta constant, nt, the total total value value of each each shareholder!s portfolio will not increase. The only circumstances in which a stoc' dividend may be of some useful usefulnes nesss and perhap perhapss increa increase se value value is when when divide dividends nds per share share rema remain in cons consta tant nt and and tota totall divi divide dend ndss go up, up, or wher wheree subs substa tant ntia iall information is provided about a growth company. stoc' stoc' split may have some functionality in placing the company into a lower /stoc' price0 trading range. 26-1
Chat!" #$
Sharing Firm Wealth: Dividends, Share Share Repurchases Repurchases and Other Payouts
. corpo corporat ration ion can can ma'e a ration rational al case case for purchasi purchasing ng its own euit euity y share as an alternate to a cash dividend policy. policy. +arnings per share will go up and if the P-+ ratio remains the same, the shareholder will receive the same peso benefit as through a cash dividend. 3ecause the benefits are in the format of capital gains, the tax rate will be lower and the tax may be deferred until the euity share is sold. corporation also may "ustify the repurchase of its own euity share because it is at a very low price, or to maintain constant demand for the shares. 4eacuired shares may be used for employee options or as a part of a tender offer in a merger or acuisition. &irms may also reacuire part of their euity share as protection against a hostile ta'eover. ta'eover. 5. Dividend reinvestment reinvestment plans allo allow w corp corpor orat atio ions ns to rais raisee fund fundss continually from present shareholders. This reduces the need for some external funds. These plans allow shareholders to reinvest dividends at low costs and to buy fractional shares, neither of which can be easily accomplished in the mar'et by an individual. The strategy of dividend reinvestment plans allows for the compounding of dividends and the accumulation of ordinary euity share over time. 6. Dividend policy determines the distribution of a firm!s earnings between retention and dividend payments to shareholders. 7. The three three ma"or ma"or argumen arguments ts favorin favoring g the relevanc relevancee of divide dividends nds are8 are8 )1* the “bird-in-the-hand” theory , )2* )2* the informational content effect , effect , and )* the clientele effect . 19. The residu residual al theory theory of dividend dividendss states that a firm will pay dividends only if acceptable investment opportunities for these funds are currently unavailable. 11. :umerous factors influence influence a firm!s firm!s choice of dividend policy policy,, including legal, contractual, and internal constraints; investment opportunities and growth prospects; alternative sources of capital; owner considerations, including their preferences and desire for control; the cost of selling euity share; the earnings record; and legal listing. 12. $anagers $anagers generally generally prefer a stable stable peso amount of dividends dividends because they they believ believee that that this this policy policy leads to highe higherr euity euity share prices prices and avoids erroneous informational content. 1. 3oth a stoc' dividend dividend and a stoc' split split are ways of distributing distributing shares to ordinary euity shareholders. n theory, they do not increase shareholder wealth. tax dividend or receives the proceeds from the firm!s investment and pays taxes on that amount. To find the rate at which the investor would be indifferent, we can set the two euations eual, and solve for x. Doing so, we find8 P1,999 )1 A x*1 E .9)1 A x*F @ )1 A x*GP1,9991 E .9)1 A .(*FH 1 E .9)1 A x* @ 1 E .9 )1 A .(* x @ .( or (I :ote that this argument does not depend upon the length of time the investment is held. )b* Jes, this is a reasonable answer. She is only indifferent if the after>tax proceeds from the P1,999 investment in identical securities are identical. That occurs only when the tax rates are identical. )c* Since both investors will receive the same pre>tax return, you would expect the same answer as in part )a*. Jet, because Koodrose en"oys a tax benefit from investing in euity share )59 percent of income from euity share is exempt from corporate taxes*, the tax rate on ordinary income which induces indifference, is much lower. gain, set the two euations eual and solve for x8 P1,999 )1 A x*1 E .97 )1 A x*F @ )1 A x* )P1,999G1 E .97.59 E )1 A .59* )1 A . (*FH* 1 E .97 )1 A x* @ 1 E .97 .59 E )1 A .59* )1 A .(*F x @ .19(9 or 19.(9I )d* t is a compelling argument, but there are legal constraints, which deter firms from investing large sums in euity share of other companies. P"o%l!& $
ssuming no capital gains tax, the after>tax return for the &J =ompany is the capital gains growth rate, plus the dividend yield times one minus the tax rate. Lsing the constant growth dividend model, we get8 fter>tax return @ g E D )1 A t* @ .1( 26-7
Chat!" #$
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Solving for g, we get8 .1( @ g E .9( )1 A .(* g @ .115( The euivalent pretax return for &J =ompany, which pays no dividend, is8 Pretax return @ g E D @ .115( E .9( @ .15( or 1.5(I P"o%l!& +
)a* f the company ma'es a dividend payment, we can calculate the wealth of a shareholder as8 Dividend per share @ P7,999-1,999 shares @ P7.99 The euity share price after the dividend payment will be8 PM @ P# A 7 @ P(( per share The shareholder will have an euity shares worth P(( and a P7 dividend for a total wealth of P#. f the company ma'es a repurchase, the company will repurchase8 Shares repurchased @ P7,999-P# @ 1#9. shares f the shareholder lets their shares be repurchased, they will have P# in cash. f the shareholder 'eeps their shares, they are still worth P#. )b* f the company pays dividends, the current +PS is P1.9, and the P-+ ratio is8 P-+ @ P((-P1.9 @ #2.1 26-8
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Chat!" #$
f the company repurchases euity share, the number of shares will decrease. The total net income is the +PS times the current number of shares outstanding. Dividing net income by the new number of shares outstanding, we find the +PS under the repurchase is8 +PS @ P1.9 )1,999* - )1,999 1#9.* @ P1.(1 The euity share price will remain at P# per share, so the P-+ ratio is8 P-+ @ P#-P1.(1 @ #2.1 share repurchase would seem to be the preferred course of action. Bnly those shareholders who wish to sell will do so, giving the shareholder a tax timing option that he or she does not get with a dividend payment. P"o%l!& ,
Since the P2,999,999 cash is after corporate tax, the full amount will be invested. So, the value of each alternative is8 Alternative 1: The firm invests in T>bills or in preferred share, and then pays out as special dividend in years. a. 1. If the firm invests in -!ills8 f the firm invests in T>bills, the after>tax yield of the T>bills will be8 fter>tax corporate yield
@ .9( )1 A .(* @ .92( or .2(I
So, the future value of the corporate investment in T>bills will be8 &N of investment in T>bills
@ P2,999,999 )1 E .92(* @ P2,291,#9.1
26-9
Chat!" #$
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Since the future value will be paid to shareholders as a dividend, the after> tax cash flow will be8 fter>tax cash flow to shareholders
@ P2,291,#9.1 )1 A .1(* @ P1,651,17(.2
a. ". If the firm invests in preferred share #Assumption: $% percent of dividend taxable&: f the firm invests in preferred share, the assumption would be that the dividends received will be reinvested in the same preferred share. The preferred share will pay a dividend of8 Preferred dividend
@ .96 )P2,999,999* @ P19,999
Since 59 percent of the dividends are excluded from tax8 Taxable preferred dividends
@ )1 A .59* )P19,999* @ P#6,999
nd the taxes the company must pay on the preferred dividends will be8 Taxes on preferred dividends @ .( )P#6,999* @ P1,699 So, the after>tax dividend for the corporation will be8 fter>tax corporate dividend @ P19,999 A 1,699 @ P1#,299 This means the after>tax corporate dividend yield is8 fter>tax corporate dividend yield
@ P1#,299 - P2,999,999 @ .951 or 5.1I
26-10
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Chat!" #$
The future value of the company!s investment in preferred share will be8 &N of investment in preferred share
@ P2,999,999 )1 E .951*
@ P2,#1,97.#6 Since the future value will be paid to shareholders as a dividend, the after> tax cash flow will be8 fter>tax cash flow to shareholders
@ P2,#1,97.#6 )1 A .1(* @ P2,971,72.#
Alternative ": The firm pays out dividend now, and individuals invest on their own. The after>tax cash received by shareholders now will be8 fter>tax cash received today @ P2,999,999 )1 A .1(* @ P1,599,999 he individuals invest in reasury bills: f the shareholders invest the current after>tax dividends in Treasury bills, the after>tax individual yield will be8 fter>tax individual yield on T>bills
@ .9( )1 A .1* @ .9#( or .#(I
So, the future value of the individual investment in Treasury bills will be8 &N of investment in T>bills
@ P1,599,999 )1 E .9#(* @ P1,662,979.96
he individuals invest in preferred share: f the individual invests in preferred share, the assumption would be that the dividends received will be reinvested in the same preferred share. The preferred shares will pay a dividend of8 Preferred dividend
@ .96 )P1,599,999*
26-11
Chat!" #$
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
@ P1,999
26-12
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Chat!" #$
nd the taxes on the preferred dividends will be8 Taxes on preferred dividends @ .1 )P1,999* @ P#2,19 So, the after>tax preferred dividend will be8 fter>tax preferred dividend @ P1,999 A #2,19 @ P7,6#9 This means the after>tax individual dividend yield is8 fter>tax corporate dividend yield
@ P7,6#9 - P1,599,999 @ .9((2 or (.(2I
The future value of the individual investment in preferred share will be8 &N of investment in preferred share
@ P1,599,999 )1 E .9((2*
@ P1,775,#(.6# The after>tax cash flow for the shareholders is maximi%ed when the firm invests the cash in the preferred shares and pays a special dividend later.
P"o%l!& -
)a* The earnings per share were8 +PS
=
=
P,999,999 1,(99,999 P2.99
)b* The dividends per share were8 DPS
=
)9.29* )P2.99*
=
P9.#9
26-13
Chat!" #$
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
P"o%l!& '
The dividend payout is computed by dividing the yearly dividends per share by the earnings per share. Dividend payout ratio
=
=
)#* )P9.2(* P2.(9 9.#9 or #9I
P"o%l!& ''
To maintain the capital structure, the investment must be funded as follows8 4euired debt
)9.9* )P5,999,999* @ P2,199,999
4euired euity
)9.#9* )P5,999,999* @ P#,799,999
To provide the P#,799,999 in reuired euity, Olee $ining =ompany must retain the entire P#,999,999 in earnings and issue new euity share for the remaining P799,999. 3y following the current dividend policy, the company will pay no cash dividends. P"o%l!& '#
)a* The legal limit depends on the law. f the capital impairment provisions of law are limited to the par value of ordinary euity share, the maximum amount of dividends is P2,(99,999, which is the amount of retained earnings )P(99,999* plus capital in excess of par )P2,999,999*. Btherwise, the maximum amount of dividends is the retained earnings of P(99,999. :either amount is realistic because the company would not have the cash available to pay. )b* n practice, the company!s dividends could not exceed the balance of the retained earnings. P"o%l!& '(
)a* Kith a stable dividend policy, +lena =ompany will maintain its current P1.(9 cash dividend per share.
26-14
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Chat!" #$
)b* Kith constant dividend payout ratio policy, dividends per share will be P1.5(. Dividends last year
Dividend payout ratio
Dividends this year
Dividends per share this year
=
)P1.(9* )699,999*
=
P1,299,999 P1,299,999 P,999,999
=
=
9.#9 or #9I
=
)P9.#9* )P,(99,999*
=
P1,#99,999 P1,#99,999 P699,999
=
=
P1.5(
P"o%l!& ')
)a* The peso amount transferred from retained earnings is8 Peso amount transferred from retained earnings
=
)299,999* )9.29* )P9*
=
P1,299,999
)b* total of #9,999 shares )9.29 x 299,999* is added to the ordinary euity share account. )c* Bf the P1,299,999 transferred from retained earnings, P129,999 )P par x #9,999* is added to the ordinary euity share account, and P1,969,999 )P1,299,999 A P129,999* is added to the capital in excess of par account. The shareholders! euity accounts are as follows8 Brdinary euity share )2#9,999 shares outstanding at P par* =apital in excess of par 4etained earnings Total shareholders! euity
26-15
P 529,999 2,#69,999 2,699,999 P,999,999
Chat!" #$
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
P"o%l!& '*
Kith a >for>1 stoc' split, the par value declines from P to P1, and the number of outstanding shares triples to 99,999 shares. Brdinary euity share )99,999 shares outstanding at P1 par* =apital in excess of par 4etained earnings Total shareholders! euity
P"o%l!& '$ Dividends
Payout ratio
=
+arnings A 4etained funds
=
P19 million A P199 million
=
P9 million
=
=
=
Dividends +arnings P9 million P19 million 9.5( or 5.(I
P"o%l!& '+ Dividends
ddition to retained earnings
=
)+arnings x Payout ratio*
=
)P699 million* )(I*
=
P269 million
=
+arnings A Dividends
=
P699 million A P269 million
=
P(29 million
26-16
P 99,999 1,#99,999 #,999,999 P,999,999
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Chat!" #$
P"o%l!& ',
Orape =o. is not growing very fast so it does not need cash for growth unless it desires to change its policies. ssuming it does not, Orape =o. should have a high payout ratio. =herry =orp. is growing very fast and needs its cash for reinvestment in assets. &or this reason, =herry should have a low dividend payout. P"o%l!& '-
)a* Plan
)P1.(9 E 1.(9 E 1.(9 E 1.9 E 1.9* @ P5.59
Plan 3
)P.(9 E 2.99 E.29 E #.99 E 1.59*
@ P6.#9
)b* Plan Di/i0!n0 P!" Sha"!
1 2 # (
1
PVI2 3'45
P1.(9 .797 1.(9 .62 1.(9 .5(1 1.9 .6 1.9 .21 Present Nalue of &uture Dividends
PV
P1. 1.2# 1.1 1.97 .77 P(.61
Plan 3 Di/i0!n0 P!" Sha"!
1 2 # (
1
PVI2 3'#45
P .(9 .67 2.99 .575 .29 .512 #.99 . 1.59 .(5 Present Nalue of &uture Dividends
PV
P .#( 1.(7 .1# 2.(# .7 P(.6
Plan will provide the higher present value of future dividends. P"o%l!& #
nnual dividend
@ ).5I* )P#9* @ P2.6
uarterly dividend
@ P2.6 - #
@ P .5
The euity share should go down by P.5 to P7.. 26-17
Chat!" #$
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
P"o%l!& #' R!tain ncremental earnings
+arnings per share
=
)1(I* )P#99,999*
=
P9,999 P5(9,999 E P9,999 99,999
=
P619,999 99,999
=
=
Price of euity share
P2.59
=
)P-+* )+PS*
=
)1* )P2.59*
=
P#.29
Pa6out :ew P-+
+arnings per share
=
)1.19* )1*
=
15.
=
=
Price of euity share
P5(9,999 99,999 P2.(9
=
)P-+* )+PS*
=
)15.* )P2.(9*
=
P##.99
The payout option provides the maximum mar'et value.
26-18
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Chat!" #$
P"o%l!& ##
)a* +ight )6* million shares would be outstanding at a par value of P( per share. +verything else will be the same. )b* Twelve )12* million shares would be outstanding at a par value of P. per share. +verything else will be the same. )c*
+PS 3efore
=
=
+PS fter 2>1 Split
=
=
+PS fter >1 Split
=
=
)d*
P1#,999,999 #,999,999 P.(9 +PS P1#,999,999 6,999,999 P1.5( +PS P1#,999,999 12,999,999 P1.15 +PS
Price
=
)P-+* )+PS*
Price after 2>1 Split
=
)29* )P1.5(*
=
P(.99
=
)29* )P1.15*
=
P2.#9
Price after >1 Split
)e* Probably not. stoc' split should not change the price>earnings ratio unless it is combined with a change in dividends to the shareholders. Oenerally spea'ing, nothing of real value has ta'en place. Bnly to the limited extent that new information content from this split increased investor!s expectations would the stoc' split possibly have an impact on the P-+ ratio.
26-19
Chat!" #$
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
P"o%l!& #(
)a*
Price
=
+PS
=
=
Price
)b*
Dividends per share
Shares reacuired
=
P(9
=
=
Shares outstanding after repurchase
+PS
Price
P#,999,999 1,999,999 P#
P#,999,999 P(# 5#,95#
=
1,999,999 A 5#,95#
=
72(,72
=
=
)e*
P( )19* )P(*
=
)d*
P(,999,999 1,999,999
=
=
)c*
)P-+* )+PS*
P(,999,999 72(,72 P(.#9
=
)P-+* )+PS*
=
)19* )P(.#9*
=
P(#
The euity share price has increased by P#.
26-20
Sharing Firm Wealth: Dividends, Share Repurchases and Other Payouts
Chat!" #$
)f* :o. Kith the cash dividend8 $ar'et value per share =ash dividend per share Total value
P(9 # P(#
Kith the repurchase of euity share8 Total value per share
P(#
)g* The )potential* appreciation in value associated with an euity share repurchase receives preferential capital gains tax treatment whereas a cash dividend is taxed at the investor!s normal tax rate. The capital gains tax may also be deferred until the euity share is sold. )h* The corporation may thin' its shares are underpriced in the mar'et. The purchase may stave off further decline and perhaps even trigger a rally. 4eacuired shares may also be used for employee euity share options or as part of a tender offer in a merger or an acuisition. &irms may also reacuire part of their shares as a protective device against being ta'en over as a merger candidate.
26-21
View more...
Comments
