Exam 15: Distributions to Shareholders: Dividends and Share Repurchases

Del Grasso Fruit Company has more positive NPV projects than it can finance under its current policies without issuing new stock,but its board of directors had decreed that it cannot issue any new shares in the foreseeable future.Your boss,the CFO,wants to know how the capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy.You obtained the following data,which shows the firm's projected net income (NI),its current capital structure and dividend payout policies,and three possible new policies.Projected net income for the coming year will not be affected by a policy change.How much larger could the capital budget be if (1)the target debt ratio were raised to the indicated amount,other things held constant, (2)the target payout ratio were lowered to the indicated amount,other things held constant,or (3)the debt ratio and dividend payout were both changed by the indicated amounts? ? ? $\text { Policy Changes }$ Current policy Increase debt Lower payout Do both Projected NI \ 237.5 \ 237.5 \ 237.5 \ 237.5 \% Debt 25.0\% 75.0\% 25.0\% 75.0\% \% Equity 75.0\% 25.0\% 75.0\% 25.0\% \% Payout 65.0\% 65.0\% 20.0\% 20.0\% ?

If a firm uses the residual dividend model to set dividend policy,then dividends are determined as a residual after providing for the equity required to fund the capital budget.Under this model,the better the firm's investment opportunities,the lower its payout ratio will be,other things held constant.

Your firm adheres strictly to the residual dividend model.All else equal,which of the following factors would be most likely to lead to an increase in the firm's dividend per share?

The federal government sometimes taxes dividends and capital gains at different rates.Other things held constant,an increase in the tax rate on dividends relative to that on capital gains would logically lead to an increase in dividend payout ratios.

The federal government sometimes taxes dividends and capital gains at different rates.Other things held constant,if the tax rate on dividends is high relative to that on capital gains,then individuals with low taxable incomes should favor stocks with low payouts and high-income individuals should favor high-payout companies.

Other things held constant,the higher a firm's target payout ratio,the higher its expected growth rate should be.

Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is lowered.Their argument is based on the assumption that

Chicago Brewing has the following data,dollars in thousands.If it follows the residual dividend model,what will its dividend payout ratio be? Capital budget \ 5,800 \% Debt 40\% Net income (NI) \ 8,000 ?

A "reverse split" reduces the number of shares outstanding.

Purcell Farms Inc.has the following data,and it follows the residual dividend model.Currently,it finances with 15% debt.Some Purcell family members would like for the dividend payout ratio to be increased.If Purcell increased its debt ratio,which the firm's treasurer thinks is feasible,by how much could the dividend payout ratio be increased,holding other things constant? Capital budget \ 5,000,000 Net income (NI) \ 5,500,000 \% Debt now 15\% \% Debt after change 80\% ?

Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?

Which of the following statements is CORRECT?

It has been argued that investors prefer high-payout companies because dividends are more certain (less risky)than the capital gains that are supposed to come from retained earnings.However,Miller and Modigliani say that this argument is incorrect,and they call it the "bird-in-the-hand fallacy." MM base their argument on the belief that most dividends are reinvested in stocks,hence are exposed to the same risks as reinvested earnings.

Firm M is a mature company in a mature industry.Its annual net income and cash flows are consistently high and stable.However,M's growth prospects are quite limited,so its capital budget is small relative to its net income.Firm N is a relatively new company in a new and growing industry.Its markets and products have not stabilized,so its annual operating income fluctuates considerably.However,N has substantial growth opportunities,and its capital budget is expected to be large relative to its net income for the foreseeable future.Which of the following statements is CORRECT?

The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price.

New Orleans Builders Inc.has the following data.If it follows the residual dividend model,what is its forecasted dividend payout ratio? Capital budget \ 7,500 \% Debt 40\% Net income (NI) \ 7,500 ?

Fauver Industries plans to have a capital budget of $600,000.It wants to maintain a target capital structure of 40% debt and 60% equity,and it also wants to pay a dividend of $300,000.If the company follows the residual dividend model,how much net income must it earn to meet its investment requirements,pay the dividend,and keep the capital structure in balance?

Which of the following statements is CORRECT?

Pavlin Corp.'s projected capital budget is $2,000,000,its target capital structure is 40% debt and 60% equity,and its forecasted net income is $1,150,000.If the company follows the residual dividend model,how much dividends will it pay or,alternatively,how much new stock must it issue?

Which of the following statements about dividend policies is CORRECT?