Problems 3
a. What will be the new price of the stock?
Answer: $90 x 2/1= $45 New price of stock $45.00
b. If the firm’s total earnings do not change, what is the payout ratio before and after the stock split?
| Before | After | |
| Dividends | $6.00 | $6.00 |
| ÷ | ||
| Earnings | $9.50 | $9.50 |
| Dividends payout ratio | 63.2% | 63.2% |
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Payout ratio: 63.2%
Problem 4
a. A cash dividend of $1 per share?
$28,000,000 – ($1 * 2,000,000 shares) = $26,000,000 (cash)
$100,000,000 (common stock)
$10,000,000 (additional paid-in capital)
$62,000,000 – ($1 * 2,000,000 shares) = $60,000,000 (retained earnings)
b. A 5% stock dividend (fair market value is $100 per share)?
$28,000,000 (cash)
$50 par * 2,100,000 shares = $105,000,000 (common stock)
$10,000,000 + $5,000,000 = $15,000,000 (additional paid-in capital)
$62,000,000 – $10,000,000 = $52,000,000 (retained earnings)
c. A one-for-two reverse split?
$28,000,000 (cash)
$100 par * 1,000,000 shares = $100,000,000 (common stock)
$10,000,000 (additional paid-in capital)
$62,000,000 (retained earnings)
Problem 5
20% of 100,000 shares outstanding = 20,000 shares
Total stock dividend amount
= Number of shares x Fair market value of each share=20,000 x $4 per share
=$80,000 (Amount of total stock dividend)
January 1
Common stock [ $100,000 + (100,000 x 0.20 x $1)] = $ 120,000
Additional paid-in capital [ $200,000 + (100,000 x 0.20 x $3)] = 260,000
Retained earnings [ ($225,000 - (100,000 x 0.20 x $4)] = 145,000
Total stockholders' equity$ 525,000
The firm declares cash dividends of $0.25, its market price will also be reduced by the same amount. The new price of the stock is: $3.75.
Total cash dividend
= cash dividend per share x Number of outstanding shares
= $0.25 x 120,000 shares
= $30,000 (deducted from retained earnings)
March 1st.
Common stock (120,000 shares of $1 par value) = $120,000
Additional paid-in capital = $260,000
Retained earnings (145,000-30,000) = $115,000
Total stockholders' equity = $ 495,000
The stock dividend reduces retained earnings by $80,000 and increases common stock by $20,000 and additional paid-in-capital by $60,000.
Problem 7
a. Earnings per share $4.20
$4.20 / 2 = $2.10
b. Total equity $10,000,000
No change
c. Long-term debt $4,300,000
No change
d. Additional paid-in capital $1,534,000
No change
e. Number of shares outstanding 1,000,000
1,000,000 * 2 = 2,000,000 shares
f. Earnings $4,200,000
No change
Chapter 11 Problem Set (261–262 of the textbook)
Problems 1
a. What is the value of stock if: D0 = $2, k = 10%, and g = 6%?
[2(1 + .06)] / (.10 - .06) = $53.00
b. What is the value of this stock if the dividend is increased to $3 and the other variables remain constant?
[3(1 + .06)] / (.10 - .06) = $79.50
c. What is the value of this stock if the required return declines to 7.5% and the other variables remain constant?
[2(1 + .06)] / (.075 - .06) = $141.33
d. What is the value of this stock if the growth rate declines to 4% and the other variables remain constant?
[2(1 + .04)] / (.10 - .04) = $34.67
e. What is the value of this stock if the dividend is increased to $2.30, the growth rate declines to 4%, and the required return remains 10%?
[2.3(1 + .04)] / (.10 - .04) = $39.87
Problem 2
What is the maximum price you would be willing to pay for the stock?
[3.5(1 + .10)] / (.15 - .10) = $77.00
Problem 3
a. What is the maximum price that the investor should pay for each stock based on the dividend-growth model?
Dividend (1+G)/(r-g)
A = 1.07/.07 = 15.29
B = 3.06/.12 = 25.50
C = 7.425/.15 = 49.50
b. If the investor does buy stock A, what is the implied percentage return?
1.07/15.29 = 11.65%
c. If the appropriate P/E ratio is 12, what is the maximum price the investor should pay for each stock? Would your answers be different if the appropriate P/E were 7?
A 2 x 12 = 24
B3.2 x 12= 38.40
C7 x 12 = 84
Yes, the answers would be different as follows
A 2 x 7 = 14
B3.2 x 7= 22.40
C7 x 7 = 49
d. What does stock C's negative growth rate imply?
It means that the future dividend will be less than current dividend by the negative growth rate, as D(1+(-h) =D (1-g), if growth rate is negative 1 it means that the future divided will be 99% of current dividend declared.
Problem 5
a. What is the required return for JJM?
5% + 1.2 (11%- 5%) =
0.05 + 1.2 (.11 - 0.05) =
0.05 + 1.2 (.06) =
0.122 or required return = 12.2%
b. Given the required return, what is the value of the stock?
[$4.50 (1.06)] / (0.122 - 0.06)
=$4.77 / .062 = $76.94 (current stock value)
c. If the stock is selling for $80, what should you do?
The stock should not be bought given that $80.00 is greater than $76.94
d. If the beta coefficient declines to 1.0, what is the new value of the stock?
$4.77 / (0.11- 0.06) =
$4.77 /0.05 = $95.40 (new stock value)
e. If the price remains $80, what course of action should you take given the valuation in d?
In this case, the stock can and should be bought given the fact that $80.00 is less than $95.40
Chapter 14 Problem Set (307)
Problem 1
Market Value of Shares with 13% Required Rate of Return: $9/.13=$69.23
Market Value of Shares with 11% Required Rate of Return: $9/.11=$81.82
Change in the price of the stock = $12.59 increase with lower rate of return.
Problem 2
a.MN Inc., $8 preferred ($100 par)
$8/0.07=$114.28
b.CH Inc., $8 preferred ($100 par) with mandatory retirement after 20 years
$8(10.594) +$100(0.258) =$110.55
Problem 4
What does your analysis indicate about the firm’s capacity to pay preferred stock dividends?
Times-preferred-dividend-earned = Earnings after taxes / Dividends on preferred stock
[$12,000,000 - $3,000,000 - $4,000,000] / $1,000,000 = 5.0 (X1)
[$15,000,000 - $5,900,000 - $5,400,000] / $1,000,000 = 3.7 (X2)
[$17,000,000 - $11,000,000 - $4,000,000] / $1,500,000 = 1.3 (X3)
X1 is in the best position to cover its preferred dividend, which is followed by X2, and finally X3.
