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Assignment 12

1. Residual dividend model

Axel Telecommunications has a target capital structure that consists of 50% debt and 50% equity. The company anticipates that its capital budget for the upcoming year will be $3,000,000. If Axel reports net income of $2,500,000 and it follows a residual dividend payout policy, what will be its dividend payout ratio? Round your answer to two decimal places.

________ %

2. Stock split

Gamma Medical's stock trades at $150 a share. The company is contemplating a 3-for-2 stock split. Assuming that the stock split will have no effect on the market value of its equity, what will be the company's stock price following the stock split? Round your answer to the nearest cent.

$ ________

3. Stock repurchases

Beta Industries has net income of $3,100,000, and it has 1,940,000 shares of common stock outstanding. The company's stock currently trades at $47 a share. Beta is considering a plan in which it will use available cash to repurchase 10% of its shares in the open market. The repurchase is expected to have no effect on net income or the company's P/E ratio. What will be its stock price following the stock repurchase? Round your answer to two decimal places.

$ ________

4. Stock split

After a 5-for-1 stock split, Strasburg Company paid a dividend of $1.5 per new share, which represents a 12% increase over last year's pre-split dividend. What was last year's dividend per share? Round your answer to the nearest cent.

$ ________

5. External equity financing

Northern Pacific Heating and Cooling Inc. has a 6-month backlog of orders for its patented solar heating system. To meet this demand, management plans to expand production capacity by 25% with a $10 million investment in plant and machinery. The firm wants to maintain a 50% debt-to-total-assets ratio in its capital structure. It also wants to maintain its past dividend policy of distributing 30% of last year's net income. In 2012, net income was $5 million. How much external equity must Northern Pacific seek at the beginning of 2013 to expand capacity as desired? Assume the firm uses only debt and common equity in its capital structure. Write out your answer completely. For example, 25 million should be entered as 25,000,000. Round your answer to the nearest cent.

$ ________

6. Residual dividend model

Welch Company is considering three independent projects, each of which requires a $5 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects is presented below:

Project H (High risk): |
Cost of capital = 16% |
IRR = 18% |

Project M (Medium risk): |
Cost of capital = 14% |
IRR = 13% |

Project L (Low risk): |
Cost of capital = 8% |
IRR = 12% |

Note that the projects' costs of capital vary because the projects have different levels of risk. The company's optimal capital structure calls for 25% debt and 75% common equity, and it expects to have net income of $10,924,000. If Welch establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to two decimal places.

________ %

7. Dividends

Bowles Sporting Inc. is prepared to report the following 2012 income statement (shown in thousands of dollars).

Sales |
$18,100 |

Operating costs including depreciation |
13,394 |

EBIT |
$4,706 |

Interest |
396 |

EBT |
$4,310 |

Taxes (40%) |
1,724 |

Net income |
$2,586 |

Prior to reporting this income statement, the company wants to determine its annual dividend. The company has 450,000 shares of stock outstanding, and its stock trades at $58 per share.

a. The company had a 40% dividend payout ratio in 2011. If Bowles wants to maintain this payout ratio in 2012, what will be its per-share dividend in 2012? Round your answer to the nearest cent.

$ ________

b. If the company maintains this 40% payout ratio, what will be the current dividend yield on the company's stock? Round your answer to two decimal places.

________ %

c. The company reported net income of $2.35 million in 2011. Assume that the number of shares outstanding has remained constant. What was the company's per-share dividend in 2011? Round your answer to the nearest cent.

$ ________

d. As an alternative to maintaining the same dividend payout ratio, Bowles is considering maintaining the same per-share dividend in 2012 that it paid in 2011. If it chooses this policy, what will be the company's dividend payout ratio in 2012? Round your answer to two decimal places.

________ %

e. Assume that the company is interested in dramatically expanding its operations and that this expansion will require significant amounts of capital. The company would like to avoid transactions costs involved in issuing new equity. Given this scenario, would it make more sense for the company to maintain a constant dividend payout ratio or to maintain the same per-share dividend?

I. Since the company would like to avoid transactions costs involved in issuing new equity, it would be best for the firm to maintain a constant dividend payout ratio.

II. Since the company would like to avoid transactions costs involved in issuing new equity, it would be best for the firm to maintain the same per-share dividend.

_________________

8. Alternative dividend policies

Rubenstein Bros. Clothing is expecting to pay an annual dividend per share of $0.75 out of annual earnings per share of $4. Currently, Rubenstein Bros.' stock is selling for $16.50 per share. Adhering to the company's target capital structure, the firm has $8 million in assets, of which 40% is funded by debt. Assume that the firm's book value of equity equals its market value. In past years, the firm has earned a return on equity (ROE) of 19%, which is expected to continue this year and into the foreseeable future.

a. Based on that information, what long-run growth rate can the firm be expected to maintain? Round your answer to two decimal places. Do not round intermediate calculations. (Hint: g = Retention rate x ROE.)

________ %

b. What is the stock's required return? Round your answer to two decimal places. Do not round intermediate calculations.

________ %

c. If the firm changed its dividend policy and paid an annual dividend of $1.50 per share, financial analysts would predict that the change in policy will have no effect on the firm's stock price or ROE. Therefore, what must the firm's new expected long-run growth rate? Round your answer to two decimal places. Do not round intermediate calculations.

________ %

If this plan is implemented, what must the firm's required return be? Round your answer to two decimal places. Do not round intermediate calculations.

________ %

d. Suppose instead that the firm has decided to proceed with its original plan of disbursing $0.75 per share to shareholders, but the firm intends to do so in the form of a stock dividend rather than a cash dividend. The firm will allot new shares based on the current stock price of $16.50. In other words, for every $16.50 in dividends due to shareholders, a share of stock will be issued. How large will the stock dividend be relative to the firm's current market capitalization? (Hint: Remember market capitalization = P_{0} x number of shares outstanding.) Round your answer to two decimal places. Do not round intermediate calculations.

________ %

e. If the plan in Part d is implemented, how many new shares of stock will be issued? Round your answer to the nearest whole. Do not round intermediate calculations.

________

If the plan in Part d is implemented, by how much will the company's earnings per share be diluted? Round your answer to the nearest cent. Do not round intermediate calculations.

$ ________ per share

9. Alternative dividend policies

In 2011 the Keenan Company paid dividends totaling $2,150,000 on net income of $12.5 million. Note that 2011 was a normal year and for the past 10 years, earnings have grown at a constant rate of 10%. However, in 2012, earnings are expected to jump to $17.5 million and the firm expects to have profitable investment opportunities of $9 million. It is predicted that Keenan will not be able to maintain the 2012 level of earnings growth because the high 2012 earnings level is attributable to an exceptionally profitable new product line introduced that year. After 2012, the company will return to its previous 10% growth rate. Keenan's target capital structure is 40% debt and 60% equity.

a. Calculate Keenan's total dividends for 2012 assuming that it follows each of the following policies: (Write out your answers completely. For example, 25 million should be entered as 25,000,000.)

1. Its 2012 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest cent.

$ ___________

2. It continues the 2011 dividend payout ratio. Round your answer to the nearest cent.

$ ___________

3. It uses a pure residual dividend policy (40% of the $9 million investment is financed with debt and 60% with common equity). Round your answer to the nearest cent.

$ ___________

4. It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy. Round your answer to the nearest cent.

Regular-dividend |
$ ___________ |

Extra dividend |
$ ___________ |

b. Which of the preceding policies would you recommend?

_________________

c. Assume that investors expect Keenan to pay total dividends of $7,000,000 in 2012 and to have the dividend grow at 10% after 2012. The stock's total market value is $220 million. What is the company's cost of equity? Round your answer to two decimal places.

________ %

d. What is Keenan's long-run average return on equity? [Hint: g = Retention rate x ROE = (1.0 - Payout rate)(ROE).] Round your answer to two decimal places.

________ %

e. Does a 2012 dividend of $7,000,000 seem reasonable in view of your answers to parts c and d? If not, should the dividend be higher or lower?

_________________

Subject | Business |

Due By (Pacific Time) | 12/04/2013 12:00 pm |

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