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Chapter 5: Q7BP (page 596)

A financial analyst is attempting to assess the future dividend policy of Environmental Systems by examining its life cycle. She anticipates no payout of earnings in the form of cash dividends during the development stage (I). During the growth stage (II), she anticipates 12 percent of earnings will be distributed as dividends. As the firm progresses to the expansion stage (III), the payout ratio will go up to 35 percent and will eventually reach 58 percent during the maturity stage (IV).

a Assuming earnings per share will be as follows during each of the four stages, indicate the cash dividend per share (if any) during each stage.

Stage I

\(0.10

Stage II

\)1.80

Stage III

\(2.80

Stage IV

\)3.70

b. Assume in Stage IV that an investor owns 325 shares and is in a 15 percent tax bracket. What will be the investor鈥檚 after-tax income from the cash dividend?

c. In what two stages is the firm most likely to utilize stock dividends or stock splits?

Short Answer

Expert verified

The dividend in stage I is 0, stage II is $0.22, stage III is $0.98, and stage IV is $2.15. The after-tax income will be $593.94. The company will utilise stock dividends and split them into stages II and III.

Step by step solution

01

Calculation of cash dividend

Earnings

Pay-out ratio

Dividends

Stage I

$0.10

0

0

Stage II

$1.80

12%

$0.22

Stage III

$2.80

35%

$0.98

Stage IV

$3.70

58%

$2.15

02

Calculation of after-tax income

The after-tax income will be $593.94.

Dividend=Shares脳Dividends per share=325脳$2.15=$698.75

After - tax income=Dividend脳1-Tax rate=$698.75脳1-0.15=$698.75脳0.85=$593.94

03

The stages where the company should utilize stock dividends and stock splits

The company is most likely to utilise the stock dividend and split during stages II and III as stage II is the growth stage and stage III is the expansion stage.

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Most popular questions from this chapter

Solar Energy Corp. has $4million in earnings with 4 million shares outstanding. Investment bankers think the stock can justify P/E ratio of 21. Assume the underwriting spread is 5 percent. What should the price to the public be?

Question: I. B. Michaels has a chance to participate in a new public offering by Hi-Tech Micro Computers. His broker informs him that demand for the 700,000 shares to be issued is very strong. His broker鈥檚 firm is assigned 25,000 shares in the distribution and will allow Michaels, a relatively good customer, 1.3 percent of its 25,000-share allocation. The initial offering price is \(30 per share. There is a strong aftermarket, and the stock goes to \)32 one week after issue. The first full month after issue, Mr. Michaels is pleased to observe his shares are selling for \(33.50. He is content to place his shares in a lockbox and eventually use their anticipated increased value to help send his son to college many years in the future. However, one year after the distribution, he looks up the shares in The Wall Street Journal and finds they are trading at \)28.50.

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Question: The Robinson Corporation has $43 million of bonds outstanding that were issued at a coupon rate of 11戮 percent seven years ago. Interest rates have fallen to 10戮 percent. Mr. Brooks, the vice president of finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 2.4 percent of the total bond value. The underwriting cost on the new issue will be 1.7 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 9 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Assume the discount rate is equal to the after-tax cost of new debt rounded up to the nearest whole number.

a. Compute the discount rate.

The Hastings Sugar Corporation has the following pattern of net income each year and associated capital expenditure projects. The firm can earn a higher return on the projects than the stockholders could earn if the funds were paid out in the form of dividends.

Year

Net income

Profitable capital expenditure

1

\(14 million

\)7 million

2

\(16 million

\)11 million

3

\(12 million

\)6 million

4

\(16 million

\)8 million

5

\(16 million

\)9 million

The Hastings Corporation has 3 million shares outstanding. (The following questions are separate from each other.)

a. If the marginal principle of retained earnings is applied, how much in total cash dividends will be paid over the five years?

b. If the firm simply uses a payout ratio of 30 percent of net income, how much in total cash dividends will be paid?

c. If the firm pays a 10 percent stock dividend in years 2 through 5, and also pays a cash dividend of $3.40 per share for each of the five years, how much in total dividends will be paid?

d. Assume the payout ratio in each year is to be 20 percent of the net income and the firm will pay a 10 percent stock dividend in years 2 through 5, how much will dividends per share for each year be? (Assume the cash dividend is paid after the stock dividend.)
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