Phoenix Tool Company and Denver Tool Company have had a very similar record of earnings performance over the past 8 years. Both firms are in the same industry and, in fact, compete directly with each other. The two firms have nearly identical capital structures. Phoenix has a policy of paying a constant 50 percent of each year’s earnings as dividends, whereas Denver has sought to maintain a stable dollar dividend policy, with changes in the dollar dividend payment occurring infrequently.

The record of the two companies follows:

The president of Phoenix wonders what accounts for Denver’s current (2010)
higher stock price, in spite of the fact that Phoenix currently earns more per share than Denver and frequently has paid a higher dividend.

a. What factors can you cite that might account for this phenomenon?

b. What do you suggest as an optimal dividend policy for both Phoenix and Denver that might lead to increases in both of their share prices? What are the limitations of your suggestions? P-698