East Coast Warehouse Club

Frank O'Connor, CFO of East Coast Warehouse Club, was reviewing notes from the annual shareholders' meeting the week before. Most of the meeting was routine: greetings from the CEO and chairman of the board, review of last year's results, plans for the coming year, election of directors (no surprises), ratification of the auditors, and so on. The only unexpected incident occurred during a question-and-answer period with the CFO when a major institutional shareholder asked if and when the company expected to start paying dividends. The question was met with loud applause and a few cheers of "Hear, hear!" Frank answered, not quite truthfully, that the matter was being discussed internally and was on the agenda for the next board of directors' meeting. In any case, it was on the agenda now.

When the directors met the following month, they looked over a report they had asked the CFO to compile on the pros and cons of instituting dividends. The report first provided a review of the company's financial situation. A recent economic downturn and high energy prices had been devastating for otherretailers, but had actually been good for East Coast because hard-pressed consumers looked for the lowest prices on everything from groceries to computers to automobile tires and batteries. East Coast had recently added gas pumps to many locations and could sell gasoline for a few cents less per gallon than other retailers. The gas business was thriving, and company research showed that gas sales brought customers to the stores for other purchases. On the other hand, East Coast's growth policy had become cautious. Its extensive real estate holdings were losing value in a declining market, and the company was unwilling to build stores so close together that it would be competing with itself or so far from its regional base that distribution would become inefficient. Ten percent of total assets were now in cash and short-term investments. Long-term debt had fallen from 38% of assets a few years ago to less than 22%.

Cash flow from operations was more than double the investment in new assets.

There was no question that East Coast could pay a dividend, but should it? Frank wondered what some of his bright young staffers long dashseveral of whom had used East Coast's generous education benefits to obtain MBA would have to say about this question, so he put it on the agenda for the regular Wednesday afternoon staff meeting.

3. Assume an investor holds 1,000 shares of East Coast stock, which is trading at $73.50 per share immediately before the following actions. Calculate the probable value of the stock, the amount of cash received, and total investor wealth immediately after the following actions. Consider each action independently.

a.East Coast pays a 20% stock dividend.

b.East Coast splits its stock 3-for-1.

c.East Coast pays a $2.50 per share cash dividend. The tax rate on dividends is 15%.

d.East Coast pays a $2.50 per share cash dividend. The investor holds her shares in a tax-sheltered retirement account.

e.The investor sells 100shares, which were purchased for $48.50 per share. The tax rate on capital gains is 15%.