Figure 1 Selected financial data, Penny Corporation (in millions, except per share data) 2009 2010 2011 2012 2013 2014 2015 Sales....................................................... $27,357.4 $30,019.8 $35,882.9 $38,828.0 $40,715.3 $44,281.5 $48,000.0 Net income.............................................. $ 650.1 $ 861.2 $ 1,342.2 $ 1,454.8 $ 1,303.3 $ 1,351.3 $ 1,700.0 Amount to preferred dividends................ $ 16.7 $ 21.5 $ 16.8 $ 22.6 Amount to common dividends................. $ 429.1 $ 476.3 $ 537.0 $ 630.8 $ 639.0 $ 648.3 $ 725.4 Amount to retained earnings................... $ 221.0 $ 384.9 $ 805.2 $ 807.3 $ 642.8 $ 686.2 $ 952.0 Common shares outstanding .................. 347.9 351.4 354.6 361.6 363.1 376.6 378.0 Earnings per share (on average common shares).................................................. $ 1.96 $ 2.46 $ 3.80 $ 4.06 $ 3.60 $ 3.65 $ 4.51 DPS (on average common shares)......... $ 1.36 $ 1.36 $ 1.48 $ 1.70 $ 1.76 $ 1.76 $ 1.96 Payout ratio (DPS/EPS)* ........................ 69.4% 55.3% 38.9% 41.8% 48.9% 48.2% 43.5% Total retained earnings ........................... $ 7,041.2 $ 7,426.1 $ 8,231.3 $ 9,038.6 $ 9,681.4 $10,367.6 $11,319.6 Cash balance.......................................... $ 1,170.7 $ 1,307.6 $ 1,502.5 $ 1,765.0 $ 2,357.2 $ 2,984.4 $ 3,235.0 *DPS (dividends per share)/EPS (earnings per share) Figure 2 Selected financial data, other retail chains 2009 2010 2011 2012 2013 2014 2015 Dillard Department Store: EPS............................. $0.69 $0.93 $1.38 $1.82 $2.29 $2.35 $2.50 DPS............................. $0.05 $0.05 $0.08 $0.09 $0.10 $0.12 $0.13 Payout ratio ................. 7.3% 5.4% 5.8% 5.0% 4.4% 5.1% 5.2% Dollar General: ................ EPS............................. $0.38 $0.61 $0.81 $1.10 $0.95 $0.23 $0.30 DPS............................. $0.09 $0.11 $0.13 $0.17 $0.20 $0.20 $0.20 Payout ratio ................. 23.7% 18.0% 16.1% 15.5% 21.1% 87.0% 66.7% Limited, Inc.:.................... EPS............................. $0.10 $0.19 $0.37 $0.51 $0.80 $1.21 $1.40 DPS............................. $0.01 $0.02 $0.04 $0.08 $0.11 $0.16 $0.24 Payout ratio ................. 10.0% 10.5% 10.8% 15.7% 13.8% 13.2% 17.1% Nordstrom, Inc.:............... EPS............................. $0.35 $0.38 $0.54 $0.55 $0.66 $0.91 $1.10 DPS............................. $0.06 $0.06 $0.07 $0.10 $0.11 $0.13 $0.18 Payout ratio ................. 17.1% 15.8% 13.0% 18.2% 16.7% 14.3% 16.4% J.C. Penney:.................... EPS............................. $2.75 $2.94 $3.13 $2.91 $2.66 $3.53 $4.70 DPS............................. $0.92 $1.00 $1.08 $1.18 $1.18 $1.24 $1.48 Payout ratio ................. 33.5% 34.0% 34.5% 40.6% 44.4% 35.1% 31.5% Wal-Mart Stores: ............. EPS............................. $0.16 $0.23 $0.35 $0.48 $0.58 $0.80 $1.10 DPS............................. $0.02 $0.02 $0.04 $0.05 $0.07 $0.09 $0.12 Payout ratio ................. 12.5% 8.7% 11.4% 10.4% 12.1% 11.3% 10.9% Note: DPS refers to dividends per share, EPS to earnings per share.

Mr. Clarence Autry, who was also on the board of directors of the Exxon corporation and no stranger to the world of corporate finance, broke in. Young man, he said dryly, your proposal ignores reality. Its not whether the stockholders are theoretically better off that counts, its what they want. You cannot tell the stockholders youre doing whats best for them by cutting the dividend; the dividend is what they want. Not only is that dividend sure money in their pockets now, but the fact that its the same size as last time, or even higher, is a signal to them that their company is doing well and will continue to do so in the future. These decisions cant always be made on the basis of good-looking formulas from the back room, you know. Ms. Barbara Reynolds, who was the head of directors auditing committee, and somewhat of an accounting expert, agreed with Mr. Autry. Thats a good point, Clarence, and one thats well recognized by our competitors, too. If you check, I dont think youll find a single one of them thats cut their dividend in the last six years, even though their net income may have declined significantly. Furthermore, the whole argument is meaningless, anyway, because the dividend is not really competing with the capital budget for fundswe dont turn away profitable projects in favor of paying the dividend. If there are worthy projects in which we want to invest, and we would rather use our available cash to pay the dividend, then we seek financing for the investments from outside sources. In a way, we can have our cake and eat it too. She chuckled, pleased at the analogy. Don Jackson, however, was not to be intimidated so easily. Yes, maam, what you say is true, he replied, and I would respond that competitors are not treating their stockholders fairly, either. Furthermore, you do seek outside financing occasionally for large projects, but there are two problems associated with doing it routinely, as you suggest. First, it might be viewed as borrowing, or issuing stock, to pay the dividend, which would cast the company in a very poor light. Second, its more expensive to finance from outside sources than from inside due to the fees charged by the investment banker. Therefore, I believe you should exhaust our inside sources of financing before turning to the outside. Ms. Reynolds held her ground. Thats all very well, but its still not necessary to cut the dividend in order to fund the capital budget. As a last resort, if the companys cash balances were about to be drawn down too low, we could always declare a stock dividend instead of a cash dividend. Ladies, gentlemen, Mr. Edward Asking, the chairman, intervened, your comments are all very perceptive, but we must move on to the business at hand. All those in favor of changing to a residual policy, please raise your hand.

DO NOT DO THIS CASE WITH ANYONE ELSE. YOU WILL BE GRADED ON YOUR SOLO WORK. CHEATING WILL RESULT IN SEVERE PENALTY

Questions (Equally Weighted) 1. Refer to Figure 1. Would you say that Pennys policy up to now has been to pay a constant dividend, with occasional increases as the company grows?

2. Refer to Figure 2. What type of dividend policies would you say are being practiced by Pennys competitors in the retailing industry? 3 What kind of signal a change to residual dividend policy will send to the shareholders and the investment community? 4. How does the residual dividend policy support Modigliani and Millers (MM) theory about dividend policy in a world with no taxes? 5. Do you go along with Clarence Autrys comment that its what the stockholders want that counts, not their total rate of return? Why or why not? 6. Barbara Reynolds suggests that, if cash is needed for the capital budget, a stock dividend could be substituted for the cash dividend. Do you agree? How do you think the stockholders would react? Regardless of their reaction, is the stock dividend an equivalent substitute for the cash dividend? 7. After all is said and done, do you think the firms dividend policy matters? If so, what do you think Pennys policy should be?

Additional Question #8. Assume that Penny Corporation is a cash-only company. The company is now considering switching to a 30-day credit policy with no discounts. What factors should the firm consider before making the switch? Discuss.