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Mini Case ( 1 ) Mini Case Central Canada Steel ( CCS ) was formed 5 years ago to exploit a new continuous - casting
Mini Case
Mini Case
Central Canada Steel CCS was formed years ago to exploit a new
continuouscasting process. CCSs founders, Donald Brown and Margo
Lapointe, had been employed in the research department of a major
integratedsteel company, but when that company decided against using the
new process which Brown and Lapointe had developed they decided to
strike out on their own. One advantage of the new process was that it
required relatively little capital in comparison with the typical steel
company, so Brown and Lapointe have been able to avoid issuing new stock,
and thus they own all of the shares. However, CCS has now reached the
stage where outside equity capital is necessary if the firm is to achieve its
growth targets yet maintain its target capital structure of equity and
debt. Therefore, Brown and Lapointe have decided to take the company
public. Until now, Brown and Lapointe have paid themselves reasonable
salaries but routinely reinvested all aftertax earnings in the firm, so
dividend policy has not been an issue. However, before talking with
potential outside investors, they must decide on a dividend policy.
Assume that you were recently hired by Pierce Westerfield Carney PWC a
national consulting firm, which has been asked to help CCS prepare for its
public offering. Martha Millon, the senior PWC consultant in your group,
has asked you to make a presentation to Brown and Lapointe in which you
review the theory of dividend policy and discuss the following questions.
a
What is meant by the term distribution policy
The terms irrelevancebirdinthehand, and tax preference
have been used to describe three major theories regarding the way
dividend payouts affect a firms value. Explain what these terms
mean, and briefly describe each theory.
What do the three theories indicate regarding the actions
management should take with respect to dividend payouts?
What results have empirical studies of the dividend theories
produced?
How does all this affect what we can tell managers about
dividend payouts?
Discuss the information content, or signalling, hypothesis,
the clientele effect, and their effects on distribution policy.
Assume that CCS has an $ capital budget planned for the
coming year. You have determined that its present capital structure
equity and debt is optimal, and its net income is forecast
at $ Use the residual distribution model approach to
determine CCSs total dollar distribution. Assume for now that the
distribution is in the form of a dividend. Then, explain what would
happen if net income were forecast at $ or at $
In general terms, how would a change in investment
opportunities affect the payout ratio under the residual distribution
policy?
What are the advantages and disadvantages of the residual
policy? Hint: Dont neglect signalling and clientele effects.
d What are stock repurchases? Discuss the advantages and disadvantages
of a firm repurchasing its own shares.
e Describe the series of steps that most firms take in setting dividend
policy in practice.
f What are stock splits and stock dividends? What are the advantages and
disadvantages of stock splits and stock dividends?
g What is a dividend reinvestment plan DRIP and how does it work?
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