P143 Residual dividend policy As president of Youngs of California, a large clothing

chain, you have just received a letter from a major stockholder. The stockholder

asks about the companys dividend policy. In fact, the stockholder has asked you to

estimate the amount of the dividend that you are likely to pay next year. You have

not yet collected all the information about the expected dividend payment, but you

do know the following:

(1) The company follows a residual dividend policy.

(2) The total capital budget for next year is likely to be one of three amounts,

depending on the results of capital budgeting studies that are currently under

way. The capital expenditure amounts are $2 million, $3 million, and

$4 million.

(3) The forecasted level of potential retained earnings next year is $2 million.

(4) The target or optimal capital structure is a debt ratio of 40%.

You have decided to respond by sending the stockholder the best information available

to you.

a. Describe a residual dividend policy.

b. Compute the amount of the dividend (or the amount of new common stock

needed) and the dividend payout ratio for each of the three capital expenditure

amounts.

c. Compare, contrast, and discuss the amount of dividends (calculated in part b)

associated with each of the three capital expenditure amounts.

P147 Alternative dividend policies Over the last 10 years, a firm has had the earnings per

share shown in the following table.

LG 4

Year Earnings per share Year Earnings per share

2015 $4.00 2010 $2.40

2014 3.80 2009 1.20

2013 3.20 2008 1.80

2012 2.80 2007 -0.50

2011 3.20 2006 0.25

a. If the firms dividend policy were based on a constant payout ratio of 40% for

all years with positive earnings and 0% otherwise, what would be the annual

dividend for each year?

b. If the firm had a dividend payout of $1.00 per share, increasing by $0.10 per

share whenever the dividend payout fell below 50% for two consecutive years,

what annual dividend would the firm pay each year?

c. If the firms policy were to pay $0.50 per share each period except when earnings

per share exceed $3.00, when an extra dividend equal to 80% of earnings beyond

$3.00 would be paid, what annual dividend would the firm pay each year?

d. Discuss the pros and cons of each dividend policy described in parts a through c

P1410 Cash versus stock dividend Milwaukee Tool has the following stockholders equity

account. The firms common stock currently sells for $4 per share.

Preferred stock $ 100,000

Common stock (400,000 shares at $1 par) 400,000

Paid-in capital in excess of par 200,000

Retained earnings 320,000

Total stockholders equity $1,020,000

a. Show the effects on the firm of a cash dividend of $0.01, $0.05, $0.10, and

$0.20 per share.

b. Show the effects on the firm of a 1%, 5%, 10%, and 20% stock dividend.

c. Compare the effects in parts a and b. What are the significant differences between

the two methods of paying dividends?

P1417 Stock repurchase The following financial data on the Bond Recording Company are

available:

Earnings available for common stockholders $800,000

Number of shares of common stock outstanding 400,000

Earnings per share ($800,000 , 400,000) $2

Market price per share $20

Price/earnings (P/E) ratio ($20 , $2) 10

The firm is currently considering whether it should use $400,000 of its earnings to

pay cash dividends of $1 per share or to repurchase stock at $21 per share.

a. Approximately how many shares of stock can the firm repurchase at the $21-pershare

price, using the funds that would have gone to pay the cash dividend?

b. Calculate the EPS after the repurchase. Explain your calculations.

c. If the stock still sells at 10 times earnings, what will the market price be after the

repurchase?

d. Compare the pre- and postrepurchase earnings per share.

e. Compare and contrast the stockholders positions under the dividend and repurchase

alternatives. What are the tax implications under each alternative?