The treasurer of Kelly Bottling Company (a corporation) currently has $200,000 invested in preferred stock yielding 10 percent. He appreciates the tax advantages of preferred stock and is considering buying $200,000 more with borrowed funds. The cost of the borrowed funds is 12 percent. He suggests this proposal to his board of directors. They are somewhat concerned by the fact that the treasurer will be paying 2 percent more for funds than the company will be earning on the investment. Kelly Bottling is in a 30 percent tax bracket, with dividends taxed at 10 percent.

a.	Compute the amount of the aftertax income from the additional preferred stock if it is purchased. (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

Aftertax income

$

Problem 18-16 Dividend valuation model and wealth maximization [LO2]

Omni Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate.

P0	=	D1
		Ke − g

P₀ = Price of the stock today

D₁ = Dividend at the end of the first year

D₁ = D₀ × (1 + g)

D₀ = Dividend today

K_e = Required rate of return

g = Constant growth rate in dividends

D₀ is currently $2.90, K_e is 9 percent, and g is 5 percent.

Under Plan A, D₀ would be immediately increased to $3.20 and K_e and g will remain unchanged.

Under Plan B, D₀ will remain at $2.90 but g will go up to 6 percent and K_e will remain unchanged.

a.	Compute P0 (price of the stock today) under Plan A. Note D1 will be equal to D0 × (1 + g) or $3.20 (1.05). Ke will equal 9 percent, and g will equal 5 percent.(Round your intermediate calculations and final answer to 2 decimal places.)

Stock price for Plan A

$

b.	Compute P0 (price of the stock today) under Plan B. Note D1 will be equal to D0 × (1 + g) or $2.90 (1.06). Ke will be equal to 9 percent, and g will be equal to 6 percent.(Round your intermediate calculations and final answer to 2 decimal places.)

Stock price for Plan B

$

c.

Which plan will produce the higher value?

	Plan A
	Plan B

Problem 18-17 Stock split and its effect [LO4]

Wilson Pharmaceuticals’ stock has done very well in the market during the last three years. It has risen from $15 to $40 per share. The firm’s current statement of stockholders’ equity is as follows:

Common stock (5 million shares issued at par value of $10 per share)	$	50,000,000
Paid-in capital in excess of par		16,000,000
Retained earnings		44,000,000
Net worth	$	110,000,000

a-1.	How many shares would be outstanding after a two-for-one stock split? (Do not round intermediate calculations. Input your answer in millions (e.g., $1.23 million should be entered as "1.23").)

Number of shares

million

a-2.	What would be its par value? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Par value

$

b-1.	How many shares would be outstanding after a three-for-one stock split? (Do not round intermediate calculations. Input your answer in millions (e.g., $1.23 million should be entered as "1.23").)

Number of shares

million

b-2	What would be its par value? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Par value

$

c.	Assume that Wilson earned $15 million. What would its earnings per share be before and after the two-for-one stock split? After the three-for-one stock split? (Do not round intermediate calculations and round your answers to 2 decimal places.)

EPS before	$
EPS after 2-for-1 split	$
EPS after 3-for-1 split	$

d.	What would be the price per share after the two-for-one stock split? After the three-for-one stock split? (Assume that the price-earnings ratio of 13.33 stays the same.) (Do not round intermediate calculations and round your answers to 2 decimal places.)

Price after 2-for-1 split	$
Price after 3-for-1 split	$

Problem 18-15 Dividends and stockholder wealth maximization [LO2]

The Vinson Corporation has earnings of $1,106,000 with 370,000 shares outstanding. Its P/E ratio is 12. The firm is holding $410,000 of funds to invest or pay out in dividends. If the funds are retained, the aftertax return on investment will be 10 percent, and this will add to present earnings. The 10 percent is the normal return anticipated for the corporation, and the P/E ratio would remain unchanged. If the funds are paid out in the form of dividends, the P/E ratio will increase by 10 percent because the stockholders in this corporation have a preference for dividends over retained earnings.

a.	Compute the price of the stock under the two plans. (Do not round intermediate calculations and round your answers to 2 decimal places.)

	Price of Stock
Retention plan	$
Payout plan	$

b.

Which plan will maximize the market value of the stock?

	Retention plan
	Payout plan

Problem 18-19 Stock dividend and cash dividend [LO4]

Health Systems Inc. is considering a (expression error) percent stock dividend. The capital accounts are as follows:

Common stock ((expression error) shares at $(expression error) par)	$ (expression error)
Capital in excess of par*	(expression error)
Retained earnings	(expression error)
Net worth	$(expression error)

*The increase in capital in excess of par as a result of a stock dividend is equal to the shares created times (Market price – Par value).

The company’s stock is selling for $(expression error) per share. The company had total earnings of $(expression error) with (expression error) shares outstanding and earnings per share were $(expression error). The firm has a P/E ratio of (expression error).

a.	What adjustments would have to be made to the capital accounts for a (expression error) percent stock dividend? Show the new capital accounts. (Do not round intermediate calculations. Input your answers in dollars, not millions (e.g. $1,230,000).)

Common stock	$
Capital in excess of par
Retained earnings
Net worth	$

b.	What adjustments would be made to EPS and the stock price? (Assume the P/E ratio remains constant.) (Do not round intermediate calculations and round your answers to 2 decimal places.)

EPS	$
Stock price	$

c.	How many shares would an investor have if he or she originally had (expression error)? (Do not round intermediate calculations and round your answer to the nearest whole share.)

Number of shares

d.	What is the investor’s total investment worth before and after the stock dividend if the P/E ratio remains constant? (Do not round intermediate calculations and round your answers to the nearest whole dollar.)

	Total Investment
Before stock dividend	$
After stock dividend	$

e.	Assume Mr. Heart, the president of Health Systems, wishes to benefit stockholders by keeping the cash dividend at a previous level of $(expression error) in spite of the fact that the stockholders how have (expression error) percent more shares. Because the cash dividend is not reduced, the stock price is assumed to remain at $(expression error).
	What is an investor’s total investment worth after the stock dividend if he/she had (expression error) shares before the stock dividend?

Total investment

$

f.

Under the scenario described in part e, is the investor better off?

	Yes
	No

g.	As a final question, what is the dividend yield on this stock under the scenario described in part e?(Input your answer as a percent rounded to 2 decimal places.)

Dividend yield

%

Problem 18-20 Reverse stock split [LO4]

Worst Buy Company has had a lot of complaints from customers of late, and its stock price is now only $4 per share. It is going to employ a one-for-six reverse stock split to increase the stock value. Assume Dean Smith owns 90 shares.

a.	How many shares will he own after the reverse stock split? (Do not round intermediate calculations and round your answer to the nearest whole number.)

Number of shares

b.	What is the anticipated price of the stock after the reverse stock split? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Anticipated stock price

$

c.	Because investors often have a negative reaction to a revere stock split, assume the stock only goes up to 90 percent of the value computed in part b. What will the stock’s price be? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Stock price

$

d.

How has the total value of Dean Smith’s holdings changed from before the reverse stock split to after the reverse stock split (based on the stock value computed in part c)? To get the total value before and after the split, multiply the shares held times the stock price.(Input the amount as a positive value. Do not round intermediate calculations and round your answer to 2 decimal places.)

Dean Smith’s holdings (Click to select) Increased by decreased by $

Problem 18-22 Retaining funds versus paying them out [LO1]

The Hastings Sugar Corporation has the following pattern of net income each year, and associated capital expenditure projects. The firm can earn a higher return on the projects than the stockholders could earn if the funds were paid out in the form of dividends.

Year	Net Income			Profitable Capital Expenditure
1		$13 million			$ 7 million
2		22 million			11 million
3		13 million			6 million
4		21 million			8 million
5		17 million			9 million

The Hastings Corporation has 2 million shares outstanding (The following questions are separate from each other).

a.	If the marginal principle of retained earnings is applied, how much in total cash dividends will be paid over the five years? (Enter your answer in millions.)

Total cash dividends

$ million

b.	If the firm simply uses a payout ratio of 30 percent of net income, how much in total cash dividends will be paid? (Enter your answer in millions and round your answer to 1 decimal place.)

Total cash dividends

$ million

c.