Question $4($total $50\%)$

Dividend policy

KMS Corporation has assets with a market value of $$500$ million, $$50$ million of which

are cash. It has debt of $$200$ million, and $10$ million shares outstanding. Assume

perfect capital markets.

a$)$ What is its current stock price?

$[8\%]$

b$)$ If KMS distributes $$50$ million as a dividend, what will its share price be after

the dividend is paid?

$[8\%]$

c$)$ If instead, KMS distributes $$50$ million as a share repurchase, what will its share

price be once the shares are repurchased?

$8\%$

d$)$ What will its new market debt$-$equity ratio be after either transaction?

$[8\%]$

On Monday, November $15,2004,$

TheStreet.com reported: $"$An experiment in the

efficiency of financial markets will play out Monday following the expiration of a $$3\mathrm{.}08$

dividend privilege for holders of Microsoft." The story went on: "The stock is currently

trading ex$-$dividend both the special $$3$ payout and Microsoft's regular $$0\mathrm{.}08$ quarterly

dividend, meaning a buyer doesn't receive the money if he acquires the shares now."

Microsoft stock ultimately opened for trade at $$27\mathrm{.}34$ on the ex$-$dividend date

$($November $15),$ down $$2\mathrm{.}63$ from its previous close.

e$)$ Assuming that this price drop resulted only from the dividend payment $($no other

information affected the stock price that day$),$ what does this decline in price

imply about the effective dividend tax rate for Microsoft?

$10\%$

f$)$ Based on this information, which of the following investors were most likely to

be the marginal investors $($the ones who determine the price$)$ in Microsoft stock:

long$-$term individual investors,

one$-$year individual investors,

pension funds,

corporations