Payout Policy_Homework
Chapter 17
Payout Policy
17-1. What options does a firm have to spend its free cash flow (after it has satisfied all interest obligations)?
17-2. ABC Corporation announced that it will pay a dividend to all shareholders of record as of Monday, April 3, 2006. It takes three business days of a purchase for the new owners of a share of stock to be registered.
a. When is the last day an investor can purchase ABC stock and still get the dividend payment?
b. When is the ex-dividend day?
17-3. Describe the different mechanisms available to a firm to use to repurchase shares
17-4. RFC Corp. has announced a $1 dividend. If RFC’s price last price cum-dividend is $50, what should its first ex-dividend price be (assuming perfect capital markets)?
17-5. EJH Company has a market capitalization of $1 billion and 20 million shares outstanding. It plans to distribute $100 million through an open market repurchase. Assuming perfect capital markets:
a. What will the price per share of EJH be right before the repurchase?
b. How many shares will be repurchased?
c. What will the price per share of EJH be right after the repurchase?
Berk/DeMarzo?Corporate Finance, Second Edition217 17-6. 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?
b. If KMS distributes $50 million as a dividend, what will its share price be after the dividend
is paid?
c. If instead, KMS distributes $50 million as a share repurchase, what will its share price be
once the shares are repurchased?
d. What will its new market debt-equity ratio be after either transaction?
17-7. Natsam Corporation has $250 million of excess cash. The firm has no debt and 500 million shares outstand ing with a current market price of $15 per share. Natsam’s board has decided to pay out this cash as a one-time dividend.
a. What is the ex-dividend price of a share in a perfect capital market?
b. If the board instead decided to use the cash to do a one-time share repurchase, in a perfect
capital market what is the price of the shares once the repurchase is complete?
c. In a perfect capital market, which policy, in part (a) or (b), makes investors in the firm
better off?
17-8. Suppose the board of Natsam Corporation decided to do the share repurchase in Problem 7(b), but you, as an investor, would have preferred to receive a dividend payment. How can you leave yourself in the same position as if the board had elected to make the dividend payment instead? 17-9. The HNH Corporation will pay a constant dividend of $2 per share, per year, in perpetuity.
Assume all investors pay a 20% tax on dividends and that there is no capital gains tax. Suppose that other investments with equivalent risk to HNH stock offer an after-tax return of 12%.
a. What is the price of a share of HNH stock?
b. Assume that management makes a surprise announcement that HNH will no longer pay
dividends but will use the cash to repurchase stock instead. What is the price of a share of
HNH stock now?
218Berk/DeMarzo?Corporate Finance, Second Edition
17-10. Suppose that all capital gains are taxed at a 25% rate, and that the dividend tax rate is 50%.
Arbuckle Corp. is currently trading for $30, and is about to pay a $6 special dividend.
a. Absent any other trading frictions or news, what will its share price be just after the
dividend is paid?
Suppose Arbuckle made a surprise announcement that it would do a share repurchase rather than pay a special dividend.
b. What net tax savings per share for an investor would result from this decision?
c. What would happen to Arbuckle’s stock price upon the announcement of this change?
17-11. A stock that you know is held by long-term individual investors paid a large one-time dividend.
You notice that the price drop on the ex-dividend date is about the size of the dividend payment.
You find this relationship puzzling given the tax disadvantage of dividends. Explain how the dividend-capture theory might account for this behavior.
17-12. Explain under which conditions an increase in the dividend payment can be interpreted as a signal of the following:
a. Good news
b. Bad news
17-13. Why is an announcement of a share repurchase considered a positive signal?
17-14. AMC Corporation currently has an enterprise value of $400 million and $100 million in excess cash. The firm has 10 million shares outstanding and no debt. Suppose AMC uses its excess cash
to repurchase shares. After the share repurchase, news will come out that will change AMC’s enterprise value to either $600 million or $200 million.
a. What is AMC’s share price prior to the share repurchase?
b. What is AMC’s share price after the repurchase if its enterprise value goes up? What is
AMC’s share price after the repurchase if its enterprise value declines?
c. Suppose AMC waits until after the news comes out to do the share repurchase. What is
AMC’s share price after the repurchase if its enterprise value goes up? What is AMC’s
share price after the repurchase if its enterprise value declines?
d. Suppose AMC management expects good news to come out. Based on your answers to parts
(b) and (c), if management desires to maximize AMC’s ultimate share price, will they
Berk/DeMarzo?Corporate Finance, Second Edition219 undertake the repurchase before or after the news comes out? When would management
undertake the repurchase if they expect bad news to come out?
e. Given your answer to part (d), what effect would you expect an announcement of a share
repurchase to have on the stock price? Why?
17-15. Berkshire Hathaway’s A shares are trading at $120,000. What split ratio would it need to br ing its stock price down to $50?