Strictly for course AB1201 internal circulation only.

Nanyang Business School

AB1201 Financial Management
Tutorial 11: Dividend and Share Repurchases
(Common Questions)
Questions 1 to 4 will be presented by students while Question 5 will be presented by instructors.

1) Indicate whether the following statements are true or false. Explain.

a) Companies with high growth rates tend to have high dividend-payout ratios because they want
to attract more investors.
b) Both stock dividends and stock splits appear to send positive signals to the market about the
company and often result in positive stock-price reactions.
c) Some dividend reinvestment plans increase the amount of equity capital available to the firm.

2) The cost of retained earnings is less than the cost of new outside equity capital. Consequently, it
is totally irrational for a firm to sell a new issue of stock and to pay dividends during the same
year. Discuss the meaning of those statements.

3) Stock Repurchases. Beta Industries has net income of $2,000,000, and it has 1,000,000 shares
of common stock outstanding. The companys stock currently trades at $32 a share. Beta is
considering a plan in which it will use available cash to repurchase 20% of its shares in the open
market. The repurchase is expected to have no effect on net income or the companys P/E ratio.
What will be Betas stock price following the stock repurchase?

4) Stock Split. After a 5-for-1 stock split, Strasburg Company paid a dividend of $0.75 per new
share. The total dividends paid this year is 9% more than last years. What was last years
dividend per share?

5) Alternative dividend policies. Rubenstein Bros. Clothing is expecting to pay an annual

dividend per share of $0.75 out of annual earnings per share of $2.25. The company is expected
to maintain the same payout ratio into the future. Currently, Rubenstein Bros. stock is selling for
$12.50 per share. Adhering to the companys target capital structure, the firm has $10million in
capital, of which 40% is funded by debt. Assume that the firms book value of equity equals its
market value. In past years, the firm has earned a return on equity (ROE) of 18%, which is
expected to continue this year and into the foreseeable future.
a) Based on that information, what long-run growth rate can the firm be expected to maintain?
(Hint: g = Retention rate x ROE)
b) What is the stocks required return, assuming market equilibrium?
c) If the firm decides to change its dividend policy and plan to pay an annual dividend of $1.50
per share instead, financial analysts would predict that the change in policy will have no effect on
the firms stock price or ROE. Therefore, what must be the firms new expected long-run growth
rate and required return? Again assume market equilibrium.
d) Suppose instead that the firm has decided to proceed with its original plan of disbursing $0.75
per share to shareholders, but the firm intends to do so in the form of a stock dividend rather than
a cash dividend. The firm will allot new shares based on the current stock price of $12.50. In
other words, for every $12.50 in dividends due to shareholders, a share of stock will be issued.
How many new shares of stock will be issued and by how much will the companys earnings per
share be diluted?
e) What might be the reasons that the firm pay stock dividend instead of cash dividend? Discuss.

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 Strictly for course AB1201 internal circulation only.
Self-Practice Questions

Question 1
Whited Products recently completed a 4-for-1 stock split. Prior to the split, its stock sold for $120
per share. If the firm's total market value increased by 5% as a result of increased liquidity and
favorable signaling effects, what was the stock price following the split?

Question 2
ABC Ltds expected earnings before taxes (EBT) and net income for 2011 are $4.5 million and
$3.15 million, respectively. It has 1.5 million shares outstanding. The Company had a 60%
dividend payout ratio in 2010. If it wants to maintain this payout ratio in 2011, what will be its per-
share dividend in 2011?

Answers to self-practice questions

Question 1
Post-split stock price = (P0/[New shares per old shares) (1 + % Value increase)]
= (120/4) (1+5%)
= $31.50
Question 2
Payout = Dividends/Net Income Dividends = 0.6*3.15 = 1.89 million
DPS = 1.89/1.5 = $1.26

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