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The after-tax dividend is the pretax dividend times one minus the tax rate, so:
The equity share price should drop by the after-tax dividend amount, or:
Problem 2
Since the par value of the new shares is P1, the capital surplus per share is P29. The total capital surplus is therefore:
Since the par value of the new shares is P1, the capital surplus per share is P29. The total capital surplus is therefore:
(c) To find the new shares outstanding, we multiply the current shares outstanding times the ratio of new shares to old
shares, so:
The equity accounts are unchanged except the par value of the equity share is changed by the ratio of new shares to old
shares, so the new par value is:
(d) To find the new shares outstanding, we multiply the current shares outstanding times the ratio of new shares to old
shares, so:
Problem 3
Assuming no capital gains tax, the after-tax return for the FYI Company is the capital gains growth rate, plus the dividend
yield times one minus the tax rate. Using the constant growth dividend model, we get:
After-tax return = g + D (1 – t)
= .15
Solving for g, we get:
The equivalent pretax return for FYI Company, which pays no dividend, is:
Pretax return = g + D
= .1175 + .05
= .1675 or 16.75%
Problem 4
(a) If the company makes a dividend payment, we can calculate the wealth of a shareholder as:
The equity share price after the dividend payment will be:
PX = P64 – 9
= P55 per share
The shareholder will have an equity shares worth P55 and a P9 dividend for a total wealth of P64. If the company makes
a repurchase, the company will repurchase:
If the shareholder lets their shares be repurchased, they will have P64 in cash. If the shareholder keeps their shares, they
are still worth P64.
(b) If the company pays dividends, the current EPS is P1.30, and the P/E ratio is:
P/E = P55/P1.30
= 42.31
If the company repurchases equity share, the number of shares will decrease. The total net income is the EPS times the
current number of shares outstanding. Dividing net income by the new number of shares outstanding, we find the EPS
under the repurchase is:
The equity share price will remain at P64 per share, so the P/E ratio is:
P/E = P64/P1.51
= 42.31
A share repurchase would seem to be the preferred course of action. Only those shareholders who wish to sell will do
so, giving the shareholder a tax timing option that he or she does not get with a dividend payment.
Problem 5
Since the P2,000,000 cash is after corporate tax, the full amount will be invested. So, the value of each alternative is:
Alternative 1:
The firm invests in T-bills or in preferred share, and then pays out as special dividend in 3 years.
If the firm invests in T-bills, the after-tax yield of the T-bills will be:
So, the future value of the corporate investment in T-bills will be:
Since the future value will be paid to shareholders as a dividend, the after-tax cash flow will be:
If the firm invests in preferred share, the assumption would be that the dividends received will be reinvested in the
same preferred share. The preferred share will pay a dividend of:
And the taxes the company must pay on the preferred dividends will be:
The future value of the company’s investment in preferred share will be:
FV of investment in preferred share = P2,000,000 (1 + .0716) 3
= P2,461,093.48
Since the future value will be paid to shareholders as a dividend, the after-tax cash flow will be:
Alternative 2:
The firm pays out dividend now, and individuals invest on their own. The after-tax cash received by shareholders now
will be:
So, the future value of the individual investment in Treasury bills will be:
If the individual invests in preferred share, the assumption would be that the dividends received will be reinvested in
the same preferred share. The preferred shares will pay a dividend of:
The future value of the individual investment in preferred share will be:
The after-tax cash flow for the shareholders is maximized when the firm invests the cash in the preferred shares and
pays a special dividend later.
Problem 6
= P2.00
(b) The dividends per share were:
Problem 7
The dividend payout is computed by dividing the yearly dividends per share by the earnings per share.
Dividend (4) (P0.25)
payout ratio = P2.50
= 0.40 or 40%
Problem 8
To provide the P4,900,000 in required equity, Glee Mining Company must retain the entire P4,000,000 in earnings and
issue new equity share for the remaining P900,000. By following the current dividend policy, the company will pay no cash
dividends.
Problem 9
(a) Eight (8) million shares would be outstanding at a par value of P5 per share. Everything else will be the same.
(b) Twelve (12) million shares would be outstanding at a par value of P3.33 per share. Everything else will be the same.
(c) P14,000,000
EPS Before = 4,000,000
= P3.50 EPS
P14,000,000
EPS After 2-1 Split = 8,000,000
= P1.75 EPS
P14,000,000
EPS After 3-1 Split = 12,000,000
= P1.17 EPS
(e) Probably not. A stock split should not change the price-earnings ratio unless it is combined with a change in dividends
to the shareholders. Generally speaking, nothing of real value has taken place. Only to the limited extent that new
information content from this split increased investor’s expectations would the stock split possibly have an impact on
the P/E ratio.
Problem 10
= P5
P4,000,000
Dividends per share = 1,000,000
(b)
= P4
P4,000,000
(c) Shares reacquired = P54
= 74,074
P5,000,000
EPS = 925,926
= P5.40
(g) The (potential) appreciation in value associated with an equity share repurchase receives preferential capital gains tax
treatment whereas a cash dividend is taxed at the investor’s normal tax rate. The capital gains tax may also be deferred
until the equity share is sold.
(h) The corporation may think its shares are underpriced in the market. The purchase may stave off further decline and
perhaps even trigger a rally. Reacquired shares may also be used for employee equity share options or as part of a tender
offer in a merger or an acquisition. Firms may also reacquire part of their shares as a protective device against being
taken over as a merger candidate.