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# Dividend Hypothesis/Theory

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Phil Grange, the CEO of Haveloche Corporation, has been asked to be a guest lecturer at Cokesbury College. One of the finance professors has specifically requested a discussion on Haveloche's dividend policy. In preparation, Phil has reviewed several textbooks that Dr. Roche, the professor, has provided, and has printed out the history of dividends for the nine years that Haveloche Corporation has been publicly traded.
The case addresses the presence of data that does not seem to correlate with any particular dividend policy hypothesis (except for irrelevance, perhaps). The student is asked to graphically analyze the price data. Astute readers will understand that dividends are not the only element at work on the firm's stock price. The case highlights the difficulty of determining an optimal policy since other factors cannot be held constant while dividends are manipulated in the current point in time, and that even if that were possible, the variety of opinions and hypotheses surrounding dividend policy does not indicate any concrete conclusion as to what is an ideal policy.

1. Enter the data from tables 1 and 2 into a spreadsheet program. Graph a scatter plot of the dividend with the stock price. Does there appear to be a correlation?

2. Plot the change in price (from t-1 to t+1) with the dividend amount. Does there appear to be a correlation? Plot the change in price with the year to year change in the dividend. Does there appear to be a correlation?

3. Summarize the implications of each dividend hypothesis/theory found in your financial management textbooks. Which one explains what is going on with Haveloche?

4. What would you suggest to Phil concerning what type of dividend policy to pursue? Justify your answer.

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#### Solution Preview

QUESTIONS FROM THE CASE

1. Enter the data from tables 1 and 2 into a spreadsheet program. Graph a scatter plot of the dividend with the stock price. Does there appear to be a correlation?

Students will find that no correlation is obvious from the scatter plot. The resulting graph appears below: Price\$0.00\$10.00\$20.00\$30.00\$40.00\$50.00\$60.00\$70.00\$80.00\$90.00\$0.00\$0.50\$1.00\$1.50\$2.00\$2.50\$3.00

2. Plot the change in price (from t-1 to t+1) with the dividend amount. Does there appear to be a correlation? Plot the change in price with the year to year change in the dividend. Does there appear to be a correlation?

Students will find that there is little correlation between the dividend level and the price change. The resulting graph appears below: ...

\$2.19

## Finance: Lease Agreement and Capital Budgeting

At the beginning of its accounting year Alice plc leases a machine from Louise Leasing plc. The following information relates to the lease agreement:
1. The term of the lease is 5 years, and the lease agreement is non-cancellable, requiring equal rental payments of £9,276 at the beginning of each year;
2. The machine has a fair value at the inception of the lease of £40,000, an estimated economic life of 5 years, and no residual value;
3. Alice plc's incremental borrowing rate is 10% per year;
4. Alice plc depreciates similar equipment that it owns on a straight-line basis;
5. Louise Leasing plc has set the annual rental to earn a rate of return on its investment of 8% per year; this fact is known to Alice plc.

Required:

(a) Should the above lease agreement be accounted for as a finance or an operating lease? Give reasons to justify your answer.

(b) Prepare the journal entries for Alice plc that relate to the above lease agreement during years 1 and 2 for each of the following assumptions:

(i) The lease is classified as a finance lease;

The actuarial method should be used to allocate finance charges to accounting periods during the lease term.

(ii) The lease is classified as an operating lease.

(c) With reference to (b) discuss the extent to which the distinction between a finance lease and an operating lease is important for financial reporting and analysis.

2-a) Describe the factors that should be taken into consideration by firms when forming their capital structure.

2-b) Describe the "Efficient Market Hypothesis" (EMH). Explain how the "Efficient Market Hypothesis" is used to explain the stock market behaviour.

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