# Dividend Valuation Model, Convertibles, Warrants

Dividends, Retain Earnings, Yield

1. Springsteen Music Company earned $820 million last year and paid out 20 percent of earnings in dividends.

By how much did the company's retained earnings increase?

With 100 million shares outstanding and a stock price of $50, what was the dividend yield? (Hint: First compute dividends per share.)

Dividend Yield

2. The shares of the Dyer Drilling Co. sell for $60. The firm has a P/E ratio of 15. Forty percent of earnings are paid out in dividends. What is the firm's dividend yield?

Dividend yield: Annual percentage of return earned by an investor on a common or preferred stock. The yield is determined by dividing the amount of the dividends per share by the current market price per share of the stock.

P/E ratio is 15 which means that earnings are 1/15 = 6.67% of the price.

Forty percent of earnings are paid out in dividends which means that the dividend yield is 40%*6.67% = 2.68% (I Think this is Correct)

Dividend Valuation Model and Wealth Maximization

3. Eastern Telecom is trying to decide whether to increase its cash dividend immediately or use the funds to increase its future growth rate. It will use the dividend valuation model originally presented in Chapter 10 for purposes of analysis. The model was shown as Formula 10-9 and is reproduced below (with a slight addition in definition of terms).

4. D0 is currently $3.00, Ke is 10 percent, and g is 5 percent.

Under Plan A, D0 would be immediately increased to $3.40 and Ke and g will remain unchanged.

Under Plan B, D0 will remain at $3.00 but g will go up to 6 percent and Ke will remain unchanged.

a) Compute P0 (price of the stock today) under Plan A. Note D1 will be equal to D0 - (1 + g) or $3.40 (1.05). Ke will equal 10 percent and g will equal 5 percent.

b) Compute P0 (price of the stock today) under Plan B. Note D1 will be equal to D0 - (1 + g) or $3.00 (1.06). Ke will be equal to 10 percent and g will be equal to 6 percent.

c) Which plan will produce the higher value?

Convertible Bond and Rates of return

5. Laser Electronics Company has $30 million in 8 percent convertible bonds outstanding. The conversion ratio is 50; the stock price is $17; and the bond matures in 15 years. The bonds are currently selling at a conversion premium of $60 over their conversion value.

If the price of the common stock rises to $23 on this date next year, what would your rate of return be if you bought a convertible bond today and sold it in one year? Assume on this date next year, the conversion premium has shrunk from $60 to $10.

Price Appreciation with a Warrant

Assume you can buy a warrant for $5 that gives you the option to buy one share of common stock at $14 per share. The stock is currently selling at $16 per share.

a. What is the intrinsic value of the warrant?

b. What is the speculative premium on the warrant?

c. If the stock rises to $24 per share and the warrant sells at its theoretical value without a premium, what will be the percentage increase in the stock price and the warrant price if you bought the stock and the warrant at the prices stated above? Explain this relationship.

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#### Solution Preview

Please see the attached file for excel work.

Dividends, Retain Earnings, Yield

Springsteen Music Company earned $820 million last year and paid out 20 percent of earnings in dividends.

By how much did the company's retained earnings increase?

With 100 million shares outstanding and a stock price of $50, what was the dividend yield? (Hint: First compute dividends per share.)

Earnings= $820 million

Dividend payout ratio= 20%

Therefore retention ratio=1-Dividend payout ratio= 80%

Amount retained= Retention ratio x Earnings= $656 million = 0.8 x 820

Therefore, the company's retained earnings would increase by $656 million

Dividend = Dividend payout ratio x Earnings = $164 million = 0.2 x 820

Number of shares= 100 million

Therefore, dividend per share (DPS)= $1.64 = 164/100

Stock price= $50.00

Therefore, dividend yield = DPS / Stock price= 3.28% =1.64/50

Dividend Yield

The shares of the Dyer Drilling Co. sell for $60. The firm has a P/E ratio of 15. Forty percent of earnings are paid out in dividends. What is the firm's dividend yield?

Dividend yield: Annual percentage of return earned by an investor on a common or preferred stock. The yield is determined by dividing the amount of the dividends per share by the current market price per share of the stock.

P/E ratio is 15 which means that earnings are 1/15 = 6.67% of the price.

Forty percent of earnings are paid out in dividends which means that the dividend yield is 40%*6.67% = 2.68%

P/E= 15

P=Price= $60.00

Therefore E = EPS=Earning per share= $4.00 = 60/15

40% of EPS is paid out as dividends

Therefore DPS= Dividend per share= $1.60 = 0.4 x 4

Stock price= $60.00

Therefore, dividend yield = DPS / Stock price= 2.67% = 1.6/60

Dividend Valuation Model and Wealth ...

#### Solution Summary

The solutions provides answers to Finance Problems on Dividends, Retain Earnings, Yield, Dividend Yield, Dividend Valuation Model and Wealth Maximization, Convertible Bond and Rates of return, Price Appreciation with a Warrant