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    Problems on Dividend Policy

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    Problem One:
    The Percolator Company has the following capital structure:
    Common stock ($5 par, 250,000 shares) $1,250,000
    Contributed capital in excess of par $5,000,000
    Retained earnings $4,000,000

    The company declares a 10 percent stock dividend. The pre-stock dividend market price of the company's stock is $50.
    (a). Determine the balance in the retained earnings account after the stock dividend.
    (b). Determine the balance in the common stock account after the stock dividend.

    Problem Two:
    Sharpe Manufacturing traditionally pays an annual dividend equal to 50 percent of its earnings. Earnings this year are $35,000,000. The company has 17.5 million shares outstanding. Investors expect earnings to grow at a 6 percent annual rate in perpetuity, and they require a return of 11% percent on their shares.
    (a). What is Sharpe Manufacturing's current dividend per share? What is it expected to be next year?
    (b). Use the Gordon Growth Model (see Equation 5.4) to calculate Sharpe's stock price today.

    Problem Three:
    (a). Cycle Out Company has 100,000 shares outstanding and plans to pay $1.00 per share in dividends each quarter next year. Cycle Out has a capital budget of $700,000 for next year and plans to maintain its present debt ratio of 0.30. If earnings are expected to be $7.00 per share, how much external equity Cycle Out Company must raise?
    (b). The Wagner Company tries to follow a pure "residual" dividend policy. Earnings and dividends last year were $100 million and $20 million respectively. Anticipated earnings for this year are $80 million. The company is financed completely with common equity. The required rate of return on retained earnings is 15 percent while the cost of new equity is 16 percent. If Wagner has $90 million of investment projects having expected returns greater than 16 percent, determine Wagner's dividend and investment policies.

    Problem Four:
    Belton Company earned $2.50 per share during fiscal year 2008 and paid cash dividends of $1.00 per share. During the fiscal year that just ended on December 31, 2009, Belton earned $3.00 per share, and the firm's managers expect to earn this amount per share during fiscal years 2010 and 2011 as well.
    (a). What was Belton's payout ratio for fiscal year 2008?
    (b). If Belton's managers wish to follow a constant nominal dividend policy, what dividend per share will they declare for fiscal year 2009?
    (c). If Belton's managers wish to follow a constant payout ratio dividend policy, what dividend per share will they declare for fiscal year 2010?

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    Solution Preview

    Also see the attached file.

    Problem One:
    The Percolator Company has the following capital structure:
    Common stock ($5 par, 250,000 shares) $1,250,000
    Contributed capital in excess of par $5,000,000
    Retained earnings $4,000,000

    The company declares a 10 percent stock dividend. The pre-stock dividend market price of the company's stock is $50.
    (a). Determine the balance in the retained earnings account after the stock dividend.
    No of new shares issued = 250000*10%=25000
    Value of new shares = 25000*$50=$1,250,000
    Balance in the retained earnings after the stock dividend = $4,000,000-$1,250,000=$2,750,000

    (b). Determine the balance in the common stock account after the stock dividend.
    No of new shares issued = 250000*10%=25000
    Par value of new shares = 25000*$10=$250,000
    Balance in the common stock account after the stock dividend = $1,250,000+$250,000=$1,500,000

     
    Problem Two:
    Sharpe Manufacturing traditionally pays an annual dividend equal to 50 percent of its earnings. Earnings this year are $35,000,000. The company has 17.5 million shares outstanding. Investors expect earnings to grow at a 6 percent annual rate in perpetuity, and they require a return of 11% percent on their ...

    Solution Summary

    Practice set of four problems to understand how to solve problems related to dividend policy.

    $2.19

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