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Dividend Policy and Cap Structures

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1. What is an event study designed to test?
2. What role does par value play in the pricing and sale of common stock by the issuing corporation? Why do most firms assign relatively low par values to their shares?
3. How does the signaling model of financial structure differ from the pecking-order model with respect to the assumption in this hypothesis of asymmetric information?
4. What is a firm's dividend yield? How does this compare to that firm's dividend payout ratio?
5. List and describe the three forms of informational efficiency. What is the implication for technical analysis under each of these forms?
6. What are some of the differences in U.S. bankruptcy laws and those in place internationally? What incentives do these differences provide for U.S. managers and for their peers in most other countries?
7. Which method would you use to evaluate an investment project that involved modernizing a firm's existing plant? The project will not affect the firm's target debt-to-equity ratio.
8. Why do firms with more-diverse shareholder bases typically pay higher dividends than private firms or public firms with more concentrated ownership structures? How are fixed dividends used as a bonding (commiment) mechanism by managers of firms with dispersed ownership structures and large amounts of free cash flow?
9. A CFO says that her firm chooses a capital structure that allows it to maintain a credit rating of AA. She reasons that a credit rating of AAA would be too conservative, but anything less than AA would be too risky. What capital structure model does this firm appear to follow?

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What is an event study designed to test?

An event study is mainly designed to examine market reactions to, and excess returns around specific information events occurring in the market, firm or economy. So we can say that the information events can be market-wide, such as macro-economic announcements, or firm-specific, such as earnings or dividend announcements.
Following are the steps through which event study is done

The event to be studied must be clearly identified, and the date on which the event was announced should be pinpointed. It should be presumed that the timing of the event is known with a fair degree of certainty. As the financial markets react to the information about an event instead of the event itself, most of the event studies are centered on the announcement date for that event.
Once the event dates are known, samples of returns are collected around these dates. Based on this two decisions are made. One is that the analyst has to decide whether to collect weekly, daily or shorter-interval returns around the event date. And the second is that the analyst has to determine how many periods of returns before and after the announcement date will be considered as part of the 'event window'.
The returns around and during the announcement date, are adjusted for market performance and risk to arrive at excess returns for each firm in the sample.
An average of the excess returns and its standard error by period across all firms in the sample is computed.
Then t-statistic test for each sample is used to answer the question of whether the excess returns around the announcement are different from zero by dividing the average excess return by the standard error

What role does par value play in the pricing and sale of common stock by the issuing corporation? Why do most firms assign relatively low par values to their shares?

Corporation generally establishes their legal capital by means of issuing par value stocks. The par value of corporation's common stock or the preferred stock is a dollar amount per share that is established in the article of incorporation and it is printed on each stock certificate. Generally corporations can set the offer price of their stock in the market above par or at discount. When the offer price of the stock is above the par value of the stock then it is said to be above par whereas if the offer price set by the corporation is less than the par value then it is said to be offered at discount. Legally it is recommended to sell the stock above par.
Generally corporations sell shares in the primary market through the IPO gateway with a price higher than the par value. The amount collected more than the pare value is called the additional paid in capital.
Most firm assign relatively low par values to reach to maximum number of investors waiting to invest in the capital market. A higher par value would keep a large number of small investors away from investing in the market. Apart from this argument it is also considered that corporations sell stock at low par value because in the market shares usually sold at much higher price and in that situation the legal capital for the firm is just a small portion of the that price.

How does the signaling model of financial structure differ from the pecking-order model with respect ...

Solution Summary

The dividend policy and cap structures are examined. How the signaling models of financial structure differs from the pecking-rder model with respect to the assumption in this hypothesis of asymmetric information is determined.

Similar Posting

Capital Structure, Dividend Policy and Comparing Borrowing Costs

1. (Capital Structure) Sanderson Manufacturing Company would like to achieve a capital structure consistent with a Baa2/BBB senior debt rating. Sanderson has identified six comparable firms and calculated the credit statistics shown here.

a. Sanderson's return on assets is 5.3%. It has a total capitalization of $600 million. What are reasonable targets for long-term debt/cap, funds from operations/LT debt, and fixed charge coverage?

b. Are there any firms among the six who are particularly good or bad comparables? Explain.

c. Suppose Sanderson's current ratio of long-term debt to total cap is 60% but its fixed charge coverage is 3.00. What would you recommend?

Senior debt rating Baa2/BBB Baa3/BBB- Baa2/BBB Baa1/A- Baa1/BBB- Baa2/BBB+
Return on assets 5.20% 5.00% 5.40% 5.70% 5.20% 5.30%
Long-term debt/cap 38% 41% 45% 40% 25% 43%
Total cap ($MM) 425 575 525 650 210 375
Funds from
operations/LT debt 39% 43% 28% 46% 57% 43%
Fixed charge cov 2.57 2.83 2.75 2.38 3.59 2.15

2. (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firm's chief financial officer would like the firm to distribute 25% of its annual earnings (POR = 0.25) and adjust the dividend rate to changes in earnings per share at the rate ADJ = 0.75. Regional paid $1.00 per share in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable future. Use the dividend adjustment model, Equation (18.1), to calculate projected dividends per share for this year and the next four.

3. (Dividend Policy) A firm has 20 million common shares outstanding. It currently pays out $1.50 per share per year in cash dividends on its common stock. Historically, its payout ratio has ranged from 30% to 35%. Over the next five years it expects the earnings and discretionary cash flow shown below in millions.

a. Over the five-year period, what is the maximum overall payout ratio the firm could achieve without triggering a securities issue?

b. Recommend a reasonable dividend policy for paying out discretionary cash flow in years 1 through 5.

1 2 3 4 5 THEREAFTER
Earnings 100 125 150 120 140 150+ per year
Discretionary cash flow 50 70 60 20 15 50+ per year

4. (Comparing Borrowing Costs) Stephens Security has two financing alternatives: (1) A publicly placed $50 million bond issue. Issuance costs are $1 million, the bond has a 9% coupon paid semiannually, and the bond has a 20-year life. (2) A $50 million private placement with a large pension fund. Issuance costs are $500,000, the bond has a 9.25% annual
coupon, and the bond has a 20-year life. Which alternative has the lower cost (annual percentage yield)?

5. (Leasing, taxes, and the time value of money) The lessor can claim the tax deductions associated with asset ownership and realize the leased asset's residual value. In return, the lessor must pay tax on the rental income.

a. Explain why a financial lease represents a secured loan in which the lender's entire debt service stream is taxable as ordinary income to the lessor/lender.

b. In view of this tax cost, what tax condition must hold in order for a financial lease transaction to generate positive net-present-value tax benefits for both the lessor and lessee?

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