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Various Dividends, Stock Repurchase and Policy Questions

1. Millman Electronics will produce 60,000 stereos next year. Variable costs will equal 50% of sales, while fixed costs will total $120,000. At what price must each stereo be sold for the company to achieve an EBIT of $95,000?
$6.57
$6.87
$7.17
$7.47
$7.77

2. Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?
1.25%
1.91%
2.23%
2.64%
2.86%

3. The firm's target capital structure is consistent with which of the following?

Maximum earnings per share (EPS).
Minimum cost of debt (rd).
Highest bond rating.
Minimum cost of equity (rs).
Minimum weighted average cost of capital (WACC).

4. Jones Co. currently is 100% equity financed. The company is considering changing its capital structure. More specifically, Jones' CFO is considering a recapitalization plan in which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company's total assets nor would it affect the company's basic earning power, which is currently 15%. The CFO estimates that the recapitalization will reduce the company's WACC and increase its stock price. Which of the following is also likely to occur if the company goes ahead with the planned recapitalization?
The company's net income will increase.
The company's earnings per share will decrease.
The company's cost of equity will increase.
The company's ROA will increase.
The company's ROE will decrease.

5. Fletcher Corp. has a capital budget of $1,000,000, but it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts this year's net income to be $600,000. If the company follows a residual dividend policy, what will be its dividend paid?
$120,000
$140,000
$160,000
$180,000
$200,000

Prior to the split, its stock price was $90 per share. The firm's total market value was unchanged by the split. What was the price of the company's stock following the stock split?
$ 45.00
$ 50.00
$ 60.00
$ 90.00
$135.00

7. Which of the following should not influence a firm's dividend policy decision?

The firm's ability to accelerate or delay investment projects.
A strong preference by most shareholders in the economy for current cash income versus capital gains.
Constraints imposed by the firm's bond indenture.
The fact that much of the firm's equipment has been leased rather than bought and owned.
The fact that Congress is considering tax law changes regarding the taxation of dividends versus capital gains.

8. Howard Contracting recently completed a 3-for-1 stock split. Prior to the split, its stock price was $150 per share. The firm's total market value was unchanged by the split. What was the price of the company's stock following the stock split?
$ 50.00
$ 60.00
$ 90.00
$120.00
$150.00

9. Nistelroy Communications recently completed a 3-for-1 stock split. Prior to the split, its stock price was $120 per share. The firm's total market value increased by 5% as a result of the split. What was the price of the company's stock following the stock split? 4)
$33.00
$40.00
$42.00
$46.00
$50.00

10. Young Enterprises has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. The firm also has a debt-to-assets ratio of 50% and pays 12% interest on its debt. What is Young's ROE?
16.80%
17.10%
17.40%
17.70%
18.00%

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Solution Preview

Please find the workings and answers.

1. Millman Electronics will produce 60,000 stereos next year. Variable costs will equal 50% of sales, while fixed costs will total $120,000. At what price must each stereo be sold for the company to achieve an EBIT of $95,000?
$6.57
$6.87
$7.17
$7.47
$7.77

EBIT = PQ - VQ - F
$95,000 = P*60,000 - .5P * 60,000 - $120000
$215,000 = 60,000P - 30,000P
$215,000 = 30,000P
P = $7.17

2. Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?
1.25%
1.91%
2.23%
2.64%
2.86%

First we need to calculate the NI of the two firms:
Firm A: $400,000 - ($1M * .12) = $280,000 * (1 - .40) = $168,000
Firm B: $400,000 - ($600,000 * .10) = $340,000 * (1 - .40) = $204,000
Firm A equity = $2M * .50 = $1M
Firm A ROE = $168,000 / $1M = 16.80%
Firm B equity = $2M * .70 = $1.4M
Firm B ROE = $204,000 / $1.4M = 14.57%
Difference in ROEs = 16.80% - 14.57% = 2.23%

3. The firm's target capital structure is consistent with which of the following?

Maximum earnings per share (EPS).
Minimum cost of debt (rd).
...

Solution Summary

The solution provides step-by-step answers to the various dividends, stock repurchase and policy questions.

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