Corporate and International Finance (N1563)
Seminar 8
SHORT ANSWER
Q1. Describe (a) Miller and Modigliani (1961) approach to dividend policy and (b) dividend relevance theory.
Q2. UJ Gas is a utility that has followed a policy of increasing dividends every quarter by 5% over dividends in the prior year. The company announces that it will increase quarterly dividends from $1.00 to $1.02 next quarter. What price reaction would you expect to the announcement? Why?
Q3. Linkedin Corporation, which has had a history of high growth and pays no dividends, announces that it will start paying dividends next quarter. How would you expect its stock price to react to the announcement? Why?
Q4. JC Automobiles is a small auto parts manufacturing firm that has paid $1.00 in annual dividends each year for the past five years. It announces that dividends will increase to $1.25 next year. What would you expect the price reaction to be? Why? If your answer is different from the previous problem, explain the reasons for the difference.
Q5. WeeMart, a retailer of children’s clothes, announces a cut in dividends following a year in which both revenues and earnings dropped significantly. How would you expect its stock price to react? Explain.
Q6. RJR Nabisco, in response to stockholder pressure in 1996, announced a significant increase in dividends paid to stockholders financed by the sale of some of its assets. What would you expect the stock price to do? Why?
Let’s assume that RJR Nabisco also had $10 billion in bonds outstanding at the time of the dividend increase. How would you expect the bonds to react to the announcement? Why?
Q7. Surf & Turf Hotels is a mature business, although it pays no cash dividends. Next year’s earnings are forecast at $56 million. There are 10 million outstanding shares. The company has traditionally used 50% of earnings to repurchase shares of stock and has reinvested the remaining earnings. With reinvestment, the company has generated steady growth averaging 5% per year. Assume the cost of equity is 12%.
a. Calculate Surf & Turf’s current stock price, using the constant-growth DCF model. (Hint: Take the easy route and start by calculating the total value of outstanding equity.)
b. Now Surf & Turf’s CFO announces a switch from repurchases to a regular cash dividend. Next year’s dividend will be $2.80 per share. The CFO reassures investors that the company will continue to pay out 50% of earnings and reinvest 50%. All future payouts will come as dividends, however. What would you expect to happen to Surf & Turf’s stock price? Ignore taxes.
MULTIPLE CHOICE
Q8. A stock goes ex-dividend:
A. two business days prior to the record date.
B. two business days after the declaration date.
C. three business days after the record date.
D. three business days prior to the payment date.
Q9. What would you expect to happen to the price of a share of stock on the day it goes ex-dividend if you ignore taxes? The price should:
A. increase by the amount of the dividend.
B. decrease by the amount of the dividend.
C. decrease by one-half the amount of the dividend.
D. remain constant.
Q10. Boards of directors may be legally restricted in their declaration of dividends if:
A. cash must be borrowed for the dividend payment.
B. dividends have increased substantially over a short period of time.
C. the dividend would create a situation of insolvency.
D. the stock is selling at a low relative price.