Week 12 Solutions

2. The written agreement between a corporation and its bondholders might contain a prohibition against paying dividends in excess of current earnings. This prohibition is an example of a(n):

When a company decides to pay dividends, it has to be careful on how much it will be given to the shareholders. It is of no use to pay shareholders dividends

-Martin Industries just paid an annual dividend of $1.30 a share. The market price of the stock is $36.80 and the growth rate is 6.0 percent. What is the firm's cost of equity?

a) How many shares will the firm have to issue, assuming they issue the new shares at the current price per share?

4) The firm will pay the dividend to all shareholders of record on a specific date, set by the board, called the ________ date.

The number of shares outstanding will remain the same and thus, the only change in the equity side of the balance sheets for the next three years will be the change in the amount of retained earnings. This change will be equal to the net income of the company for last year because the company will not pay a dividend.

Generally, firms can choose among various capital structures in order to maximize overall market value of the company. It is proposed however, that

Because often dividends are perceived as spendable income (some stock holders look at stocks as a source of income as it is easier to get a dividend instead of selling the stocks). Sometimes investment opportunities are low, they reach the limit of their marketplace, so companies decides to distribute cash in the form of dividends. For some companies it is a way of showing that the company is stable financially and can fulfill the commitment of paying out a dividend. Also it is a way for companies to mitigate agency problems when they have excess cash.

a. What are Q’s EPS and dividends next year? How will EPS and dividends grow in years 2, 3, 4, and 5 and subsequent years?

* Please choose either the CAPM estimate or the DDM estimate for cost of equity based on your answer to Question 3.

It is also important to note that these assumptions are untenable in the real world and if violated may lead to the relevance of dividend policy not because dividends are preferred.

When a company generates a profit, management has one of two choices: They can either pay it out to shareholders as a cash dividend, or retain the earnings and reinvest them in the business.

In practice, dividend policy will be affected by taxes as tax rates for different categories of investors will differ. Also, a firm’s dividend policy is perceived by the financial markets to be a signaling mechanism. A cut back in dividends may signify that the firm perceives tough

The dividend policy has grown over the years. This may be so that the company projects itself as a less risky share and thus also gaining investors faith. The investors buy its shares and thus increase its demand. This helps to gives positive signals to the investors signalling that the company is stable and can generate earnings steadily. This hypothesis is gains standing from the dividend hypothesis theory.

The first objection is related to the fact that this is a totally new approach concerning dividend policy, and nobody can predict what is going to happen. We consider that this may have positive effects on share prices, especially taking in consideration that it will stabilise the market price of the company.