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Preferred stock $100,000
Common stock (10,000 shares at $2 par) 20,000
Paid-in capital in excess of par 280,000
Retained earnings 100,000
Total stockholders™ equity $500,000

a. Show the effects on Columbia of a 5% stock dividend.
b. Show the effects of (1) a 10% and (2) a 20% stock dividend.
c. In light of your answers to parts a and b, discuss the effects of stock divi-
dends on stockholders™ equity.

12“9 Cash versus stock dividend Milwaukee Tool has the following stockholders™
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equity account. The firm™s common stock currently sells for $4 per share.

Preferred stock $ 100,000
Common stock (400,000 shares at $1 par) 400,000
Paid-in capital in excess of par 200,000
Retained earnings 320,000
Total stockholders™ equity $1,020,000

a. Show the effects on the firm of a cash dividend of $0.01, $0.05, $0.10, and
$0.20 per share.
b. Show the effects on the firm of a 1%, 5%, 10%, and 20% stock dividend.
c. Compare the effects in parts a and b. What are the significant differences
between the two methods of paying dividends?

12“10 Stock dividend”Investor Sarah Warren currently holds 400 shares of Nutri-
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Foods. The firm has 40,000 shares outstanding. The firm most recently had
earnings available for common stockholders of $80,000, and its stock has been
selling for $22 per share. The firm intends to retain its earnings and pay a 10%
stock dividend.
a. How much does the firm currently earn per share?
b. What proportion of the firm does Sarah Warren currently own?
486 PART 4 Long-Term Financial Decisions


c. What proportion of the firm will Ms. Warren own after the stock dividend?
Explain your answer.
d. At what market price would you expect the stock to sell after the stock
dividend?
e. Discuss what effect, if any, the payment of stock dividends will have on Ms.
Warren™s share of the ownership and earnings of Nutri-Foods.

12“11 Stock dividend”Investor Security Data Company has outstanding 50,000
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shares of common stock currently selling at $40 per share. The firm most
recently had earnings available for common stockholders of $120,000, but it has
decided to retain these funds and is considering either a 5% or a 10% stock divi-
dend in lieu of a cash dividend.
a. Determine the firm™s current earnings per share.
b. If Sam Waller currently owns 500 shares of the firm™s stock, determine his
proportion of ownership currently and under each of the proposed stock div-
idend plans. Explain your findings.
c. Calculate and explain the market price per share under each of the stock divi-
dend plans.
d. For each of the proposed stock dividends, calculate the earnings per share
after payment of the stock dividend.
e. What is the value of Sam Waller™s holdings under each of the plans? Explain.
f. Should Mr. Waller have any preference with respect to the proposed stock
dividends? Why or why not?

12“12 Stock split”Firm Growth Industries™ current stockholders™ equity account is as
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follows:

Preferred stock $ 400,000
Common stock (600,000 shares at $3 par) 1,800,000
Paid-in capital in excess of par 200,000
Retained earnings 800,000
Total stockholders™ equity $3,200,000

a. Indicate the change, if any, expected if the firm declares a 2-for-1
stock split.
b. Indicate the change, if any, expected if the firm declares a 1-for-11/2 reverse
stock split.
c. Indicate the change, if any, expected if the firm declares a 3-for-1
stock split.
d. Indicate the change, if any, expected if the firm declares a 6-for-1
stock split.
e. Indicate the change, if any, expected if the firm declares a 1-for-4 reverse
stock split.

12“13 Stock split versus stock dividend”Firm Mammoth Corporation is considering
LG5 LG6
a 3-for-2 stock split. It currently has the stockholders™ equity position shown.
The current stock price is $120 per share. The most recent period™s earnings
available for common stock is included in retained earnings.
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CHAPTER 12 Dividend Policy


Preferred stock $ 1,000,000
Common stock (100,000 shares at $3 par) 300,000
Paid-in capital in excess of par 1,700,000
Retained earnings 10,000,000
Total stockholders™ equity $13,000,000

a. What effects on Mammoth would result from the stock split?
b. What change in stock price would you expect to result from the stock split?
c. What is the maximum cash dividend per share that the firm could pay on
common stock before and after the stock split? (Assume that legal capital
includes all paid-in capital.)
d. Contrast your answers to parts a through c with the circumstances surround-
ing a 50% stock dividend.
e. Explain the differences between stock splits and stock dividends.

12“14 Stock repurchase The following financial data on the Bond Recording Com-
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pany are available:

Earnings available for common stockholders $800,000
Number of shares of common stock outstanding 400,000
Earnings per share ($800,000 400,000) $2
Market price per share $20
Price/earnings (P/E) ratio ($20 $2) 10

The firm is currently considering whether it should use $400,000 of its earnings
to pay cash dividends of $1 per share or to repurchase stock at $21 per share.
a. Approximately how many shares of stock can the firm repurchase at the $21-
per-share price, using the funds that would have gone to pay the cash divi-
dend?
b. Calculate the EPS after the repurchase. Explain your calculations.
c. If the stock still sells at 10 times earnings, what will the market price be after
the repurchase?
d. Compare the pre- and post-repurchase earnings per share.
e. Compare and contrast the stockholders™ positions under the dividend and
repurchase alternatives. What are the tax implications under each
alternative?


CHAPTER 12 CASE Establishing General Access Company™s
Dividend Policy and Initial Dividend

G eneral Access Company (GAC) is a fast-growing Internet access provider
that initially went public in early 1997. Its revenue growth and profitability
have steadily risen since the firm™s inception in late 1995. GAC™s growth has
been financed through the initial common stock offering, the sale of bonds in
2000, and the retention of all earnings. Because of its rapid growth in revenue
and profits, with only short-term earnings declines, GAC™s common stockholders
488 PART 4 Long-Term Financial Decisions


have been content to let the firm reinvest earnings to expand capacity to meet the
growing demand for its services. This strategy has benefited most stockholders in
terms of stock splits and capital gains. Since the company™s initial public offering
in 1997, GAC™s stock twice has been split 2-for-1. In terms of total growth, the
market price of GAC™s stock, after adjustment for stock splits, has increased by
800 percent during the seven-year period 1997“2003.
Because GAC™s rapid growth is beginning to slow, the firm™s CEO, Marilyn
McNeely, believes that its shares are becoming less attractive to investors. Ms.
McNeely has had discussions with her CFO, Bobby Joe Rook, who believes that
the firm must begin to pay cash dividends. He argues that many investors value
regular dividends and that by beginning to pay them, GAC would increase the
demand”and therefore the price”for its shares. Ms. McNeely decided that at
the next board meeting she would propose that the firm begin to pay dividends
on a regular basis.
Ms. McNeely realized that if the board approved her recommendation, it
would have to (1) establish a dividend policy and (2) set the amount of the initial
annual dividend. She had Mr. Rook prepare a summary of the firm™s annual
EPS. It is given in the following table.

Year EPS

2003 $3.70
2002 4.10
2001 3.90
2000 3.30
1999 2.20
1998 0.83
1997 0.55


Mr. Rook indicated that he expects EPS to remain within 10% (plus or minus)
of the most recent (2003) value during the next three years. His most likely esti-
mate is an annual increase of about 5%.
After much discussion, Ms. McNeely and Mr. Rook agreed that she would
recommend to the board one of the following types of dividend policies:
1. Constant-payout-ratio dividend policy
2. Regular dividend policy
3. Low-regular-and-extra dividend policy
Ms. McNeely realizes that her dividend proposal would significantly affect
future financing opportunities and costs and the firm™s share price. She also
knows that she must be sure her proposal is complete and that it fully educates
the board with regard to the long-term implications of each policy.

Required
a. Analyze each of the three dividend policies in light of GAC™s financial position.
b. Which dividend policy would you recommend? Justify your recommendation.
c. What are the key factors to consider when setting the amount of a firm™s ini-
tial annual dividend?
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CHAPTER 12 Dividend Policy


d. How should Ms. McNeely go about deciding what initial annual dividend
she will recommend to the board?
e. In view of your dividend policy recommendation in part b, how large an ini-
tial dividend would you recommend? Justify your recommendation.

WEB EXERCISE Go to the Web site www.smartmoney.com. In the column on the right under
WW Quotes & Research enter the symbol DIS; click on Stock Snapshot; and then
W
click on Go.

1. What is the name of the company?
2. What is its dividend amount? Its dividend frequency? Its dividend yield? Its
return on equity (ROE)?

Enter those data into the matrix below. Then click on the Key Ratios tab and
enter the current ROE. Enter the next stock symbol into the box on the bottom
of the page under Stock Search and then click on Submit. Complete the follow-
ing matrix in that manner.


Dividend
Symbol Company name $ Amount frequency Yield % ROE

DIS
AIT
MRK
LG
LUV
IBM
GE
BUD
PFE
INTC



3. Which of the companies have the lowest dividend yields?
4. Which of the companies have the highest dividend yields?
5. Looking at return on equity, can you draw any conclusions about the rela-
tionship between dividends and ROE?




Remember to check the book™s Web site at
www.aw.com/gitman
for additional resources, including additional Web exercises.

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