Chapter14_Meyer

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Jan 9, 2024

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FINC 5307 - Meyer ASMT 14 Discussion Questions 14-2. How would each of the following changes tend to affect aggregate payout ratios (that is, the average for all corporations), other things held constant? Explain your answers. a. An increase in the personal income tax rate. Decrease – An increase in personal income tax rates would make a firm want to retain earnings. b. A liberalization of depreciation for federal income tax purposes – that is, faster tax write-offs. Increase – Cash flows would increase, making the payout ratios also increase. c. A rise in interest rates. Increase – Retained earnings would become an attractive way of raising capital for new investments but fewer projects may qualify for capital budgeting, making the payout ratio increase. d. An increase in corporate profits. Decrease – Profit increases will lead to higher dividends but not necessarily a higher payout ratio. e. A decline in investment opportunities. Increase – If investment opportunities declined, the payout ratio would increase while cash flows stayed the same. f. Permission for corporations to deduct dividends for tax purposes as they now do interest charges. Increase – Dividends would be cheaper to pay out if firms are able to deduct dividends like interest charges, which would increase the payout ratio. g. A change in the Tax Code so that both realized and unrealized capital gains in any year were taxed at the same rate as dividends. Increase – capital gains would be less wanted, so the payout ratio would increase. 1. List and briefly discuss two motivations that would lead a firm to engage in a stock repurchase versus a straight cash dividend. 2. Briefly describe the implications of the tradeoff between dividends and free cash flow retention. Problems

FINC 5307 - Meyer ASMT 14 14-3. The Wei Corporation expects next year’s net income to be $15 million. The firm is currently financed with 40% debt. Wei has $12 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual distribution model (assuming all payments are in the form of dividends), how large should Wei’s dividend payout ratio be next year? Equity financed = $12 million*(60%) = $7.2 million Dividends = Net income – Equity = $15 million - $7.2 million = $7.8 million Dividend payout ratio = D / Net income = $7.8 million / $15 million = 52% 14-4. A firm has 10 million shares outstanding with a market price of $20 per share. The firm has $25 million in extra cash (short-term investments) that it plans to use in a stock repurchase; the firm has no other financial investments or any debt. What is the firm’s value of operations, and how many shares will remain after the repurchase? V OP = (n 0 *P) – cash = (10 million*$20) - $$25 million = $175 million n = V op /P = $175 million / $20 = 8,750,000 14-5. JPix management is considering a stock split. JPix currently sells for $120 per share and a 3-for-2 stock split is contemplated. What will be the company’s stock price following the stock split, assuming that the split has no effect on the total market value of JPix’s equity? P = $120 Split = 3 for 2 P New = $120 / (3/2) = $80 14-6. Gardial GreenLights, a manufacturer of energy-efficient lighting solutions has had such success with its new products that it is planning to substantially expand its manufacturing capacity with a $15 million investment in new machinery. Gardial plans to maintain its current 30% debt-to-total-assets ratio for its capital structure and to maintain its dividend policy in which at the end of each year it distributes 55% of the year’s net income. This year’s net income was $8 million. How much external equity must Gardial seek now to expand as planned? RE = Net income(1-Payout ratio) = $8 million(1-55%) = $3.6 million Equity needed = Potential investment(1-debt ratio) = $15m(1-30%) = $10.5m EEN = $10.5m-$3.6m = $6.9 million 14-8. Fauver Enterprises declared a 3-for-1 stock split last year, and this year its dividend is $1.50 per share. This total dividend payout represents a 6% increase over last year’s pre-split total dividend payout. What was last year’s dividend per share? Pre-split Div. = $1.50(3/1) = $4.50 New Div. = Last year’s Div.(1+g) $4.50 = D 0 (1.06) Last years D = $4.25 14-12. Bayani Bakery’s most recent FCF was $48 million; the FCF is expected to grow at a constant rate of 6%. The firm’s WACC is 12%, and it has 15 million shares of common stock outstanding. The firm has $30 million in short-term investments, which it plans to liquidate and distribute to common shareholders via a stock repurchase; the

FINC 5307 - Meyer ASMT 14 firm has no other nonoperating assets. It has $368 million in debt and $60 million in preferred stock. Before After Value of Ops $848m $848m + Value of nonop. Assets 30m 0 Total intrinsic value of firm $878m $848m - Debt 368m 368m - Preferred Stock 60m 60m Intrinsic value of equity $450m $420m / # of shares 15m 14m Intrinsic stock price $30 $30 a. What is the value of operations? V op = (FCF(1+g))/(WACC-g) = ($48m(1+6%))/(12%-6%) = $848,000,000 b. Immediately prior to the repurchase, what is the intrinsic value of equity? $450 million c. Immediately prior to the repurchase, what is the intrinsic stock price? $30 d. How many shares will be repurchased? How many shares will remain after the repurchase? 1 million shares repurchased; 14 million remain e. Immediately after the repurchase, what is the intrinsic value of equity? The intrinsic stock price? $420 million;$30

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