finance data bank
Lecture Five – Payout Policy
17-1. What options does a firm have to spend its free cash flow (after it has satisfied all interest obligations)?
17-2. ABC Corporation announced that it will pay a dividend to all shareholders of record as of Monday, April 3, 2006. It takes three business days of a purchase for the new owners of a share of stock to be registered.
a. When is the last day an investor can purchase ABC stock and still get the dividend payment?
b. When is the ex-dividend day?
17-3. Describe the different mechanisms available to a firm to use to repurchase shares
17-4. RFC Corp. has announced a $1 dividend. If RFC’s price last price cum-dividend is $50, what should its first ex-dividend price be (assuming perfect capital markets)?
17-5. EJH Company has a market capitalization of $1 billion and 20 million shares outstanding. It plans to distribute $100 million through an open market repurchase. Assuming perfect capital markets:
a. What will the price per share of EJH be right before the repurchase?
b. How many shares will be repurchased?
c. What will the price per share of EJH be right after the repurchase?
17-7. Natsam Corporation has $250 million of excess cash. The firm has no debt and 500 million shares outstanding with a current market price of $15 per share. Natsam’s board has decided to pay out this cash as a one-time dividend.
a. What is the ex-dividend price of a share in a perfect capital market?
b. If the board instead decided to use the cash to do a one-time share repurchase, in a perfect capital market what is the price of the shares once the repurchase is complete?
c. In a perfect capital market, which policy, in part (a) or (b), makes investors in the firm better off?
17-8. Suppose the board of Natsam Corporation decided to do the share repurchase in Problem 7(b), but you, as an investor, would have preferred to receive a dividend payment. How can you leave yourself in the same position as if the board had elected to make the dividend payment instead?
17-9. Suppose you work for Oracle Corporation, and part of your compensation takes the form of stock options. The value of the stock option is equal to the difference between Oracle’s stock price and an exercise price of $10 per share at the time that you exercise the option. As an option holder, would you prefer that Oracle use dividends or share repurchases to pay out cash to shareholders? Explain.
17-10. The HNH Corporation will pay a constant dividend of $2 per share, per year, in perpetuity. Assume all investors pay a 20% tax on dividends and that there is no capital gains tax. Suppose that other investments with equivalent risk to HNH stock offer an after-tax return of 12%.
a. What is the price of a share of HNH stock?
b. Assume that management makes a surprise announcement that HNH will no longer pay dividends but will use the cash to repurchase stock instead. What is the price of a share of HNH stock now?
17-11. Using Table 17.2, for each of the following years, state whether dividends were tax disadvantaged or not for individual investors with a one-year investment horizon:
17-12. What was the effective dividend tax rate for a U.S. investor in the highest tax bracket who planned to hold a stock for one year in 1981? How did the effective dividend tax rate change in 1982 when the Reagan tax cuts took effect? (Ignore state taxes.)
58.33% in 1981 and 37.5% in 1982
17-13. The dividend tax cut passed in 2003 lowered the effective dividend tax rate for a U.S. investor in the highest tax bracket to a historic low. During which other periods in the last 35 years was the effective dividend tax rate as low?
17-14. Suppose that all capital gains are taxed at a 25% rate, and that the dividend tax rate is 50%. Arbuckle Corp. is currently trading for $30, and is about to pay a $6 special dividend.
a. Absent any other trading frictions or news, what will its share price be just after the dividend is paid?
Suppose Arbuckle made a surprise announcement that it would do a share repurchase rather than pay a special dividend.
b. What net tax savings per share for an investor would result from this decision?
c. What would happen to Arbuckle’s stock price upon the announcement of this change?
17-15. You purchased CSH stock for $40 one year ago and it is now selling for $50. The company has announced that it plans a $10 special dividend. You are considering whether to sell the stock now, or wait to receive the dividend and then sell.
a. Assuming 2008 tax rates, what ex-dividend price of CSH will make you indifferent between selling now and waiting?
b. Suppose the capital gains tax rate is 20% and the dividend tax rate is 40%, what ex-dividend price would make you indifferent now?
17-16. On Monday, November 15, 2004, TheStreet.com reported: “An experiment in the efficiency of financial markets will play out Monday following the expiration of a $3.08 dividend privilege for holders of Microsoft.” The story went on: “The stock is currently trading ex-dividend both the special $3 payout and Microsoft’s regular $0.08 quarterly dividend, meaning a buyer doesn’t receive the money if he acquires the shares now.” Microsoft stock ultimately opened for trade at $27.34 on the ex-dividend date (November 15), down $2.63 from its previous close.
a. Assuming that this price drop resulted only from the dividend payment (no other information affected the stock price that day), what does this decline in price imply about the effective dividend tax rate for Microsoft?
b. Based on this information, which of the following investors are most likely to be the marginal investors (the ones who determine the price) in Microsoft stock:
i. Long-term individual investors?
ii. One-year individual investors?
iii. Pension funds?
17-17. At current tax rates, which of the following investors are most likely to hold a stock that has a high dividend yield:
a. Individual investors?
b. Pension funds?
c. Mutual funds?
17-18. Que Corporation pays a regular dividend of $1 per share. Typically, the stock price drops by $0.80 per share when the stock goes ex-dividend. Suppose the capital gains tax rate is 20%, but investors pay different tax rates on dividends. Absent transactions costs, what is the highest dividend tax rate of an investor who could gain from trading to capture the dividend?
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