Principles of Finance I week 6 Assignment

Principles of Finance I week 6 Assignment

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Principles of Finance I week 6 Assignment

14-3. What is the difference between a stock dividend and a stock spilt? As a stockholder, would you prefer to see your company declare a 100% stock dividend or 2-for-1 spilt? Assume that either action is feasible.

A stock dividend occurs when a company decides to retain any money so they can reinvest for purposes of growth in the business whereas a stock spilt occurs when the stock of the company is higher than the usual price range of their stock. According to L Altfest , (2016) a company usually use split to regulate the prices of the stock to the preferred range.

14-4. One position expressed in the financial literature is that firms set their dividends as a residual policy implies (assuming that all distributions are in the form of dividends), illustrating your answer with a table showing how different investment opportunities could lead to different dividend payout ratios.

The money usually gotten from the residual policy, is usually placed back into the business and reinvested for purposes of growth. (Ram Brooks, S Titman, 2011)The money that remains after reinvesting into the company is used in dividends. The table below shows different companies and their dividend payout ratios

14-5. Indicate whether the following statements are true or false. If the statement is false, explain why.

This statement is true. A company that decides to resell its stock are able to capital gain taxes.

• If a firm repurchases its stock in the open market, the shareholders who tender the stock are subject to capital gains taxes.

It is a true statement. After a 2-for-1 split, a person owning 100 shares will earn 200.

• If you own 100 shares in a company’s stock and the company’s stock splits 2-for-1, then you will own 200 shares in the company following the spilt.

The statement is true. There will be an increase in the amount of equity that can be available to the company.

• Some dividend reinvestment plans increase the amount of equity capital available to the firm.

The statement is false. The tax code usually encourages the companies to use the loan and pay the shareholders or investors the interest they get and not in form of dividends because they are not taxed (SF LeRoy, J Werner, 2014). The tax code also emphasize investors to invest in a company that usually reinvest their earning compared to those that pay very high costs of dividends.

• The tax code encourages companies to pay a large percentage of their net income in the form of dividends.

The statement is true. When a company’s clientele opt for large dividends, the company can get used to a residual dividend policy, which means that there will be a very low or zero dividends for a duration of time which will not be good for the company.

• A company that has established a clientele of investors who prefer large dividends is unlikely to adopt a residual dividend policy.

The statement is false. When a firm follows a residual dividend policy, holding all else constant, the firm’s investment potential will be higher because the dividend payout will be rejected (DN Hyman, 2014).

• If a firm follows a residual dividend policy then, holding all else constant, it’s dividend payout will tend to rise whenever the firm’s investment opportunities improve.

15-1. Shapland Inc. has fixed operating costs of $500,000 and variable costs of $50 per unit. If it sells the product for $75 per unit, what is the break even quantity?

Break even quantity = Fixed costs

Unit contribution margin

Fixed costs= $500,000

Unit cost margin = ( $75 – $50)

= $25

Break event quantity = ($500,000)/($25)

= 20,000

15-2. Counts Accounting’s beta is 1.15 and its tax rate is 40%. If it is financed with 20% debt, what is its unleavened beta?

Unlevered beta= (1.15/(1+((1-tax rate)) * (debt / equity)))

Equity = (100%-20%)

=80%

Therefore,

unlevered beta= 1.15/(1+((1-40%)) * (20% / 80%)))

= 1.15/1+((1-0.4)) * (0.2/0.8)))

=1.15/(1+(0.6) * (0.25))

=1.15/(1+0.15)

=1.15/1.15

Therefore, unlevered beta=1

15-3. Ethier enterprise has an unlevered beta of 1.0. Ether is financed with 50% debt and has a levers beta of 1.6. If the risk-free rate is 5.5% and the market risk premium is 6%, how much is the additional premium that Ethier’s shareholders require to be compensated for financial risk?

Return without debt=5.5% + 1.0(6%)

=5.5% + 6%

=11.5%

Return with debt= 5.5% + 1.6(6%)

=5.5% + 9.6%

=15.1%

Thus the additional premium =(return with debt – return without debt)

=(15.1% -11.5%)

=3.6%

15-4. Nichols corporation’s value of operations is equal to $500 million after a recapitalization (the firm had no debt before the recap). It raised $200 million in new debt and used this to buy back stock. Lee had no short-term investments before or after the recap. After the recap, wd = 40%. What is S ( the value of equity after the recap).

Spost = Voperationnew(1-Wd)

=$500,000,000 * (1- 40%)

=$500,000,000 * ( 1 – 0.4)

=$500,000,000 * 0.6

=$300,000,000

15-5. Lee Manufacturing’s value of operations is equal to $900 million after a recapitalization (the firm has no debt before the recap). Lee raised $300 million in new debt and used this to buy back stock. Lee had no short term investments before or after the recap. After the recap, wd = 1/3. The firm had 30 million shares before the recap. What is P (the stock price after the recap)?

Ppost = Vopnew – Dold

Nprior

= 900,000,000 – 300,000,000

30,000,000

=$600,000,000

$30,000,000

Stock price after recap=20/share

Reference

SF LeRoy, J Werner, (2014), Principles of financial economics

DN Hyman, (2014), Public Finance,A contemporary application of theory to policy

Ram Brooks, S Titman, (2011), Financial Management

L Altfest , (2016), Personal Financial planning