FINS1613 Lecture Notes - Lecture 4: Dividend, Dividend Yield, Risk Premium

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22 Jul 2018

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A security sold by corporations to raise money from investors today in exchange for expected future payments. The holder of equity shares receives dividend payments. These dividend payments are not guaranteed and may change over time. Failure to make dividend payments to ordinary shares does not trigger any legal procedure. Equity financing includes ordinary shares (common stock) and preference shares (preferred stock). A final payment at the market price on the stock exchange. The market price is not known with certainty before sale. The total (cid:396)etu(cid:396)(cid:374) f(cid:396)o(cid:373) e(cid:395)uit(cid:455) o(cid:449)(cid:374)e(cid:396)ship is ofte(cid:374) sepa(cid:396)ated i(cid:374)to t(cid:449)o disti(cid:374)(cid:272)t (cid:272)o(cid:373)po(cid:374)e(cid:374)ts: The e(cid:454)pe(cid:272)ted di(cid:448)ide(cid:374)d of a sha(cid:396)e di(cid:448)ided (cid:271)(cid:455) its (cid:272)u(cid:396)(cid:396)e(cid:374)t p(cid:396)i(cid:272)e. usuall(cid:455) e(cid:454)p(cid:396)essed as e(cid:454)pe(cid:272)ted annual di(cid:448)ide(cid:374)d (cid:455)ield. The (cid:272)ha(cid:374)ge i(cid:374) sto(cid:272)k p(cid:396)i(cid:272)e, capital gain, as a pe(cid:396)(cid:272)e(cid:374)t of i(cid:374)itial p(cid:396)i(cid:272)e. *historical cash flows are known, but cannot be used to value shares. Expected future cash flows must be forecasted for valuation.

Related Questions

Harris Corp has 4 million outstanding common shares, and paid $2.15 per share in dividends last year. The current share price is $28. For the past 6 years the company has maintained a policy of paying out 65% of earnings as cash dividends. Exhibit below contains the projected balance sheet for Harris Corp for the upcoming year end, assuming no dividends. Earnings after tax are projected at $14,153,846.15.

a). If Harris Corp maintains its steady 65% cash dividend payout policy, what will be the total cash dividend payout and the total debt-to-equity ratio following the payout. What dividend payment will a holder of 300 common shares receive? Show your calculations.

b). Suppose that Harris Corp retains all its cash in order to finance the purchase of a large piece of land that will be used for future development of a new production centre. Instead of a cash dividend, a 30% stock dividend will be paid. Assess the impact of a stock dividend as follows:

i). What will the holder of 300 common shares receive?

ii). How will the balance sheet change, given the stock dividend, and what will the total debt-to-equity ratio be if earnings are projected to be unchanged after the land purchase?

iii). What can this same shareholder expect to receive in cash dividends next year if Harris returns to its steady 65% cash dividend payout policy?

c). Suppose that Harris has no investment plans and would like to payout 65% of its earnings to shareholders in the form of a share repurchase this year, and then will return to its policy of paying cash dividends in its future years. Earnings are projected to be unchanged. Assess the impact of a share repurchase as follows:

i). Calculate the number of shares Harris can repurchase if the share price remains at $28.

ii). Calculate the number of shares that will remain outstanding.

iii). In the next year, when the cash dividends are resumed, Calculate the per-share dividend and amount of dividends to be received by the former owner of 300 shares.

d). Referring to your analysis in part a) to c) briefly explain which of the three policies would be most attractive to shareholders.

Projected Balance Sheet Harris Corp.

Assets

Current Assets

Cash

18,000,000

Accounts Receivable

2,400,000

Inventory

9,230,000

29,630,000

PPE

6,240,000

Land

6,000,000

41,870,000

Liabilities and Shareholdersâ Equity

Current Liabilities

Accounts Payable

1,870,000

Notes Payable

2,000,000

3,870,000

Long Term Debt

9,000,000

Common Shares

4,000,000

Retained Earnings

25,000,000

$41,870,000

c14

Stock in Dragula Industries has a beta of 1.6. The market risk premium is 6 percent, and T-bills are currently yielding 5.50 percent. The companyâs most recent dividend was $1.90 per share, and dividends are expected to grow at a 7.0 percent annual rate indefinitely.

If the stock sells for $38 per share, what is your best estimate of the companyâs cost of equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Cost of equity

You are given the following information for Lightning Power Co. Assume the companyâs tax rate is 30 percent.

Debt:	6,000 7.9 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 108 percent of par; the bonds make semiannual payments.

Common stock:	510,000 shares outstanding, selling for $69 per share; the beta is 1.12.

Preferred stock:	29,000 shares of 4 percent preferred stock outstanding, currently selling for $89 per share.

Market:	10 percent market risk premium and 5.90 percent risk-free rate.

What is the company's WACC? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

WACC

Scanlin, Inc., is considering a project that will result in initial aftertax cash savings of $1.84 million at the end of the first year, and these savings will grow at a rate of 1 percent per year indefinitely. The firm has a target debtâequity ratio of 0.75, a cost of equity of 12.4 percent, and an aftertax cost of debt of 5.2 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of 3 percent to the cost of capital for such risky projects.

What is the maximum initial cost the company would be willing to pay for the project? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.)

Maximum cost

Berta Industries stock has a beta of 1.25. The company just paid a dividend of $0.40, and the dividends are expected to grow at 5 percent. The expected return on the market is 12 percent, and Treasury bills are yielding 6.4 percent. The most recent stock price for Berta is $81.

a.	Calculate the cost of equity using the DCF method. (Round your answer to 2 decimal places. (e.g., 32.16))

DCF method

b.	Calculate the cost of equity using the SML method. (Round your answer to 2 decimal places. (e.g., 32.16))

SML method

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Total Current Asset Current Ratio Effect on Net Income

a		Cash is acquired through issuance of additional common stock		____		____		____
b	Merchandise is sold for cash		____		____		____
c	Federal income tax due for the previous year is paid		____		____		____
d	A fixed asset is sold for less than book value		____		____		____
e	A fixed asset is sold for more than book value		____		____		____
f	Merchandise is sold on credit		____		____		____
g	Payment is made to trade creditors for previous purchases		____		____		____
h	A cash dividend is declared and paid		____		____		____
I	Cash is obtained through short- term bank loans		____		____		____
J	Short- term notes receivable are sold at a discount		____		____		____
k	Marketable securities are sold below cost		____		____		____
L	Advances are made to employees		____		____		____
m	Current operating expenses are paid		____		____		____
n	Short- term promissory notes are issued to trade creditors in exchange for past due accounts payable		____		____		____
o	10- year notes are issued to pay off accounts payable		____		____		____
p	A fully depreciated asset is retired		____		____		____

4 DEBT RATIO- Bartley Barstools has an equity multiplier of 2.4, and its assets are financed with some combination of long-term debt and common equity. What is its equity ratio? What is its debt ratio?

6 MARKET/BOOK RATIO- Jaster Jets has $10 billion in total assets. Its balance sheet shows $1 billion in current liabilities, $3 billion in long-term debt and $6 billion in common equity. It has 800 million shares of common stock outstanding, and its stock price is $32 per share. What is Jaster

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FINS1613 Lecture Notes - Lecture 4: Dividend, Dividend Yield, Risk Premium

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