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1 Nov 2018

Assume that a firm has a steady record of paying stable dividends for years. Market analysts had expected management to increase the dividend by 7.5% in the latest quarter. However, management announced a 15% increase in the current year's dividend. The market value of the stock rose 20% on the day of the announcement. Which of the following would best explain the stock market's reaction to the announcement? Please choose from the 4 options below.

Agency theory

Dividend irrelevance theory

Residual Dividend Theory

Expectations Theory

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Please show work if possible!

The residual dividend theory suggests that dividends should be paid to stockholders first and then what is left can be reinvested by the firm.
True.
False.

An investor purchased 300 shares of ABC Inc. stock on Wednesday, December 16. ABC paid its quarterly dividend of $1.10 a share on Thursday, December 31. The record date was Friday, December 18. How much dividend income did the investor receive on December 31 from his investment in JLK stock?
$0.00
$110
$165
$330

The higher the dividend payout ratio, the more a company must rely on external financing.
True
False

Which of the following transactions will increase a corporation's retained earnings?

stock repurchase
stock split
stock dividend
none of the above

JBC Corp. declared a dividend of $2 per share, which was an increase of 25% from the prior year, yet JBC Corp. stock declined by 3% the day of the announcement. RBG Corp. declared a dividend of $2 per share, which was the same as the prior year, and its stock increased in value by 2% on the day of the announcement. These events could be most readily explained by the _________
Information effect.
Residual dividend theory.
Clientele effect.
Expectations theory.

Which one of the following is probably the best argument in favor of a reverse stock split?
to lower the current stock price to its normal trading range
to provide additional shares to all its shareholders
to avoid delisting
to increase the value of the firm

The ex-dividend date is ________ the holder of record date.
2 days before.
5 days before.
2 weeks before.
3 days after.

Edwards Enterprises currently has 145,000 shares of stock outstanding at a market price per share of $57. Today, the firm announced a 3-for-2 stock split. What will the price per share be after the split?
$19.00
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$47.20
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Books and More currently has 75,000 shares of stock outstanding, net income of $46,000, and a PE ratio of 18.7. What will the firm's PE ratio be if the firm repurchases 15,000 shares? Assume all else remains constant.
12.67
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John owns 1000 shares of stock in Zebar Corporation with a market value of $2,000. Zebar declares a 10% stock dividend. After the dividend is paid, John owns____________

1100 shares with a market value of $2,200.
1000 shares with a market value of $2,200.
1100 shares with a market value of $2,000.
1100 shares with a market value of $2,100.

scarletsea-lion205

In March 2015 the management team of Londonderry Air (LA) met to discuss a proposal to purchase five short haul aircraft at a total cost of $25 million. There was general enthusiasm for the investment, and the new aircraft were expected to generate an annual cash flow of $4 million for 20 years.

The focus of the meeting was on how to finance the purchase. LA had $20 million in cash and marketable securities (see table), but Ed Johnson, the chief financial officer, pointed out that the company needed at least $10 million in cash to meet normal outflow and as a contingency reserve. This meant that there would be a cash deficiency of $15 million, which the firm would need to cover either by the sale of common stock or by additional borrowing. While admitting that the arguments were finely balanced, Mr. Johnson recommended an issue of stock. He pointed out that the airline industry was subject to wide swings in profits and the firm should be careful to avoid the risk of excessive borrowing. He estimated that in market value terms the long-term debt ratio was about 59% and that a further debt issue would raise the ratio to 62%.

Mr. Johnson's only doubt about making a stock issue was that investors might jump to the conclusion that management believed the stock was overpriced, in which case the announcement might prompt an unjustified selloff by investors. He stressed therefore that the company needed to explain carefully the reasons for the issue. Also, he suggested that demand for the issue would be enhanced if at the same time LA increased its dividend payment. This would provide a tangible indication of management's confidence in the future.

These arguments cut little ice with LA's chief executive. "Ed," she said, "I know that you're the expert on all this, but everything you say flies in the face of common sense. Why should we want to sell more equity when our stock has fallen over the past year by nearly a fifth? Our stock is currently offering a dividend yield of 6.5%, which makes equity an expensive source of capital. Increasing the dividend would simply make it more expensive. What's more, I don't see the point of paying out more money to the stockholders at the same time that we are asking them for cash. If we hike the dividend, we will need to increase the amount of the stock issue; so we will just be paying the higher dividend out of the shareholders' own pockets. You're also ignoring the question of dilution. Our equity currently has a book value of $12 a share; it's not playing fair by our existing shareholders if we now issue stock for around $10 a share.

"Look at the alternative. We can borrow today at 6%. We get a tax break on the interest, so the after-tax cost of borrowing is .65*6 = 3.9%. That's about half the cost of equity. We expect to earn a return of 15% on these new aircraft. If we can raise money at 3.9% and invest it at 15%, that's a good deal in my book.

"You finance guys are always talking about risk, but as long as we don't go bankrupt, borrowing doesn't add any risk at all. In any case my calculations show that the debt ratio is only 45%, which doesn't sound excessive to me.

"Ed, I don't want to push my views on this after all, you're the expert. We don't need to make a firm recommendation to the board until next month. In the meantime, why don't you get one of your new business graduates to look at the whole issue of how we should finance the deal and what return we need to earn on these planes?"

Evaluate Mr. Johnson's arguments about the stock issue and dividend payment as well as the reply of LA's chief executive. Who is correct? What is the required rate of return on the new planes?

Balance sheet
bank Debt	50	cash	20
other current liabilities	20	other current assets	20
10% bond, due 2032*	100	Fixed assets	250
Stockholders' equity**	120
Total liabilities	290	Total Assets	290
Income statement
Gross Profit	$57.5
Depreciation	20.0
Interest	7.5
Pretax profit	30.0
Tax	10.5
Net profit	19.5
Dividend	6.5

*the yield to maturity on LA debt is currently 6%

**LA has 10 million shares outstanding, with a market price of $10 a share. LA's equity beta s estimated at 1.25, the market risk premium is 8%, and the Treasury bill rate is 3%

Read through the article about Imagination Tech and its market "implosion" thanks to the announcement that Apple is going to begin using its own Graphics Chips in upcoming phones (years from now).

Notice the share price of Imagination Tech since the issue happened. Is the company undervalued now from this crash? Why or why not? Why do you think the stock has crashed so far, even though Apple's announcement won't affect them for years? what do you think this company might be able to do to recover? How do you think the market "discounts" this firm's cash flows from a risk perspective? Do you think this has changed after the Apple announcement?

Also, from a capital budgeting perspective, I would like you to think about the "Project" that Imagination might need to implement to survive. How do you think company executives would have approached the cash outflows that were necessary to help fix this situation? Think about how future cash flows would be impacted if the company did nothing, what would happen to future cash flows if the company successfully created a new product or innovation that helps increase cash flows? Would managers find a positive NPV from their capital budgeting analysis?

Article:

Shares in Imagination Tech crashed more than 70 percent on Monday after the British company said its biggest customer, Apple, would stop using its graphics technology in iPhones, iPads and Apple Watches.

Imagination said Apple, which accounts for about half its revenue, had notified the British firm it was developing its own graphics chips and would no longer use Imagination's processing designs in 15 months to two years time. Shares in Imagination, in which Apple holds an 8 percent stake, plunged to 76 pence, their lowest level since 2009 and about a 10th of their record of 734 pence hit in 2012. "The biggest risk to Imagination's business model was realized this morning," analysts at Investec said.

"The loss of this revenue stream will have a material impact on the financials of the company." Imagination's shares were trading down 61 percent at 105 pence by 0915 GMT, giving the company a market value of 298 million pounds ($372 million), or 463 million pounds less than it was worth on Friday. The technology company has licensed its processing designs to Apple from the time of the iPod and receives a small royalty on every graphics chip used in a device.

Imagination, however, said it doubted Apple could go it alone without violating Imagination's patents, intellectual property and confidential information, and analysts said legal battles could lie ahead.

"This evidence has been requested by Imagination but Apple has declined to provide it," said the British company, which was founded in 1985 and listed in 1994.Apple did not immediately respond to a request for comment. Imagination's shares rose sharply between 2009 and 2012 as sales of smartphones boomed and Apple and Intel bought stakes. The company was valued at more than 2 billion pounds ($2.5 billion) in April 2012.

It struggled, however, to reduce its reliance on Apple, and has faced increased competition from the likes of chipmaker Qualcomm and British rival ARM, which developed its own graphics to complement its core processor blueprints. Imagination says it has 50 percent of the high-end smartphone market, but only 7 percent of mid-tier devices, where it has been trying to regain market share, including in phones made by Chinese manufacturers.

It said that Apple's notification had triggered talks on alternative commercial arrangements for the current license and royalty agreement. Analysts said there could be room for a compromise, and it could be a bargaining move by Apple to reduce royalties.

Apple paid Imagination license fees and royalties totalling 60.7 million pounds for the year to end-April 2016, half of its total revenue, and is expected to pay about 65 million pounds for this year, Imagination said. Most of its costs are incurred designing new technology years ahead of when it appears in devices, and it said there were minimal direct costs associated with the Apple revenue.

scarletelk92

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