Corporate Finance (FINM2001)
Tutorial Eight - Solutions
Question One
Problem 17.2, pg. 664.
ABC Corporation announced that it will pay a dividend to all shareholders of record as
of Monday, April 2, 2012. 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?
Solution
a. March 28
b. March 29
Question Two
Problem 17.6, pg. 665.
KMS Corporation has assets with a market value of $422 million, $36 million of which
are cash. It has debt of $186 million, and 18 million shares outstanding. Assume perfect
capital markets.
a) What is its current stock price?
b) If KMS distributes $36 million as a dividend, what will its share price be after the
dividend is paid?
c) If instead, KMS distributes $36 million as a share repurchase, what will its share
price be once the shares are repurchased?
d) What will its new market debt-equity ratio be after either transaction?
Solution
a. (422 – 186)/18 = 13.11
b. (422 − 36 – 186)/18 = 11.11
c. (422 − 36 – 186)/(18 – 36/13.11) = 13.11
d. 186/(422-186-36) = 0.93
Question Three
Problem 17.9, pg. 665.
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.
1
Corporate Finance (FINM2001)
Solution
Because the payoff of the option depends upon Oracle’s future stock price, you
would prefer that Oracle use share repurchases, as it avoids the price drop that
occurs when the stock price goes ex-dividend.
Question Four
Problem 17.11, pg. 665.
The HNH Corporation will pay a constant dividend of $4 per share, per year, in
perpetuity. Assume all investors pay a 25% 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 11%.
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?
Solution
a. P = $3/0.11 = $27.27
b. P = $4/0.11 = $36.36
Question Five
Problem 17.15, pg. 666.
Suppose that all capital gains are taxed at a 24% rate, and that the dividend tax rate is
38%. Arbuckle Corp. is currently trading for $32 and is about to pay a $4 special
dividend.
a) Absent any other trading frictions or news, what will its share price be just after
the dividend is paid?
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?
Solution
a. t*_ d = (38% – 24%)/(1 – 24%) = 18.42%, P_ex = 32 – 4(1 – 0.1842) = $28.74
b. With dividend, tax would be 4 × 38% = $1.52 for dividend, with a tax savings
of (32-28.74) × 24% = $0.7824 for capital loss, for a net tax from the dividend
of (1.52-0.7824)= $0.7376 per share. This amount would be saved if Arbuckle
does a share repurchase instead.
c. Stock price rises to by $0. 7376 to $32. 7376 to reflect the tax savings.
