Finance 338 Time spent: 2 hours 45 minutes

Jonathan Wiley Name: Daniel Gabriel-Emmanuel

[email protected] Date: 10/26/2020

Homework Project b-4

Pre-question: In the space below, write down the seventh and eighth commandments given
in the Ten Commandments (Ex. 20:2-17; Deut. 5:6-21). The short versions are fine.

7. Thou shall not commit adultery

8. Thou shall not steal.

Questions (worth 5 raw points per numerical question, and show your work):

1. A. How is the payout rate or payout ratio calculated?

The payout rate/payout ratio is calculated by Dividends Per Share/Earnings Per Shares. DPS/EPS
B .What isthe retention rate or retention ratio? (be sure to provide an equation)

The retention ratio is the percentage of earnings that are credited to retained earnings. This is
essentially (1- Dividend payout ratio)

2. A. Discuss the target payout ratio and how it is related to the optimal dividend policy.

The target payout ratio is the target percentage of net income that is paid out in cash
dividends to shareholders. Paying too much in dividends leads to less reinvestments which
means there is less growth. Optimal dividend policy is the balance between growth and
dividends. The target payout ratio is related to the optimal dividend policy related because
the target rate is essentially the optimal dividend policy because the goal(target) is
maximizing the shareholder wealth by paying all the consistent dividends of what is left in
the net income. Any change in the payout policy will have two contrasting effects so the
optimal dividend policy can strike the balance between the current dividends and the future
growth which maximizes the stock price.

B. What is the clientele effect, and how might it affect dividend policy?

The clientele effect means that different groups prefer different dividend payout policies this
means its tendency of a firm to attract a set of investors who prefer its dividend policy. It
might affect the dividend policy because changes in the dividend policy can cause the
investors to be unsettled and unhappy. This can eventually cause to a negative change in the
company’s stock price.

3. A. What is used to pay cash dividends – cash flow or earnings?

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 Cash dividends are paid with cash flow, but this means that potential retained earnings are
sacrificed in the process.

B. What happens to a company’s stock price when dividends are unexpectedly

reduced?
When a company’s dividends are unexpectedly reduced, the company’s stock price will
decrease.

C. What if dividends are unexpectedly increased?

If the dividends are unexpectedly increased the company’s stock price usually increases

D. Why do these things occur?

These things occur due to the expectations the company sets for the stockholders of the
dividend payouts. Changes in dividends are used as a prediction for the earnings in the future
which is called the signaling hypothesis. When the dividend payouts changes, this goes
against their initial expectations and whether these changes displease or please the investors
determine the buying or selling of the stocks.

4. A. What is the goal of dividend payments to stockholders?

The goal of the dividend payments to stockholders is to maximize shareholder wealth and to
keep the shareholders satisfied in the long run.

B. What is meant by double taxation?

Double taxation means that the investors will be taxed twice. Once on the dividends they
receive and secondly on the income they make on the company which they “own”. This is
essentially the same earnings that are subjected to taxation twice.

C. How does double taxation influence the investor?

Double taxation influences the investor because this means that the investors make less
money in returns. This also creates the incentive to purchase growth companies that do not
pay dividends because this will cause tax to be calculated at the capital gains rate instead as
normal income.

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5. Discuss the residual dividend model and how it is connected with the concept of the
optimal capital budget and stockholder wealth maximization.

The residual dividend model is

6. Define in your own words the declaration date, the holder-of-record date, the ex-
dividend date, and the payment date.

7. What is a DRIP?

A DRIP is a Dividend Reinvestment Plan, this is where the stockholder’s dividend is

automatically reinvested in the company’s stock either as a old or as a new stock.

8. A. List five constraints that influence dividend policies, and provide a short phrase
explaining each.

B. List two issues relevant to investment opportunities that influence dividend policies,
and provide a short phrase explaining each.

C. List three issues pertaining to alternative sources of capital that influence dividend
policies, and provide a short phrase explaining each.

9. A. What is a stock split?

A stock split is a firm that is increasing their outstanding shares by splitting them into smaller
portions

B. What happens to the number of shares when a 2-for-1 stock split occurs?

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 When a 2-for-1 stock split occurs. The numbers of outstanding shares will double. For
instance, if I have 20 shares when the stock split occurs, I will end up with 40 shares in total.

C. What happens to the share price as a result of the 2-for-1 split?

The price of these shares will be cut in half which means it will be divided by two.

D. Why would a company split its stock?

the reason why a company would split its stock is when their prices fall too low and this
causes the investors to become cautious of the financial well-being of the company

E. Do all companies split their stock?

Not all companies split their stock

F. What is a reverse stock split?

A reverse stock split is cutting the number of shares in half whilst doubling their prices
G. Why would a company employ a reverse stock split?
A company will look to employ a reverse stock split in order to bring the stock’s price to an
optimal level if the price of stock gets too low.

10. A. Is a stock dividend the same as an ordinary dividend?

B. Does a stock dividend by itself increase a stockholder’s wealth?

11. A. What are the three major reasons that a company would engage in stock
repurchases?

B. List three advantages of stock repurchases. Provide a short phrase describing each.

C. List three disadvantages of stock repurchases. Provide a short phrase describing

each.

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12. A. Define the price to earnings ratio, and explain what it means.

B. Do you always want to buy companies with a high P/E ratio? Why or why not?

C. Do you always want to buy a company with a low P/E ratio? Why or why not?

D. If the P/E ratio remained constant, how could you use it to find the future share
price? (HINT: Use dimensional analysis [What are the “units” of the P/E ratio?])

13. I hereby certify that all work contained in this homework assignment is exclusively my
own. I have abided by all aspects of the Honor Code during the preparation of this
assignment, and I pledge to uphold the Honor Code by continuing to personally abide
by it and by reporting all violations that I observe. I recognize that copying another
student’s work is plagiarism and an Honor Code violation. Furthermore, I realize that
although consulting other students as I complete this assignment is permissible,
ultimately the work that I submit must be exclusively my own.

Signature: Daniel Gabriel-Emmanuel

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