- The Board of Directors of Sarkel Systems Corp is considering approving an 8-for-5 stock split for the company common stock. The company currently has 1.5 million shares outstanding, and EPS for the prior year were $0.60. The company intends to maintain a 50% payout ratio. The company’s stock price is currently $40 per share., Sarkel’s CFO provided a memo to the board to help them with their decision of whether to approve the dividend. The memo contained the following statements: I) The stock price after the split will be $25 per share. II) The company’s dividend yield after the split will be 1.2% III) After the split, the company’s price-to-earnings ratio will remain 41.7x earnings. How many of the statements are correct? A) Three B) Two C) One 2) Arizona Seafood, Inc., plans $45 million in new borrowing to repurchase 3,600,000 shares at their market price of $12.50. The yield on the new debt will be 12%. The company has 36 million shares outstanding and EPS of $0.60 before the repurchase. The company’s tax rate is 40%. The company’s EPS after the share repurchase will be closest to: A) $0.50 B) $0.57 C) $0.67 3) A company has provided the following financial data: Target capital structure is 50% debt and 50% equity. After-tax cost of debt is 8% Cost of retained earnings is estimated to be 13.5% Cost of equity is estimated to be 14.5% if the company issues new common stock Net income is $2,500 The company is considering the following investment projects: Project Size of Project IRR of Project A $1,000 12.0% B $1,200 11.5% C $1,200 11.0% D $1,200 10.5% E $1,000 10.0% If the company follows a residual dividend policy, its payout ratio will be closest to: A) 32% B) 54% C) 66%
Question 1, B I) The stock price after the split will be $25 per share: TRUE. 1.5M shares*8/5=2.4M shares, the stock price is proportionally reduced, the MV of the company remains the same, $40*1.5M=60M, but in 2.4M shares of 60M/2.4M=25 per share II) The company’s dividend yield after the split will be 1.2%: TRUE. Dividend yield=D0(most recent full year dividend)/P1(new price, after stock dividend issue)=0.5*0.60/$25=1.2% III) After the split, the company’s price-to-earnings ratio will remain 41.7x earnings. FALSE The P/E ratio, before the stock split, was $40/0.6=66.67x earnings, not 41.7xearnings. The new P/E ratio would be $25/new EPS (that is, 1.5M*0.6/2.4M=0.375)=66.67x earnings. T will remain the same, but not 41.7x earnings. Question 2, B NI=EPS0*existing # shares=21.6M After tax cost of debt (ATCD)=(1-40%)*12%*45M=3.24 New # shares after repurchase=36-3.6=32.4 New EPS= (NI-ATCD)/new #of shares outstanding=(21.6-3.24)/32.4=0.57, answer B There is a shortcut that works sometime, comparing the earnings yield with the ATCB: if earnings yield (EPS/P) > ATCD, new EPS goes up if earnings yield (EPS/P) < ATCD, new EPS goes down if equal, EPS remains unchanged In this case it doesn’t work for a straight solution (E/P is 0.6/12.5=4.8%, ATCD=(1-40%)*12%=7.2%, the E/P
Agree with map1.
1: C I: Stock price: 25/8/5 II: Dividend yield is .6*1.5/(1.5*8/5) -> .375, new EPS. .5*.375/25 =.75% III:, P/E is now 25/.375, which is not 41.7 2: B (.6*36-45*(.12*.6))/(36-3.6) = .57 3: A Find the required return. .5*.08+.5*.135, in the residual dividend case, we use retained earnings rate. so we get 10.75%, so project 1,2,3 selected. 3400*.5=1700 used in cap budget from equity. Thus 800 left-> 800/2500 is 32% Damil4real Wrote: ------------------------------------------------------- > 1) The Board of Directors of Sarkel Systems Corp > is considering approving an 8-for-5 stock split > for the company common stock. The company > currently has 1.5 million shares outstanding, and > EPS for the prior year were $0.60. The company > intends to maintain a 50% payout ratio. The > company’s stock price is currently $40 per share., > Sarkel’s CFO provided a memo to the board to help > them with their decision of whether to approve the > dividend. The memo contained the following > statements: > > I) The stock price after the split will be $25 per > share. > II) The company’s dividend yield after the split > will be 1.2% > III) After the split, the company’s > price-to-earnings ratio will remain 41.7x > earnings. > > How many of the statements are correct? > > A) Three > B) Two > C) One > > 2) Arizona Seafood, Inc., plans $45 million in new > borrowing to repurchase 3,600,000 shares at their > market price of $12.50. The yield on the new debt > will be 12%. The company has 36 million shares > outstanding and EPS of $0.60 before the > repurchase. The company’s tax rate is 40%. The > company’s EPS after the share repurchase will be > closest to: > > A) $0.50 > B) $0.57 > C) $0.67 > > > 3) A company has provided the following financial > data: > > Target capital structure is 50% debt and 50% > equity. > After-tax cost of debt is 8% > Cost of retained earnings is estimated to be > 13.5% > Cost of equity is estimated to be 14.5% if the > company issues new common stock > Net income is $2,500 > > The company is considering the following > investment projects: > > Project Size of Project IRR > of Project > A $1,000 > 12.0% > B $1,200 > 11.5% > C $1,200 > 11.0% > D $1,200 > 10.5% > E $1,000 > 10.0% > > If the company follows a residual dividend policy, > its payout ratio will be closest to: > > A) 32% > B) 54% > C) 66%
Correct Answers: 1 C 2 B 3 A CFABLACKBELT got them all right.