Question

1. Skip Company announced its regular quarterly cash dividend of $0.20 per share. Currently there are one million shares outstanding. (7 points)

Declaration date: October 24, 2006

Ex-dividend date: November 20, 2006

Record date: November 22, 2006

Payment date: December 15, 2006

1. On which date will the stock price change to reflect the value of the dividend?

2. Skips stock price at the end of November is expected to be $20. What is the dividend yield?

3. Suppose that the marginal tax rate on dividend is 15% and the marginal tax rate on capital gain is 10%, how much is the stock price likely to fall?

4. Suppose that the company decides to use the same amount of cash to buy back shares rather than to issue cash dividends. The company will buy back shares at the market price at the end of November. You currently hold 10000 shares, and you decide to sell 1000 shares during the repurchase. What is the percentage ownership after the repurchase?

5. Suppose that the company decides to issue a 10% stock dividend instead of a cash dividend. How much is the stock price likely to fall? Let P’ be the new price after the stock dividend. We know that the number of shares outstanding will increase by a factor of 1.1 after the dividend, but the total value of equity does not change.

Answer 1

Part (a)

The stock price will change to reflect the value of the dividend, on the Ex-dividend date: November 20, 2006

Part (b)

Annual dividend = 4 x quarterly dividend = 4 x 0.2 = $ 0.80 / share

Dividend yield = Annual dividend / Expected price = 0.8 / 20 = 4%

Part (c)

Stock price fall = D x (1 - marginal tax rate on dividend) / (1 - marginal tax rate on capital gain) = 0.2 x (1 - 15%) / (1 - 10%) = $  0.1889

Part (d)

Total funds for repurchase = 0.2 x number of shares outstanding = $ 0.2 x 1 mn = $ 0.2 mn

Repurchase price = $ 20 / shares

Nos. of shares repurchased = $ 0.2 mn / 20 = $ 10,000

Number of shares outstanding after repurchase = 1 mn - 10,000 = 990,000

the percentage ownership after the repurchase = (10,000 - 1,000) / 990,000 = 0.9091%

Part (e)

Value of the equity after the stock dividend will remain same as before dividend

Hence, 20 x 1,000,000 = P' x 1,100,000

Hence, P' = 20/1.1 = $ 18.18

Hence, the stock price will fall by = $ 20 - $ 18.18 = $ 1.82 / share