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projects would you accept and why)?


d. How much cash will the company have available to pay out as dividends next year?
(What is the maximum amount the company can pay out as dividends? )
e. Would you pay out this maximum amount as dividends? Why or why not? What other
considerations would you bring to this decision?
f. JKL Corporation currently has a cash balance of $100 million (after paying the current
year's dividends). If it pays out $125 million as dividends next year, what will its
projected cash balance be at the end of the next year?

2. GL Corporation, a retail firm, is making a decision on how much it should pay out to
its stockholders. It has $100 million in investible funds. The following information is
provided about the firm:
(a) It has 100 million shares outstanding, each share selling for $15. The beta of the stock
is 1.25 and the riskfree rate is 8%. The expected return on the market is 16%.
(b) The firm has $ 500 million of debt outstanding. The marginal interest rate on the debt
is 12%.
(c) The corporation's tax rate is 50%.
(e) The firm has the following investment projects:
Project Investment After-Tax Return on capital
A 15 million 27%
B 10 million 20%
C 25 million 16%
D 20 million 14%
E 30 million 12%
The firm plans to finance all its investment needs at its current debt ratio.
(i) Should the company return money to its stockholders?
(ii) If so, how much should be returned to stockholders?

3. InTech Corporation, a computer software firm which has never paid dividends before,
is considering whether it should start doing so. This firm has a cost of equity of 22% and
a cost of debt of 10% (the tax rate is 40%). The firm has $100 million in debt outstanding
and 50 million shares outstanding, selling for $10 per share. The firm currently has net


income of $90 million and depreciation charges of $10 million. It also has the following
projects available:
Project Initial Investment Annual Lifetime Salvage
EBIT Depreciation
1 $10 million $ 1 mil $500,000 5 years $2.5 mil
2 $40 million $ 5 mil $ 1 million 10 years $10 mil
3 $50 million $ 5 mil $ 1 million 10 years $10 mil
The firm plans to finances its future capital investment needs using 20% debt.
a. Which of these projects should the firm accept?
b. How much (if any) should the firm pay out as dividends?

4. LimeAde Corporation, a large soft drink manufacturing firm, is faced with the decision
of how much to pay out as dividends to its stockholders. It expects to have a net income
of $ 1000 (after depreciation of $500), and it has the following projects:
Project Initial Investment Beta IRR (to equity investors)
A $ 500 2.0 21%
B $600 1.5 20%
C $ 500 1.0 12%
The firm's beta is 1.5 and the current risk-free rate is 6%. The firm plans to finance net
capital expenditures (cap ex -depreciation) and working capital with 20% debt. The firm
also has current revenues of $5000, which it expects to grow at 8 %. Working capital will
be maintained at 25% of revenues. How much should the firm return to its stockholders
as a dividend?

5. NoLone Corporation, an all-equity manufacturing firm, has net income of $100 million
currently and expects this number to grow at 10% a year for the next three years. The
firm's working capital increased by $10 million this year and is expected to increase by
the same dollar amount each of the next three years. The depreciation is $50 million and
is expected to grow 8% a year for the next three years. Finally, the firm plans to invest
$60 million in capital expenditure for each of the next three years. The firm pays 60% of
its earnings as dividends each year. RYBR has a cash balance currently of $50. Assuming


that the cash does not earn any interest, how much would you expect to have as a cash
balance at the end of the third year?

6. Boston Turkey is a publicly traded firm, with the following income statement and balance
sheet from its most recent financial year:

Income Statement
Revenues $ 1,000,000
- Expenses $ 400,000
- Depreciation $ 100,000
EBIT $ 500,000
- Interest Expense $ 100,000
Taxable Income $ 400,000
- Tax $ 160,000
Net Income $ 240,000

Balance Sheet
Assets Liabilities
Property, Plant & Equipment $ 1,500,000 Accounts Payable $ 500,000
Land & Buildings $ 500,000 Long Term Debt $ 1,000,000
Current Assets $ 1,000,000 Equity (100,000 shares) $ 1,500,000
Total $ 3,000,000 Total $ 3,000,000
Boston Turkey expects its revenues to grow 10% next year and its expenses to remain at 40% of
revenues. The depreciation and interest expenses will remain unchanged at $100,000 next year.
The working capital, as a percentage of revenue, will also remain unchanged next year.
The managers of Boston Turkey claim to have several projects available to choose from
next year, in whichthey plan to invest the funds from operations, and they suggest that the firm
really should not be paying dividends. The projects have the following characteristics:
Project Equity Investment Expected Annual CF to Equity Beta
A $ 100,000 12,500 1.00
B $ 100,000 14,000 1.50
C $ 50,000 8,000 1.80


D $ 50,000 12,000 2.00
The treasury bill rate is 3%, and the treasury bond rate is 6.25%. The firm plans to finance 40%
of its future net capital expenditures (Cap Ex - Depreciation) and working capital needs with
a. How much can the company afford to pay in dividends next year?
b. Now assume that the firm actually pays out $1.00 per share in dividends next year. The current
cash balance of the firm is $150,000. How much will the cash balance of the firm be at the end of
next year, after the payment of the dividend?

7. Z-Tec Corporation, a firm providing Internet services, reported net income of $ 10 million in
the most recent year, while making $ 25 million in capital expenditures (depreciation was $ 5
million). The firm had no working capital needs and uses no debt.
a. Can the firm afford to pay out dividends right now? Why or why not?
b. Assuming net income grows 40% a year and that net capital expenditures grow 10% a year,
when will the firm be in a position to pay dividends?

8. You are analyzing the dividend policy of Conrail, a major railroad, and you have collected the
following information from the last 5 years “
Year Net Income Capital Expenditure Depreciation Non-cash Working Capital Dividends
1991 $ 240 $ 314 $ 307 $ 35 $ 70
1992 $ 282 $ 466 $ 295 $ (110) $ 80
1993 $ 320 $ 566 $ 284 $ 215 $ 95
1994 $ 375 $ 490 $ 278 $ 175 $ 110
1995 $ 441 $ 494 $ 293 $ 250 $ 124

The average debt ratio during this period was 40% and the total non-cash working capital at the
end of 1990 was $ 10 million.
a. Estimate how much Conrail could have paid in dividends during this period.
b. If the average return on equity during the period was 13.5%, and Conrail had a beta of 1.25,
what conclusions would you draw about Conrail™s dividend policy? (The average T.Bond rate
during the period was 7%, and the average return on the market was 12.5% during the period)


9. Assume now that you have been asked to forecast cash flows that you will have available to
repurchase stock and pay dividends during the next 5 years for Conrail (from problem 8). In
making these forecasts, you can assume the following “
Net Income is anticipated to grow 10% a year from 1995 levels for the next 5 years

Capital expenditures and depreciation are expected to grow 8% a year from 1995 levels

The revenues in 1995 were $ 3.75 billion, and are expected to grow 5% each year for the next

5 years. The working capital as a percent of revenues is expected to remain at 1995 levels
The proportion of net capital expenditures and depreciation that will be financed with debt

will drop to 30%
a. Estimate how much cash Conrail will have available to pay dividends or repurchase stocks
over the next 5 years.
b. How will the perceived uncertainty associated with these cash flows affect your decision on
dividends and equity repurchases?

10. Cracker Barrel, which operates restauarants and gift stores, is reexamining its policy of
paying minimal dividends. In 1995, Cracker Barrel reported net income of $ 66 million; it had
capital expenditures of $ 150 million in that year and claimed depreciation of only $ 50 million.
The working capital in 1995 was $ 43 million on sales of $ 783 million. Looking forward,
Cracker Barrel expects the following:
Net Income is expected to grow 17% a year for the next 5 years

During the 5 years, capital expenditures are expected to grow 10% a year and depreciation is

expected to grow 15% a year
The working capital as a percent of revenues is expected to remain at 1995 levels, and

revenues are expected to grow 10% a year during the period
The company has not used debt to finance its net capital expenditures and does not plan to

use any for the next 5 years
a. Estimate how much cash Cracker Barrel would have available to pay out to its stockholders
over the next 5 years
b. How would your answer change, if the firm plans to increase its leverage by borrowing 25%
of its net capital expenditure and working capital needs?


11. Assume that Cracker Barrel, from problem 10, wants to continue with its policy of not
paying dividends. You are the CEO of Cracker Barrel and have been confronted by dissident
stockholders, demanding to know why you are not paying out your FCFE (estimated in the
previous problem) to your stockholders. How would you defend your decision? How receptive
will stockholders be to your defense? Would it make any difference that Cracker Barrel has
earned a return on equity of 25% over the previous five years, and that its beta is only 1.2?

12. Manpower Corporation, which provides non-government emplyments services in the United
States, reported net income of $ 128 million in 1995. It had capital expenditures of $ 50 million
and depreciation of $ 24 million in 1995, and its working capital was $ 500 million (on revenues
of $ 5 billion). The firm has a debt ratio of 10%, and plans to maintain this debt ratio.
a. Estimate how much Manpower Corporation will have available to pay out as dividends next
b. The current cash balance is $ 143 million. If Manpower Corporation is expected to pay $ 12
million in dividends next year and repurchase no stock, estimate the expected cash balance at the
end of the next year.

13. How would your answers to the previous problem change if Manpower Corporation in
problem 12 plans to pay off its outstanding debt of $ 100 million next year and become a debt-
free company?

14. You are an institutional investor and have the collected the following information on five
maritime firms in order to assess their dividend policies:
Company FCFE Dividends Paid ROE Beta
Alexander & Brown $ 55 $ 35 8% 0.80
American President $ 60 $ 12 14.5% 1.30
OMI Corporation - $ 15 $5 4.0% 1.25
Overseas Shipholding $ 20 $ 12 1.5 % 0.90
Sea Containers -$5 $8 14% 1.05
The average riskfree rate during the period was 7% and the average return on the market was
a. Assess which of these firms you would pressure to pay more in dividends.


b. Which of the firms would you encourage to pay less in dividends?
c. How would you modify this analysis to reflect your expectations about the future of the entire

15. You are analyzing the dividend policy of Black and Decker, a manufacturer of tools
and appliances. The following table summarizes the dividend payout ratios, yields and
expected growth rates of other firms in the waste disposal business.
Company Payout Ratio Dividend Yield Ex. Growth
Fedders Corporation 11% 1.2% 11.0%
Maytag Corporation 37% 2.8% 23.0%
National Presto 67% 4.9% 13.5%
Toro Corporation 15% 1.5% 16.5%
Whirlpool Corp. 30% 2.5% 20.5%
Black & Decker 24% 1.3% 23.0%

a. Compare Black and Decker™s dividend policy to those of its peers, using the average
dividend payout ratios and yields.
b. Do the same comparison, controlling for differences in expected growth.

16. The following regression was run using all NYSE firms in 1995
YIELD = 0.0478 - 0.0157 BETA + 0.0000008 MKTCAP + 0.6797 DBTRATIO + 0.0002
R2 = 12.88%
ROE - 0.09 NCEX/TA
where BETA = Beta of the stock
MKTCAP = Market Value of Equity + Book Value of Debt
DBTRATIO = Book Value of Debt / MKTCAP
ROE = Return on Equity in 1994
NCEX/TA = (Capital Expenditures - Depreciation) / Total Assets


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