Writing Assignment 3

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Thomas Edison State College *

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FIN-301-OL

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Finance

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Feb 20, 2024

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Writing Assignment 3 Chapter 10 (3,4,5,7) 3. Jersey Medical earns $9.50 per share, sells for $90, and pays a $6 per share dividend. The stock is split two-for-one and a $3 per share cash dividend is declared. a. What will be the new price of the stock? a. New price of the stock: $90/2 = $45 b. If the firm’s total earnings do not change, what is the payout ratio before and after the stock split? a. Payout ratio before the split: $6/$9.50 = 63.2% Payout ratio after the split and the dividend is adjusted to $3 per share: $3/$4.75 = 63.2% 4. Firm A had the following selected items on its balance sheet: Cash $ 28,000,000 Common stock ($50 par; 2,000,000 shares outstanding) $ 100,000,000 Additional paid-in capital $ 10,000,000 Retained earnings $ 62,000,000 How would each of these accounts appear after: a. a cash dividend of $1 per share? a. When cash dividends are declared, retained earnings are reduced and current liabilities are increased by the amount of the dividend (in this case 2,000,000 $1). When the dividend is paid, cash and current liabilities are reduced by $2,000,000. The net effect is that cash becomes $26,000,000, and retained earnings decline to $60,000,000. b. a 5 percent stock dividend (fair market value is $100 per share)? A stock dividend would not affect the firm’s assets or liabilities. Cash $100,000 Total Assets Common stocks (30,000 shares outstanding, $1 par) $30,000 Additional paid-in capital $5,000 Retained earnings $45,000 c. a one-for-two reverse split? a. A stock split does not affect the firm’s assets or liabilities. It only alters the number of shares, their par value, and the price of the stock. In this case (a one-for-two reverse stock split), two old shares become one new share, and the par value of the new share is doubled. The new entries are Common stock (1,000,000 shares; $100 par) $100,000,000.
5. Jackson Enterprises has the following capital (equity) accounts: Common stock ($1 par; 100,000 shares outstanding) $ 100,000 Additional paid-in capital $ 200,000 Retained earnings $ 225,000 The board of directors has declared a 20 percent stock dividend on January 1 and a $0.25 cash dividend on March 1. What changes occur in the capital accounts after each transaction if the price of the stock is $4? a. The impact of the 20% stock dividend Common stock (120,000 shares at $1 par) $ 120,000 Additional paid-in capital $ 260,000 Retained earnings $ 145,000 About 20,000 new shares are issued worth $4 x 20,000 = $80,000, and retained are decreased by $80,000. An amount of $20,000 is added to common stock ($1 x 20,000) and the balance ($60,000) is added to additional paid-in capital. b. The impact of the $0.25 per share cash dividend: Common stock (120,000 shares at $1 par) $120,000 Additional paid-in capital 260,000 Retained earnings 115,000 The amount of the dividend ($0.25 × 120,000 = $30,000) is subtracted from retained earnings. (Notice that the number of shares increased from the original 100,000 shares to 120,000 because the stock dividend preceded the cash dividend.) 7. What effect will a two-for-one stock split have on the following items found on a firm’s financial statements? a. earnings per share $4.20 -The impact of the two-for-one split is Earnings per share decline from $4.20 to $2.10. b. total equity $10,000,000 Total equity does not change. c. long-term debt $4,300,000 a. Long term debt does not change. d. additional paid-in capital $1,534,000 a. Paid in capital does not change. e. number of shares outstanding 1,000,000 a. Number of shares doubles from 1,000,000 to 2,000,000. f. earnings $4,200,000 a. Earnings do not change. Chapter 11 (1, 2, 3, 5) 1. The dividend-growth model (DGM) may be used to value a stock:
a. What is the value of stock if: D=$2; k=10%; g=6% i. V=$2(1 + .06)/(.10-.06) = $53 b. What is the value of this stock if the dividend is increased to $3 and the other variables remain constant? i. V= $3(1 + .06)/(.10-.06) = $79.50 c. What is the value of this stock if the required return declines to 7.5% and the other variables remain constant? i. V=$2(1+.06)/(.075-.06) = $141.33 d. What is the value of this stock if the growth rate declines to 4% and the other variables remain constant? i. v=$2(1 + .04)/(.10-.06) = $34.67 e. what is the value of this stock if the dividend is increased to $2.30, the growth rate declines to 4%, and the required return remains 10%. i. V=$2.30(1 + .04)/(.10-.04) = $39.87 2. Last year Artworks, Inc. paid a dividend of $1.75. You anticipate that the company’s growth rate is 6% and have a required rate of return of 9% for this type of equity investment. What is the maximum price you would be willing to pay for the stock. a. Maximum price would be V=$1.75(1+.06)/(.09-.06) = $61.83 3. An investor with a required return of 14% for a very risky investments in common stocks has analyzed three firms and must decide which, if any, to purchase. The information is as follows: Firm A B C Current Earnings $2 $3.20 $7 Current Dividends $1 $3 $7.50 Expected annual growth rate 7% 2% -1% Current market price $23 $47 $60 a. What is the maximum price that the investor should pay for each stock based on the DGM? a. Firm A: v=$1(1+.07)/(.14-.07)= $15.29 b. Firm B: v= $3(1+.02)/(.14-.02)= $25.50 c. Firm C: v=$7.50(1+(-.01)/(.14-(-.01)= $49.50 b. If the investor does buy Stock A, what is the implied percentage return? a. Sum of growth rate and dividend yield: ($1(1+.07)/($23) + .07= 11.65% c. If the appropriate P/E ratio is 12, what is the maximum price the investor should pay for each stock? Would your answers be different if the appropriate P/E were 7? a. A: $23/$2= 11.5 b. B: $47/$3.2= 14.7 c. $60/$7= 8.6
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