Practice Questions – Dividend Policy

1. RESIDUAL DIVIDEND MODEL Axel Telecommunications has a target capital structure that
consists of 70% debt and 30% equity. The company anticipates that its capital budget for the
upcoming year will be $3,000,000. If Axel reports net income of $2,000,000 and it follows a
residual dividend payout policy, what will be its dividend payout ratio?

2. STOCK SPLIT Gamma Medical’s stock trades at $90 a share. The company is planning a 3-
for-2 stock split. Assuming that the stock split will have no effect on the market value of its
equity, what will be the company’s stock price following the stock split?

Q.3 The Borowiak Rose Water Company expects with some degree of certainty to generate the
following net income and to have the following capital expenditures during the next five years
(in thousands of dollars):

The company currently has 1 million shares of common stock outstanding and pays annual
dividends of $1 per share.
a. Determine dividends per share and external financing required in each year if dividend policy
is treated as a residual decision.
b. Determine the amounts of external financing that will be necessary in each year if the present
annual dividend per share is maintained.
c. Determine dividends per share and the amounts of external financing that will be necessary if
a dividend-payout ratio of 50 percent is maintained.
d. Under which of the three dividend policies are aggregate dividends (total dividends over five
years) maximized? External required financing (total financing over five years) minimized?
Q.4 Dew Drop Inn, Inc.’s earnings per share over the last 10 years were the following:

Determine annual dividends per share under the following policies:

i A constant dividend-payout ratio of 40 percent (to the nearest cent).
ii A regular dividend of 80 cents and an extra dividend to bring the payout ratio to 40 percent if it
otherwise would fall below.
iii A stable dividend that is occasionally raised. The payout ratio may range between 30 percent
and 50 percent in any given year, but it should average approximately 40 percent.

Q.5. Following is EPS of the ABC LTD over the past 10 years:

Year EPS Year EPS

10 Rs. 20
9 19
8 16
7 15
6 15
5 12
4 6
3 9
2 -2
1 1

Determine annual dividend paid each year in the following cases:

1. If the firm’s dividend policy is based on a constant dividend payout of 50 per cent for all
years.
2. If the firm pays dividend at Rs. 8 per share each year, and increase it to Rs. 10 per share
when earnings exceed Rs. 14 per share for the previous two consecutive years.
3. If the firm pays dividend at Rs. 7 per share each year, and will also pay an extra dividend
equal to 80 per cent, if earnings exceeds Rs. 14 per share.