Concept Checks

10.1: A pharmaceutical firm, whose earnings have increased steadily over the last five years, due to a successful drug
The earnings increases for the other two firms are less likely to be viewed as sustainable in the long term.

10.2: dividends to be cut only if earnings drop more than expected
Firms consider the likelihood that earnings will drop in a recession when they set dividends.

10.3: No change in dividend policy and an increase in the cash balance
This is not what I would like to see. I would prefer that they return the cash to the stockholders.

10.4: High-growth companies with significant investment needs
Many high-growth firms have positive earnings but negative cash flows (because of reinvestment needs). Forcing these companies to pay out dividends increases the cash deficit.

10.5: False
Firms which are under levered might pay out more than their earnings as dividends to increase leverage over time.

10.6: Large companies with significant holdings by pension funds
These are the firms where the Miller-Modigliani assumptions (no flotation costs, no tax effects)

10.7: pay more in dividends
Reducing the marginal tax rate reduces the tax disadvantage associated with dividends.

10.8: dividends have a tax advantage relative to capital gains
The tax rate on dividends is only 10.8% (.36 * .3), while the tax rate on capital gains is 20%.

10.9: Stocks that pay high dividends
They have no tax disadvantages, and the dividends cover the cash needs.

10.10: Something else (One idea: spin off the media business, and allow it to pay no dividends)
While cutting dividends may be the courageous thing to do, the existing investors in the firm probably like dividends.

10.11: the stock price to go down
This is a case where the dividend initiation to be viewed as a signal of fewer investment opportunities.

10.12: to be lower than dividends paid by similar companies in other countries
Managers left to themselves like to hold on to cash.

10.13: No
If the returns made on the projects is lower than the after-tax cost of borrowing, the earnings per share will decrease.

10.14: Companies which are perceived to have great investment opportunities
Buying back stock will reduce the amount that these companies have available to investment in these great projects.

10.15: bad news, since the cash dividends were cut?
The stock dividend does not create any value for the stockholders, and it replaces a cash dividend.

10.16: Sell the oil service subsidiary to the highest bidder
The management of the subsidiary is under performing its peer group.

10.17: Yes
Only if the bondholders are protected in the spin off. It is possible that the riskiest subsidiary is being spun off.

10.18: Hold the cash for projects in future years
Given that Immunotech is small and growing, it probably faces capital rationing constraints and has good projects.