Problems and Questions

1. A company that has excess cash on hand is trying to decide whether to pay out the cash as a regular dividend or a special dividend or to repurchase stock with it. What are some of the considerations that would enter into this decision.

2. ìAn equity repurchase will always provide a lesser signaling benefit than will an equivalent dollar increase in regular dividends.î Explain this statement. Does it hold true if the comparison is to special dividends?

3. A firm is planning to borrow money to make an equity repurchase to increase its stock price. It is basing its analysis on the fact that there will be fewer shares outstanding after the repurchases, and higher earnings per share.

a. Will earnings per share always increase after such an action? Explain.

b. Will the higher earnings per share always translate into a higher stock price? Explain.

c. Under what conditions will such a transaction lead to a higher price?

4.. JR Computers, a firm that manufactures and sell personal computers is an all-equity firm with 100,000 shares outstanding, $10 million in earnings after taxes and a market value of $ 150 million. Assume that this firm borrows $60 million at an interest rate of 8% and buys back 40,000 shares, using the funds. If the firmís tax rate is 50% estimate

a. the effect on earnings per share of the action.

b. what the interest rate on the debt would have to be, for the earnings per share effect to disappear.

5. Why are forward contracts to buy equity more risky to firms than repurchase agreements? Why might firms choose to use these contracts anyway?

6. JK Tobacco, a diversified firm in food and tobacco, concerned about its stock price, which has dropped almost 25% over the previous two years. The managers of the firm believe that the price drop has occurred because the tobacco division is the target of lawsuits, which may result in a large liability for the firm. What action would you recommend to the firm? What might be some of the barriers to such an action?

7. The stock price of GenChem Corporation, a chemical manufacturing firm with declining earnings, has dropped from $ 50 to $ 35 over the course of the last year, largely as a consequence of the market perception that the current management is incompetent. The management is planning to split off the firm into three businesses, but plans to continue running all of them. Do you think the split off will cause the stock price to increase? Why or why not? What would you recommend?

8. Stock prices of firms generally increase when they announce spin offs. How would you explain this phenomenon? On which types of firms would you expect spin offs to have the largest positive impact, and why?

9. The managers of PC Software, an electronics mail order firm, have seen the stock price of the firm increase over the last year from $ 25 to $ 50, and are considering a stock split to bring to stock price down to what they view as a reasonable trading range. By doing so, they hope to make the stock more affordable and increase their investor base.

a. Would you agree with this rationale for a stock split? Why or why not?

b. How would you expect the stock price to react to the split? Why?

10. WeeKids, a firm that operates play arenas for children, has paid $ 1 as a dividend per share each year for the last 5 years. Due to a decline in revenues and increased competition, their earnings have plummeted this year. They substitute a $ 1 stock dividend for the cash dividend. What would you expect the market reaction to the stock dividend to be? Why?

11. In 1995, the Limited, the specialty retailing firm, announced that they were splitting up their businesses into three separate businesses - the Limited stores forming one business, Victoriaís secret and lingerie becoming the second business and their other holdings forming the third business. The Limited had been struggling over the previous four years with lackluster sales and operating profits overall, and the market reacted positively to the announcement. What might be some of the explanations for this reaction?

12. JW Bell, a regulated company, also has extensive holdings in non-regulated businesses and reports consolidated income from all segments. There are severe restrictions on investment and financing policy in the regulated component of the business. Can you provide a rationale for spinning off the non-regulated businesses?

13. An article in a business periodical recently argued that the only reason for spin offs and split offs was to make it easier for Wall Street to value firms. Why would a spin off or a split off make it easier to value a firm? Do you agree that this is the only reason for spin offs and split offs? If it were, what types of firms would you expect to take these actions?

14. JC Conglo Corporation is a firm that was founded in the 1960s and grew to become a conglomerate through acquisitions. It has substantial corporate costs that get allocated over the different divisions of the firm. Analysts argue that divesting the firm of these divisions will increase value, since the buyer will not have to pay the corporate costs. Under what conditions would spinning off the divisions of the firm add to value of the firm? Conversely, under what conditions would a spin off have a neutral effect on value.

15. RJR Nabisco, the food and tobacco giant, is waging a battle against dissident stockholders, who want it to divest itself of its food division and pay a large dividend to the stockholders. RJR Nabisco offers to spin off the food division, while keeping it under incumbent management. Are stockholders likely to be satisfied? Why or why not?