GSLC Session 17 & 18

Javier Noel Claudio

2301949040
Accounting Technology
Corporate Financial Management
LB90
P14-4
Dividend constraints Plastic Enterprises’ stockholders’ equity account is as follows:

Common stock (280,000 shares at $3.50 par) $980,000

Paid-in capital in excess of par $900,000
Retained earnings $1,200,000
Total stockholders’ equity $3,080,000

The earnings available for the common stockholders are $280,000 and are included as part of the
$1,200,000 retained earnings.

a. Calculate the maximum dividend per share that the firm can pay if the legal capital
includes all paid-in capital.

Retained Earnings
Maximum dividend per share =
Number of shares
1,200,000
=
280,000
= 4,285

b. Calculate the maximum dividend per share that the firm can pay if the legal capital
includes only the value of the common stock.

Retained Earnings+ paid ∈capital

Maximum dividend per share =
Number of shares
1,200,000+ 900,000
=
280,000
= 7.5

c. If Plastic Enterprises has $25,000 in cash, what is the largest per-share dividend it
can pay without borrowing, assuming legal capital includes all paid-in capital?

Cash
Largest dividend can be paid without borrowing =
Number of shares
25,000
=
280,000
= 0,089

d. What the purpose of capital impairment restrictions when developing a dividend

policy?
The capital impairment rule is a state-level legal restriction on corporate dividend policy. The rule
applies in most U.S. states. It basically limits the amount of dividends a company can pay out to
shareholders. The purpose of the rule is to protect claims of creditors

P14-6
Low-regular-and-extra dividend policy Cromwell Laboratories has a target payout ratio of 60%.
However, the board realizes the that adhering strictly to the payout ratio will cause the dividend
payout to fluctuate. Therefore, the board has declared regular dividend of $0.75 per share per year
while paying extra cash dividends if funds are available. Earnings per share for the period 2015 to
2020 are shown in the following table.

Year EPS Year EPS

2020 $3.50 2017 $2.40
2019 $3.10 2016 $2.35
2018 $2.80 2015 $1.95

a. Calculate the payout ratio for each year on the basis of the regular dividend payment
and the EPS given.
Calculation of payout ratio of each year

Year Earning per Share Dividend Payable Payout Ratio =

Divided Payable
EPS
2015 $1.95 $ 0.75 38.46%
2016 2.35 0.75 31.91%
2017 2.40 0.75 31.25%
2018 2.80 0.75 26.79%
2019 3.10 0.75 24.19%
2020 3.50 0.75 21.43%

b. For each year, what is the difference between the regular $0.75 dividend and a 60%
payout?
Difference between the regular $0.75 dividend and a 60% payout

Year Earning per Payout (0.60 x Reguler Difference

Share EPS) Dividend
2015 $1.95 $1.17 $ 0.75 $0.42
2016 2.35 1.41 0.75 0.66
2017 2.40 1.44 0.75 0.69
2018 2.80 1.68 0.75 0.93
2019 3.10 1.86 0.75 1.11
2020 3.50 2.1 0.75 1.35
c. Cromwell Laboratories decides to pay an extra dividend of $0.50 in years when the
difference between the regular $0.75 dividend and the 60% payout is at least $0.70.
Indicate the dividend payments and “extra” dividend payments, if any, for each year.
Dividend payments and extra dividend payments(if any) for each year

Year Difference Normal Extra Total

Dividend Dividend Dividend
2015 $0.42 $ 0.75 $ 0.75
2016 0.66 0.75 0.75
2017 0.69 0.75 0.75
2018 0.93 0.75 0.5 1.25
2019 1.11 0.75 0.5 1.25
2020 1.35 0.75 0.5 1.25

d. The company estimates future earnings per share will remain above $3.20 per share
for most years. If the board wants to increase the regular dividend from $0.75 to
$1.25, what factors should it consider implementing the new regular dividend?
If the firm expects the earnings to remain above the earnings per share (EPS) of $3.20 the dividend
should be raised to $0.75 per share. The 75 cents per share will retain the 60% target payout but allow
the firm to pay a higher regular dividend without jeopardizing the cash position of the firm by paying
too high of a regular dividend.

P14-9
Stock dividend: Firm The stockholders’ equity account for Paper Manufacturers is shown below.
The firm’s common stock has a current market price of $20 per share.

Preferred stock $100,000

Common stock (120,000 shares at $4 par) $480,000
Paid-in capital in excess of par $1,920,000
Retained earnings $360,000
Total stockholders’ equity $2,860,000

a. How will the stockholders’ equity account changes if Paper Manufacturers pays a
5% stock dividend?
Number of shares issued of dividend = 120,000 x 5%
=6000
Increase in common stock =6000 x $4
=$24,000
Increase in paid-in capital in excess of par=6000 x $16
=$96,000
Decrease in retained earnings =6000 x 20
=$120,000
b. How will the stockholders’ equity account changes if Paper Manufactures pays (1) a
10% and (2) a 15% stock dividend?

1) 10% stock dividend

Number of shared issued of dividend =$120,000 x 10%
=12,000
Increase in common stock =12,000 x $4
=48,000
Increase in paid-in capital in excess of par=12,000 x $16
=$192,000
Decrease in retained earnings =12,000 x 20
=$240,000

2) 15% stock dividend

Number of shared issued of dividend =$120,000 x 15%
=18,000
Increase in common stock =18,000 x $4
=72,000
Increase in paid-in capital in excess of par=18,000 x $16
=$288,000
Decrease in retained earnings =18,000 x 20
=$360,000

c. What are the effects of stock dividends on stockholders’ equity?

Stockholders’ equity has not changed. Funds have only been redistributed between the stockholders’
equity accounts

P14-13
Stock split: Firm The stockholders’ equity account of Paper Weight Company is a follow:

Preferred stock $300,000

Common stock (200,000 shares at $5 par) $1,000,000
Paid-in capital in excess of par $500,000
Retained earnings $820,000
Total stockholders’ equity $2,620,000

a. How will stockholders’ equity account changes if Paper Weight Company declares a
2-for-1 stock split?
 When the company declares a 2 for 1 stock split, it will increase the number of
outstanding common shares and reduce the par value per share. The total value of
common stock will remain the same.
 Number of outstanding common shares before stock split
= 200,000 shares
 Number of outstanding common shares after stock split
= Number of shares × Stock split ratio
= 200,000 × 2/1
= 400,000 shares
 Par value per share
= Par value ÷ Stock split ratio
= $5 ÷ 2/1
= $2.50 per share.
 Total value of common shares
= Number of shares outstanding × Par value per share
= 400,000 × $2.50
= $1,000,000

The number of shares and par value per share of common stock in the stockholders'
equity account will alone change.
It will appear as follows:
Common stock (400,000 shares at $2.50 par) = $1,000,000

b. How will stockholders’ equity account changes if Paper Weight Company declares a
1-for-2 reverse stock split?
When the company declares a 2 for 1 stock split, it will increase the number of
outstanding common shares and reduce the par value per share. The total value of
common stock will remain the same.
 Number of outstanding common shares before stock split
= 200,000 shares
 Number of outstanding common shares after stock split
= Number of shares × Stock split ratio
= 200,000 × 1/2
= 100,000 shares
 Par value per share
= Par value ÷ Stock split ratio
= $5 ÷ 1/2
= $10 per share.
 Total value of common shares
= Number of shares outstanding × Par value per share
= 100,000 × $10
= $1,000,000

The number of shares and par value per share of common stock in the stockholders'
equity account will alone change.
It will appear as follows:
Common stock (100,000 shares at $10 par) = $1,000,000
c. Indicate the change, if any, expected if the firm declares a 3-for-1 stock split.
When the company declares a 3 for 1 stock split, it will increase the number of
outstanding common shares and reduce the par value per share. The total value of
common stock will remain the same.
 Number of outstanding common shares before stock split
= 200,000 shares
 Number of outstanding common shares after stock split
= Number of shares × Stock split ratio
= 200,000 × 3/1
= 600,000 shares
 Par value per share
= Par value ÷ Stock split ratio
= $5 ÷ 3/1
= $1.67 per share.
 Total value of common shares
= Number of shares outstanding × Par value per share
= 600,000 × $1.67
= $1,000,000
The number of shares and par value per share of common stock in the stockholders'
equity account will alone change.
It will appear as follows:
Common stock (600,000 shares at $1,67 par) = $1,000,000

d. How will the stockholders’ equity account change if Paper Weight Company declares
a 1-for-4 reverse stock split?
When the company declares a 1 for 4 stock split, it will increase the number of
outstanding common shares and reduce the par value per share. The total value of
common stock will remain the same.
 Number of outstanding common shares before stock split
= 200,000 shares
 Number of outstanding common shares after stock split
= Number of shares × Stock split ratio
= 200,000 × 1/4
= 50,000 shares
 Par value per share
= Par value ÷ Stock split ratio
= $5 ÷ 1/4
= $20 per share.
 Total value of common shares
= Number of shares outstanding × Par value per share
= 50,000 × $20
= $1,000,000
The number of shares and par value per share of common stock in the stockholders'
equity account will alone change.
It will appear as follows:
Common stock (50,000 shares at $20 par) = $1,000,000