QUESTIONAssume that it is now January 1, 2017. Wayne-Martin Electric Inc. (WME) has developed a solar panel capable of generating 200% more electricity than any other solar panel currently on the market. As a result, WME is expected to experience a 15% annual growth rate for the next 5 years. Other firms will have developed comparable technology by the end of 5 years, and WME’s growth rate will slow to 5% per year indefinitely. Stockholders require a return of 12% on WME’s stock. The most recent annual dividend $\left(\mathrm{D}_{0}\right)$, which was paid yesterday, was $1.75 per share. a. Calculate WME’s expected dividends for 2017, 2018, 2019, 2020, and 2021. b. Calculate the value of the stock today,$$\hat{\mathrm{P}}$_{0}$. Proceed by finding the present value of the dividends expected at the end of 2017, 2018, 2019, 2020, and 2021 plus the present value of the stock price that should exist at the end of 2021. The year end 2021 stock price can be found by using the constant growth equation. Notice that to find the December 31, 2021, price, you must use the dividend expected in 2022, which is 5% greater than the 2021 dividend. c. Calculate the expected dividend yield$\left($\mathrm{D}$_{1} / $\mathrm{P}$_{0}\right)$, capital gains yield, and total return (dividend yield plus capital gains yield) expected for 2017. (Assume that$$\hat{\mathrm{P}}$_{0}=$\mathrm{P}$_{0}$ and recognize that the capital gains yield is equal to the total return minus the dividend yield.) Then calculate these same three yields for 2022. d. How might an investor’s tax situation affect his or her decision to purchase stocks of companies in the early stages of their lives, when they are growing rapidly, versus stocks of older, more mature firms? When does WME’s stock become “mature” for purposes of this question? e. Suppose your boss tells you she believes that WME’s annual growth rate will be only 12% during the next 5 years and that the firm’s long-run growth rate will be only 4%. Without doing any calculations, what general effect would these growth rate changes have on the price of WME’s stock? f. Suppose your boss also tells you that she regardsWME as being quite risky and that she believes the required rate of return should be 14%, not 12%. Without doing any calculations, determine how the higher required rate of return would affect the price of the stock, the capital gains yield, and the dividend yield. Again, assume that the long-run growth rate is 4%. QUESTIONSt. Johns River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $24,000 to$46,000 per year. The new machine will cost $80,000; and it will have an estimated life of 8 years and no salvage value. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The applicable corporate tax rate is 40%, and the firm’s WACC is 10%. The old machine has been fully depreciated and has no salvage value. Should the old riveting machine be replaced by the new one? Explain your answer. QUESTIONSoutheastern Steel Company (SSC) was formed 5 years ago to exploit a new continuous casting process. SSC’s founders, Donald Brown and Margo Valencia, had been employed in the research department of a major integrated-steel company; but when that company decided against using the new process (which Brown and Valencia had developed), they decided to strike out on their own. One advantage of the new process was that it required relatively little capital compared to the typical steel company, so Brown and Valencia have been able to avoid issuing new stock and thus own all of the shares. However, SSC has now reached the stage in which outside equity capital is necessary if the firm is to achieve its growth targets yet still maintain its target capital structure of 60% equity and 40% debt. Therefore, Brown and Valencia have decided to take the company public. Until now, Brown and Valencia have paid them-salves reasonable salaries but routinely reinvested all after-tax earnings in the firm; so the firm’s dividend policy has not been an issue. However, before talking with potential outside investors, they must decide on a dividend policy. Assume that you were recently hired by Arthur Adamson & Company (AA), a national consulting firm, which has been asked to help SSC prepare for its public offering. Martha Millon, the senior AA consultant in your group, has asked you to make a presentation to Brown and Valencia in which you review the theory of dividend policy and discuss the following questions: a. 1. What is meant by the term dividend policy? 2. Explain briefly the dividend irrelevance theory that was put forward by Modigliani and Miller. What were the key assumptions underlying their theory? 3. Why do some investors prefer high-dividend-paying stocks, while other investors prefer stocks that pay low or nonexistent dividends? b. Discuss (1) the information content, or signaling, hypothesis; (2) the clientele effect; (3) catering theory; and (4) their effects on dividend policy. c. 1. Assume that SSC has an $800,000 capital budget planned for the coming year. You have determined that its present capital structure (60% equity and 40% debt) is optimal, and its net income is forecasted at$600,000. Use the residual dividend model to determine SSC’s total dollar dividend and payout ratio. In the process, explain how the residual dividend model works. Then explain what would happen if expected net income was $400,000 or$800,000. 2. In general terms, how would a change in investment opportunities affect the payout ratio under the residual dividend model? 3. What are the advantages and disadvantages of the residual policy? (Hint: Don’t neglect signaling and clientele effects.) d. Describe the series of steps that most firms take in setting dividend policy in practice. e. What is a dividend reinvestment plan (DRIP), and how does it work? f. What are stock dividends and stock splits? What are the advantages and disadvantages of stock dividends and stock splits? g. What are stock repurchases? Discuss the advantages and disadvantages of a firm’s repurchasing its own shares. QUESTIONIn 2015, Keenan Company paid dividends totaling $3,600,000 on net income of$10.8 million. Note that 2015 was a normal year and that for the past 10 years, earnings have grown at a constant rate of 10%. However, in 2016, earnings are expected to jump to $14.4 million and the firm expects to have profitable investment opportunities of$8.4 million. It is predicted that Keenan will not be able to maintain the 2016 level of earnings growth because the high 2016 earnings level is attributable to an exceptionally profitable new product line introduced that year. After 2016, the company will return to its previous 10% growth rate. Keenan’s target capital structure is 40% debt and 60% equity. a. Calculate Keenan’s total dividends for 2016 assuming that it follows each of the following policies: 1. Its 2016 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. 2. It continues the 2015 dividend payout ratio. 3. It uses a pure residual dividend policy (40% of the $8.4 million investment is financed with debt and 60% with common equity). 4. It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual dividend policy. b. Which of the preceding policies would you recommend? Restrict your choices to the ones listed but justify your answer. c. Assume that investors expect Keenan to pay total dividends of$9,000,000 in 2016 and to have the dividend grow at 10% after 2016. The stock’s total market value is $180 million. What is the company’s cost of equity? d. What is Keenan’s long-run average return on equity? [Hint: g=Retention rate [math]\times[/math] ROE=(1.0-Payout rate)(ROE)] e. Does a 2016 dividend of$9,000,000 seem reasonable in view of your answers to parts c