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Assignment Questions:
A. Use the information in Case Study 29 to answer the following questions:
1. The Case Study highlights that Swenson must resolve whether to pay dividends or to buy back shares. In resolving this, what important issues must she consider? (3 Marks)
2. Exhibit 8 presents an estimate of the borrowing needed assuming a 40% dividend payout ratio. Using the Total 2005-11 column in this Exhibit as the basis for your analysis, what are the implications of different dividend payout levels for Gainesboro’s capital structure and unused debt capacity if:
(a) no dividends are paid?
(b) a 20% payout ratio is pursued?
(c) a 40% payout ratio is pursued?
(d) a residual payout policy is pursued?
For the purposes of this exercise assume that maximum debt capacity is, as a matter of policy, 40% of the book value of equity. Furthermore, assume that any excess cash (after funding the operations and dividend payments) is used to buy back shares. (4 Marks)
3. How might Gainesboro’s various providers of capital, such as its shareholders and creditors, react if Gainesboro: (a) declares a dividend in 2005? What are the arguments for and against the zero payout, 40% payout, and residual payout policies? (3 Marks)
(b) repurchases its shares? Should Gainesboro repurchase its shares? (1 Marks)
4. Should the advertising proposal have any bearing on these proposals? (1 Mark)
B. THIS NEXT QUESTION DOES NOT RELATE TO CASE STUDY 29. IT IS A STAND ALONE QUESTION.
5. For the following projects, assuming a cost of capital of 10%, calculate the Accounting Rate of Return, Net Present Value, Internal Rate of Return, Modified Internal Rate of Return, Payback Period, Present Value Index and Equivalent Annuity. Which project would you recommend?
| Year | A | B | |
| Project Cash Flows | 0 | (6,000) | (6,000) |
| 1 | 990 | 3600 | |
| 2 | 990 | 2700 | |
| 3 | 990 | 900 | |
| 4 | 990 | 270 | |
| 5 | 990 | 210 | |
| 6 | 990 | – | |
| 7 | 990 | – | |
| 8 | 3000 | – | |
| Sum of Cash Flow Benefits | 9,930 | 7,680 | |
| Excess of Cash Flow Over Initial Investment | 3,930 | 1,680 |
