Problem 19-20 Dividends versus Reinvestment
After completing its capital spending for the year, Carlson Manufacturing has $2,700 extra cash.
Carlson’s managers must choose between investing the cash in Treasury bonds that yield 6 percent or
paying the cash out to investors who would invest in the bonds themselves.
a. If the corporate tax rate is 39 percent, what personal tax rate would make the investors equally willing
to receive the dividend or to let Carlson invest the money? (Do not round intermediate
calculations.)
Personal tax rate
39
%
b. Is the answer to (a) reasonable?
Yes
No
c. Suppose the only investment choice is a preferred stock that yields 13 percent. The corporate
dividend exclusion of 70 percent applies. What personal tax rate will make the stockholders indifferent
to the outcome of Carlson’s dividend decision? (Do not round intermediate calculations and round
your final answer to 2 decimal places. (e.g., 32.16))
Personal tax rate
%
d. Is this a compelling argument for a low dividend payout ratio?
Yes
No
Problem 29-18 Mergers and Shareholder Value
The Chocolate Ice Cream Company and the Vanilla Ice Cream Company have agreed to merge and form
Fudge Swirl Consolidated. Both companies are exactly alike except that they are located in different
towns. The end-of-period value of each firm is determined by the weather, as shown below. There will be
no synergy to the merger.
State
Rainy
Warm
Hot
Probability Value
.1
$ 320,000
.4
500,000
.5
980,000
The weather conditions in each town are independent of those in the other. Furthermore, each company
has an outstanding debt claim of $500,000. Assume that no premiums are paid in the merger.
a. What are the possible values of the combined company? (Do not round intermediate calculations.)
Possible states
Rain-Rain
Joint Value
$
Rain-Warm
Rain-Hot
Warm-Warm
Warm-Hot
Hot-Hot
b. What are the possible values of end-of-period debt values and stock values after the merger? (Leave
no cells blank – be certain to enter "0" wherever required. Do not round intermediate
calculations.)
Rain-Rain
Rain-Warm
Rain-Hot
Warm-Warm
Warm-Hot
Hot-Hot
Debt Value
$
Stock Value
$
c. How much do stockholders and bondholders each gain or lose if the merger is
undertaken? (Negative amount should be indicated by a minus sign. Do not round intermediate
calculations )
Bondholder gain/loss
Stockholder gain/loss
Problem 29-12 Effects of a Stock Exchange
Consider the following premerger information about Firm A and Firm B:
Total earnings
Shares outstanding
Price per share
Firm A
$ 1,500
900
$
33
Firm B
$ 1,100
250
$
37
Assume that Firm A acquires Firm B via an exchange of stock at a price of $39 for each share of B’s
stock. Both A and B have no debt outstanding.
a. What will the earnings per share, EPS, of Firm A be after the merger? (Do not round intermediate
calculations and round your final answer to 2 decimal places. (e.g., 32.16))
$
EPS
b. What will Firm A’s price per share be after the merger if the market incorrectly analyzes this reported
earnings growth (that is, the price–earnings ratio does not change)? (Do not round intermediate
calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Price per share
$
c. What will the price–earnings ratio of the postmerger firm be if the market correctly analyzes the
transaction? (Do not round intermediate calculations and round your final answer to 2 decimal
places. (e.g., 32.16))
times
Price-earnings
d-1. If there are no synergy gains, what will the share price of A be after the merger? (Do not round
intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Price per share
$
d-2. What will the price–earnings ratio be? (Do not round intermediate calculations and round your
final answer to 2 decimal places. (e.g., 32.16))
Price-earnings
times
d-3. What does your answer for the share price tell you about the amount A bid for B? Was it too high?
too low?
Too high
Too low
