1.Westendorf Equipment is considering initiating a regular dividend payment to its shareholders. Westendorf’s P/E ratio has ranged between 12-13 times earnings over the last 5 years, but Deb Chafin, the company’s CFO, believes that the P/E ratio may increase when the company initiates its dividend. Chafin has compiled the following information.

§ The growth rate for the firm is 8 percent.

§ The current required return on Westendorf stock is 12 percent.

§ Initiating a dividend would lower the required return to 11 percent.

§ Next year’s earnings are estimated to be $5.00 per share.

§ Westendorf has a target dividend payout ratio of 50 percent.

Assuming that Chafin’s estimates are correct, Westendorf’s P/E ratio after the initiation of the dividend would be closest to:

A)   13.2.

B)   16.7.

C)   14.4.

D)   20.0.

2.If a company initiates a regular dividend payment, it may lead to the company having a higher price-to-earnings ratio. Which of the following dividend theories supports this phenomenon?

A)   Residual dividend theory.

B)   Tax aversion theory.

C)   Dividend irrelevance theory.

D)   Bird-in-the-hand theory.

3.Layne Publishing currently trades at $20.00 per share and has historically reinvested all of its earnings. Looking at strategic plan of its future investment opportunities, Layne’s management believes that the company’s investors would be better off if the company paid a dividend to its shareholders. Layne expects to make $2.00 per share in the next year, and expects to grow at a stable rate of 5.6 percent. Currently, investors require an 8.0 percent return on Layne stock, but management believes that after initiating a dividend, investors will perceive the firm as having a lower risk profile and lower their required return to 7.2 percent. If Layne currently trades at 10 times next year’s expected earnings, what will be the price of the stock if Layne initiates a $0.40 per share dividend?

A)   $25.00.

B)   $20.00.

C)   $22.50.

D)   $33.34.

1.Westendorf Equipment is considering initiating a regular dividend payment to its shareholders. Westendorf’s P/E ratio has ranged between 12-13 times earnings over the last 5 years, but Deb Chafin, the company’s CFO, believes that the P/E ratio may increase when the company initiates its dividend. Chafin has compiled the following information.

§ The growth rate for the firm is 8 percent.

§ The current required return on Westendorf stock is 12 percent.

§ Initiating a dividend would lower the required return to 11 percent.

§ Next year’s earnings are estimated to be $5.00 per share.

§ Westendorf has a target dividend payout ratio of 50 percent.

Assuming that Chafin’s estimates are correct, Westendorf’s P/E ratio after the initiation of the dividend would be closest to:

A)   13.2.

B)   16.7.

C)   14.4.

D)   20.0.

The correct answer was B)

Using the constant growth dividend discount model, a company’s P/E can be found by the formula P0/E1 = (D1/E1)/(ks - g). The lower value for ks results in a higher value for P0/E1. With the new value for ks , the P/E ratio for Westendorf would increase to (0.50) / (0.11 – 0.08) = 16.67.

2.If a company initiates a regular dividend payment, it may lead to the company having a higher price-to-earnings ratio. Which of the following dividend theories supports this phenomenon?

A)   Residual dividend theory.

B)   Tax aversion theory.

C)   Dividend irrelevance theory.

D)   Bird-in-the-hand theory.

The correct answer was D)

According to the bird-in-the-hand theory, a company that pays dividends is often perceived has having less risk and a lower cost of equity (ks). Using the constant growth dividend discount model, a company’s P/E can be found by the formula P0/E1 = (D1/E1)/(ks - g). The lower value for ks results in a higher value for P0/E1.

3.Layne Publishing currently trades at $20.00 per share and has historically reinvested all of its earnings. Looking at strategic plan of its future investment opportunities, Layne’s management believes that the company’s investors would be better off if the company paid a dividend to its shareholders. Layne expects to make $2.00 per share in the next year, and expects to grow at a stable rate of 5.6 percent. Currently, investors require an 8.0 percent return on Layne stock, but management believes that after initiating a dividend, investors will perceive the firm as having a lower risk profile and lower their required return to 7.2 percent. If Layne currently trades at 10 times next year’s expected earnings, what will be the price of the stock if Layne initiates a $0.40 per share dividend?

A)   $25.00.

B)   $20.00.

C)   $22.50.

D)   $33.34.

The correct answer was A)

Using the constant growth dividend discount model, a company’s P/E can be found by the formula P0/E1 = (D1/E1)/(ks - g). The lower value for ks results in a higher value for P0/E1. If Layne initiates a $0.40 dividend and the required rate of return drops to 7.2 percent, Layne’s P/E ratio based on next year’s earnings would be ($0.40 / $2.00) / (0.072 – 0.056) = 12.5. Based on next year’s earnings of $2.00 per share, the price of Layne stock would be $2.00 × 12.5 = $25.00.