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Problem 14-8 Alternative dividend policies

Rubenstein Bros. Clothing is expecting to pay an annual dividend per share of $1.05 out of annual earnings per share of $4.5. Currently, Rubenstein Bros.' stock is selling for $23.00 per share. Adhering to the company's target capital structure, the firm has $10 million in total invested capital, of which 30% is funded by debt. Assume that the firm's book value of equity equals its market value. In past years, the firm has earned a return on equity (ROE) of 18%, which is expected to continue this year and into the foreseeable future.

1. Based on this information, what long-run growth rate can the firm be expected to maintain? Round your answer to two decimal places. Do not round intermediate calculations. (Hint: g = Retention rate x ROE.) Answer: _____ %

2. What is the stock's required return? Round your answer to two decimal places. Do not round intermediate calculations. Answer: ______ %

3. If the firm changed its dividend policy and paid an annual dividend of $2.10 per share, financial analysts would predict that the change in policy will have no effect on the firm's stock price or ROE. Therefore, what must the firm's new expected long-run growth rate? Round your answer to two decimal places. Do not round intermediate calculations. Answer: ________ % 4. If this plan is implemented, what must the firm's required return be? Round your answer to two decimal places. Do not round intermediate calculations. Answer: _______ %

5. Suppose instead that the firm has decided to proceed with its original plan of disbursing $1.05 per share to shareholders, but the firm intends to do so in the form of a stock dividend rather than a cash dividend. The firm will allot new shares based on the current stock price of $23.00. In other words, for every $23.00 in dividends due to shareholders, a share of stock will be issued. How large will the stock dividend be relative to the firm's current market capitalization? (Hint: Remember market capitalization = P₀ x number of shares outstanding.) Round your answer to two decimal places. Do not round intermediate calculations. Answer: _______ %

7. If the plan in part d is implemented, how many new shares of stock will be issued? Round your answer to the nearest whole dollar. Do not round intermediate calculations. Answer: $_______ If the plan in part d is implemented, by how much will the company's earnings per share be diluted? Round your answer to the nearest cent. Do not round intermediate calculations. Answer: $_______

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