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Case Study: Stock Valuation and Bond Issuance
Robert Shulzinsky
Southern New Hampshire University
December 16, 2017
A. From the figures provided compute;
1. The new dividend yield if the company increased its dividend per share by 1.75
Dividends yield is given by the formula =
The above formula or equation based on the dividend yield is normally used for calculation of the percentage return on stock in respect to dividends accrued over the period. Generally, the total return on a stock is termed as the accrued overall dividends and appreciation of a stock in the specifications. Moreover, dividends paid for a company is found on the statement on retained earnings, hence is used to compute dividends per share.
Dividends Yield Formula
The formula is used by investors who opt to focus on increasing or declining rate of the dividend yield. On wide angle, an organization or a firm that is spending less in dividends in regard to its price probably having problems or retaining most of a percentage on net income for its development. When inspecting stock, it is good to consider the whole company and its net income being retained since reinvesting on net income would lead to appreciation of the stock value and the general growth.
This formula is of greater interest on investors who depends mainly on dividends from their normal savings and investment. Furthermore, lower yield on dividends does not mean little dividends since the price may substantially be increased. As illustrated before, a sequence of declining yield on dividends may only warrant inspection but not immediate decline of the proposed investment.
The dividend Yield is calculated as= =
2. The dividend yield if the firm doubled its outstanding shares
The dividend on stock and corresponding stock split generally increase the number of outstanding shares while others remains constant, the price of stock decreases. Hence, the price of the stock dilutes further on stock dividend /stock split.
Furthermore, stock split comprises of a decision by the organization or firm board of directors aimed at increasing the shares that may be outstanding facilitated by giving more shares to the general shareholders’. in a 2-for-1 stock split, each shareholder owning a stock is given an extra share. For example, if a firm had 10m shares pending before split, it tends to be holding 20m outstanding shares after (2-for-1 split).
The price of stock is influenced directly by a stock split. Immediately after split, the price of stock is reduced since the actual number of outstanding shares goes higher. In the above 2-for-1 split example the actual price would be halved. Hence, despite the change on the outstanding shares and stock number, market capitalization pertains i.e. never change.
When or if the company doubled its outstanding shares, the price of stock will thus be halved, which will be $39.47.
Now dividend Yield will be= =
3. The rate of return on equity (i.e., the cost of stock) based on the new dividend yield you calculated above
The return on equity ratio or ROE is an interest or profit ratio that evaluates the ability of a company to increase profit returns from shareholders investments within the firm. On another case, the return on equity ratio reflects total profit on each dollar on individual stockholders' equity earned or generated.
Generally, return on 1 implies that each dollar of normal stockholders' equity earns 1 dollar on the total net income. It is an important measure for investors since they opt to see how effective a fill would use their cash capital to increase net income generation. It is also an indicator on the effective management it employs the use of equity financing policy and terms to finance operations to enhance company growth.
Return on equity ratio = = .
B. What effect would you expect each of the calculations you performed to have in terms of shareholder value? In other words, suppose the company’s goal is to maximize shareholder value. How will each of the situations support or inhibit that goal? Be sure to justify your reasoning.
Dividends influences the price in stock on the following discussed three major ways. Basically, when a certain dividend is paid for, the accrued value is subtracted from the specific firm’s or organization retained earnings. These earnings are termed as the total profit accrued or received by a company after accumulating consecutively over time which has not been placed to other alternative uses. In simple words, the total amount of money a firm has in account which can be used to pay dividends and fund companies projects.
When big firms and companies tend to display dividend histories, they seem more effective and efficient for investors. Thus, many investors come in to utilize the advantage the benefit of stock ownership, definitely the price of stock naturally shift upwards, hence increasing the belief that the stock is firm in the market. In case a company releases a higher-than-normal dividend, general public tends to break in and soar.
However, when a firm that analogically pay dividend issues a lower-than-normal dividend, it may end up to be perceived as a sign of failure or collapse on the company during hard times. Honestly it could be, the company's profits generated are being misused or used for other un necessary purposes, but in real market's reflection on the situation is always stronger and influential than the reality. For such companies, they work hard to pay consecutive dividends for the sake of avoiding spooking business investors who feel the investment as darkly, scamming and foreboding.
Dividend Declaration and Distribution
When a dividend is to be distributed, issuing firm first declare the amount in it plus the date it will be paid. Further, announces the last date where the free shares can be bought to receive dividend, namely the ex-dividend date. The date is conducted in two business days in respect to the date in the record, i.e. date on which the company reviews the list of its genuine and trusted shareholders.
The dividend declaration naturally promotes investors to increase on stock purchases. Since investors are aware and sure to receive a dividend if they buy more stock prior to ex-dividend date, they would fully be willing to pay all premiums required earlier. This poses price increment on stock in within the days leading to the ex-dividend date. Moreover, the increment almost equal to amount of the dividend. However, the actual price variation is based on market activities and is not influenced by the governing entities.
During the specified ex-dividend date, exchange decreases the price of the stock to the amount of the dividend to compensate for the fact that new business investors may not eligible to receive dividends hence unwilling to pay premiums. More also, when the market is certainly optimistic about the stock leading to ex-dividend date, price shifts upwards and creates thus may be greater than normal dividend value, leading to a net increase in respect of the automatic decrement. Incase dividend is not large; the decrement may shift unnoticed because of back and forth in the normal trading. It is established that many investors buy shares just slightly before the ex-dividend date and sell again slightly after the date of record. This tactic fetches more money.
C. To what extent do you feel the company’s dividend policies support or hinder their strategies? For example, if the company is attempting to grow, are they retaining and reinvesting their earnings rather than distributing them to investors through dividends? Be sure to substantiate your claims.
As to whether a dividend paid to individual shareholders influences the issuing firm's retained earnings, it primary depends entirely on type of dividend accrued. Cash dividends have a straight impact on retained earnings and the general issuance of stock on the dividends is quite complicated.
If a firm or organization wish to issue dividends to shareholders and don't have extra cash on hold, it may opt to use a stock dividend. Any company may also adopt this alternative as a way of reducing the value of existing shares, pulling down the price (P/E) ratio and other financial factors. Similarly called bonus shares, a dividend on stock alters the firm balance sheet in many ways depending on the issuance size.
When the shares outstanding figures increases by less than 20 to 25%, dividend is referred to as small. If a small dividend is suddenly declared, retained earning value on the account is debited by specific product on the current price of the market per share, outstanding number of shares and percentage dividend on stock. This systematic equation yields the bonus value for specified shares in dollars. In above case, when company ABC has 1.5m shares outstanding and selling at $50 per share, thus it may or announces a 10% stock dividend, then retained earnings account is then debited by the calculations as1,500,000 * 10% * $50, / $7.5 million.
If this was paid in cash dividend, it would be terminating the desired or above calculation. But since it has not paid any cash / value of the above business remains constant, the figure is reassigned direct from retained earning account through paid-in capital final to common stock accounts after issuance of available bonus shares. Moreover, common stock account (credit) = product of the total new shares issued * by the par value per share. The R is then credited as paid-in capital (reminder).
If shares on above example have a par value of 1 cent, then amount credited to common stock =1,500,000 * 10% * $0.01, simply= $1,500. The R= $7,498,500 is credited to the paid-in capital account (R-reminder). The overall worth of the company pertains or remains constant, but only assets allocation is altered.
If stock dividend raises up the number of shares outstanding in more than 20 to 25%, it is referred as a large dividend hence the accounting varies slightly. In above case, only par value of the current shares is debited direct from the retained earning account more also reassigned to common stock account after the dividend has been distributed. When a company ABC instead releases a 50% dividend, the total amount debited from retained earning account should now be =1,500,000 * 50% * $0.01, simply= $7,500. This because only the par value in the bonus shares was taken into the account.
When small stock dividend poses a greater impact on the retained earning account, the overall credit worth of the company normally remains constant or un altered by stock dividends for any available size.
3. Bond Issuance
A. By assuming this company already has bonds outstanding, calculate the following:
1. The new value of the bond if overall rates in the market increased by 5%
Assuming this company already has bonds outstanding
· The Par value=$1,000
· The Maturity date = 5 years
· The Market interest rate = 8%
· The Annual coupon payment = $80
Present value of a bond = Present Value of the Coupon Payments (an annuity) + The Present Value of the Par Value (i.e. Time value of money) = INT = $319.42+$ 680.58=$1000.003
Assuming the interest rate increase from 8% to 13%.
New bond value = Present Value of the Coupon Payments (an annuity) Present Value of the Par Value (time value # money) given by formula = INT = $281.38+$ 542.76=$824.14
2. The new value of the bond if overall rates in the market decreased by 5%
Assume the interest rate decrease from 8% to 3%.
New bond value = Present Value of the Coupon Payments (an annuity) + Present Value of Par Value (time value # money) = INT = $366.38+$ 862.61=$1228.99
3. The value of the bond if overall rates in the market stayed exactly the same
The bond value will remain constant if the overall rates in the market maintain exactly the same/ constant.
Present bond value = Present Value of the Coupon Payments (an annuity) + Present Value of Par Value (time value # money) = INT = $319.42+$ 680.58=$1000.003
B. What effect would you expect each of the calculations you performed to have in terms of the company’s decision to raise capital in this manner? In other words, for each situation, would you consider bond valuation to be a viable option for increasing capital? Be sure to justify your reasoning.
The fundamental principle behind bond investing is the fact that interest rates in market and prices of bonds move in opposite orientations. Incase market interest rates increases, prices on fixed-rate bonds drops down. This process generally referred to as interest rate risk. Based on this phenomenon, bond valuation seizes from being viable option for continuous increase in capital. Contrary to this where market interest rates drop down, the bond prices tend to rise. Hence, interest rate risk unique and similar to all bonds more also to treasury bonds.
A bond’s maturity and coupon rate generally affect how much its price will change as a result of changes in market interest rates. If two bonds offer different coupon rates while all of their other characteristics (e.g., maturity and credit quality) are the same, the bond with the lower coupon rate generally will experience a greater decrease in value as market interest rates rise. Bonds offering lower coupon rates generally will have higher interest rate risk than similar bonds that offer higher coupon rates.
When interest rates in the market falls, the bond value increase has the bond's fixed interest payments becomes greater compared to amounts available in current bonds issued at new interest rates in the market.
References:
1.https://www.sec.gov/investor/alerts/ib_interestraterisk.pdf
2. http://www.financeformulas.net/Dividend_Yield.html
3.http://www.investopedia.com/ask/answers/113.asp
4.http://www.myaccountingcourse.com/financial-ratios/return-on-equity
5.http://www.investopedia.com/articles/investing/091015/how-dividends-affect-stock-prices.asp