ur choice 1. Explain each of the following dividend types? a) Regular dividend b) Liquidating dividend c) Extra dividend

Question

2. Describe the advantages and disadvantages of each of the following dividend policies? a) Residual dividend policy b) Regular dividend policy c) The low regular plus extra dividend policy
3. Describe each of the following concepts: a) Stock split b) Reverse stock split c) Stock repurchases d) Stock dividend e) Dividend reinvestment plan
4. Alpha Company has capital investment need of Br 100,0000,000. The company has net income of Br 150,000,000 for the year ended December 31, 2017. The target capital structure of the company is 40% debt and 60% equity. If the company uses the residual dividend policy, what is the dividend to be paid in the year?
5. Distinguish among the following investment policies of working capital. a) Relaxed policy b) Restricted policy c) Moderate policy6. What are the implications of the following working capital financing
policies:
a) Maturity matching policy
b) Conservative policy
c) Aggressive policy
7. List and explain at least six factors that determine the level of working
capital a company holds.
8. What effect will the following events have on the cash conversion cycle?
a) Higher financing rates induce the firm to reduce its level of inventory.
b) The firm obtains a new line of credit that enables it to avoid stretching
payables to its suppliers.
c) The firm factors its accounts receivable.
d) A recession occurs, and the firm’s customers increasingly stretch
their payables
9. What are the costs and benefits of holding a) cash b) receivables c)
inventories?
10. Lock Boxes. Sherman’s Sherbet currently takes about 6 days to collect
and deposit checks from customers. A lock-box system could reduce this
time to 4 days. Collections average $10,000 daily. The interest rate is .02
percent per day.v
a) By how much will the lock-box system reduce collection float?
b) What is the daily interest savings of the system?
c) Suppose the lock-box service is offered for a fixed monthly fee instead
of payment per check. What is the maximum monthly fee that
Sherman’s should be willing to pay for this service? (Assume a 30-day
month.)
11. Baumol’s Model: Assume that Everyman’s Bookstore uses up cash at a
steady rate of $200,000 a year. The interest rate is 2 percent and each
sale of securities costs $20.a) What it the economic level of cash that the store should convert from marketable securities at a time?
b) How many times a year should the store sell securities? c) What is its average cash balance? d) What it the annual opportunity cost of holding cash for the store? e) What is the annual cost of trading securities for the store?
12. Economic Order Quantity. Micro-Encapsulator Corp. (MEC) expects to sell 7,200 miniature home encapsulators this year. The cost of placing an order from its supplier is $250. Each unit costs $50 and carrying costs are 20 percent of the purchase price. a) What is the economic order quantity? b) What are total costs—order costs plus carrying costs—of inventory over the course of the year?
13. Alpha Company usually purchases goods on terms of 3/15, n/45. What is the annualized cost of not taking the discount?
14. Explain the 5 C’s of credit standard? 15. List and explain aat least three factors that determine the length of credit period that a firm provides to its customers.

Answer 1

Here are the explanations and analyses requested:

1. Types of Dividends

a) Regular Dividend: A regular dividend is a consistent payment that a company makes to its shareholders, typically on a quarterly basis. This payment is usually derived from the company’s profits and shows the company's stability and ongoing financial health.

b) Liquidating Dividend: A liquidating dividend occurs when a company pays out some or all of its assets to shareholders as it winds down operations. This type of dividend typically occurs during the liquidation process when a company is dissolved, and shareholders receive their shares of the firm’s remaining assets.

c) Extra Dividend: An extra dividend is a one-time payment to shareholders, which is above the regular dividend. It often occurs when a company has excess profits or cash reserves and wants to reward its shareholders without committing to making higher regular dividends in the future.

2. Dividend Policies Advantages and Disadvantages

a) Residual Dividend Policy:

• Advantages: Aligns dividends with investment opportunities, likely to maintain a stable share price, can increase shareholder value when good profitable projects exist.
• Disadvantages: Can lead to unpredictable dividends, making it less attractive for income-seeking investors; requires well-functioning communication of the firm’s investment strategy.

b) Regular Dividend Policy:

• Advantages: Provides consistent income for shareholders, can attract and retain investors looking for regular income, reflects financial stability.
• Disadvantages: Limits the amount of equity available for reinvestment in growth projects, may lead to a risk of financial strain if earnings drop.

c) The Low Regular Plus Extra Dividend Policy:

• Advantages: Maintains a base income for shareholders while allowing for extra distributions when surplus cash is available, showing flexibility and potentially increasing shareholder loyalty.
• Disadvantages: May project uncertainty in the continuation of extra dividends, can lead to confusion among investors regarding future payouts.

3. Financial Concepts

a) Stock Split: A stock split occurs when a company divides its existing shares into multiple shares to boost the liquidity of the shares. The market capitalization remains unchanged, but the price per share is reduced.

b) Reverse Stock Split: This is the opposite of a stock split; a company consolidates its shares to reduce the number of outstanding shares and increase the stock price. This may be done to meet minimum price requirements for stock exchanges or to improve the perceived image.

c) Stock Repurchases: A stock repurchase (or buyback) is when a company buys back its own shares from the marketplace, reducing the number of outstanding shares. It can signal to investors that the company is confident about its future.

d) Stock Dividend: A stock dividend is a payment made to shareholders in the form of additional shares instead of cash. It retains the company's cash within the business while rewarding shareholders.

e) Dividend Reinvestment Plan (DRIP): A DRIP allows shareholders to reinvest their cash dividends into additional shares of the company’s stock, often at a discounted price, thereby encouraging further investment in the company.

4. Residual Dividend Policy Calculation

• Given:

  • Total capital investment need = Br 100,000,000
  • Net income = Br 150,000,000
  • Target capital structure: 40% debt, 60% equity

  To calculate dividends, we need to ascertain the equity using the residual policy:

  • Equity needed for investment = 60% of Br 100,000,000 = Br 60,000,000
  • Earnings available after capital needs = Net Income - Equity needed
  • Br 150,000,000 - Br 60,000,000 = Br 90,000,000 available for dividends.

Thus, the dividend to be paid = Br 90,000,000.

5. Investment Policies of Working Capital

a) Relaxed Policy: This approach maintains a high level of inventory and receivables, leading to increased liquidity but higher carrying costs and potentially less efficient capital use.

b) Restricted Policy: This policy maintains minimal inventory levels and tight credit controls, thus reducing carrying costs and maximizing efficiency, but can lead to stockouts and lost sales.

c) Moderate Policy: This is a balanced approach where the company maintains a sufficient amount of working capital to meet operational needs while managing costs effectively.

6. Working Capital Financing Policies

a) Maturity Matching Policy: Aligning the financing of current assets and liabilities with their respective maturities reduces the risk of illiquidity.

b) Conservative Policy: Financing more of the working capital with long-term debt provides a buffer against fluctuations in current assets and liabilities.

c) Aggressive Policy: Using a larger portion of short-term financing can maximize returns during favorable conditions but increases the risk during downturns due to potential cash flow issues.

7. Factors Determining Working Capital Levels

1. Nature of Business: Seasonal businesses may require more working capital during peak periods.
2. Sales Forecasts: Expected sales levels influence inventory and receivables requirements.
3. Length of Operating Cycle: Longer cycles indicate a need for higher working capital to support operations.
4. Credit Terms: Suppliers' credit terms can affect the level of accounts payable and inventory needed.
5. Economic Conditions: During economic growth, companies may expand and require more working capital.
6. Business Growth Stage: Startups typically require more working capital than established businesses.

8. Effects on Cash Conversion Cycle

a) Reducing inventory will likely shorten the cash conversion cycle as less cash is tied up in inventory.

b) Avoiding stretching payables will slightly lengthen the cash conversion cycle since payables are paid more promptly.

c) Factoring accounts receivable will decrease the cash conversion cycle as cash comes in faster.

d) Customers stretching their payables will elongate the cash conversion cycle, as the company takes longer to collect receivables.

9. Costs and Benefits of Holding

a) Cash:

• Benefits: Immediate liquidity, low risk.
• Costs: Opportunity costs of investing cash elsewhere, inflation erosion.

b) Receivables:

• Benefits: Potential revenue through credit sales, enhances customer relationships.
• Costs: Risk of non-payment, lower liquidity.

c) Inventories:

• Benefits: Supports sales, potential economies of scale.
• Costs: Holding costs (storage, insurance), risk of obsolescence.

10. Lockboxes

a) The lock-box system reduces collection time from 6 to 4 days, reducing float by 2 days. Daily collections are $10,000, representing a total float of $20,000.

b) Daily interest savings = Total float × Daily interest rate = $20,000 × 0.0002 = $4.

c) Monthly savings from float = $4 × 30 = $120. The maximum monthly fee for the lock-box service would be $120.

11. Baumol's Model

a) Economic level of cash (C) = √(2 * D * S / i), where D= demand, S=sale cost, i=interest rate:

C = √(2 * 200,000 * 20 / 0.02) = $1,414.21.

b) The store should sell securities about 200,000 / 1,414.21 ≈ 141 times per year.

c) Average cash balance = C / 2 = $1,414.21 / 2 = $707.11.

d) Annual opportunity cost = Cash balance × interest rate = $707.11 × 0.02 = $14.14.

e) Annual trading cost = Cost per trade × trades per year = $20 × 141 = $2,820.

12. Economic Order Quantity

a) EOQ = √(2 * D * S / H): D = 7,200 units, S = $250, H = $10.

EOQ = √(2 * 7200 * 250 / 10) = √(360,000) ≈ 600 units.

b) Total costs = Order Costs + Carrying Costs:

• Order costs: (D / EOQ) * S = (7200 / 600) * 250 = $3,000.
• Carrying costs: (EOQ / 2) * H = (600 / 2) * 10 = $3,000. Total costs = $3,000 + $3,000 = $6,000.

13. Cost of Not Taking the Discount

Discount = 3%, period = 15 days, net = 45 days. Annualized cost = (Discount / (1 - Discount)) * (360 / (Total days - Discount days)): Annualized cost = (0.03 / (1 - 0.03)) * (360 / (45 - 15)) = 0.03092783 * 12 = 0.3711 or 37.11%.

14. 5 C's of Credit

1. Character: Assessment of borrower’s honesty and reliability based on credit history and reputation.
2. Capacity: The borrower's ability to repay the loan, assessed through income and existing debt levels.
3. Capital: The amount of personal investment the borrower has in the business, indicating risk.
4. Collateral: Assets that secure the loan, mitigating risk for the lender in case of default.
5. Conditions: The economic environment affecting the borrower’s ability to repay and the loan’s terms.

15. Factors Determining Length of Credit Period

1. Industry Norms: Typical credit practices within an industry can influence the length of credit offered.
2. Customer Relationships: Long-term, trustworthy customers may receive extended credit terms as a recognition of their reliability.
3. Risk Assessment: Higher-risk customers may receive shorter terms to mitigate risk.

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