Select your language

Suggested languages for you:
Log In Start studying!
Answers without the blur. Just sign up for free and you're in → Illustration

Q1CP

Expert-verified
Essentials Of Investments
Found in: Page 439
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

At Litchfield Chemical Corp. (LCC), a director of the company said that the use of dividend discount models by investors is “proof” that the higher the dividend, the higher the stock price.

a. Using a constant-growth dividend discount model as a basis of reference, evaluate the director’s statement.

b. Explain how an increase in dividend payout would affect each of the following (holding all other factors constant):

i. Sustainable growth rate.

ii. Growth in book value.

a. Confusing statement

b. (i) reduces sustainable growth (ii) fall in sustainable growth due to fall in plowback ratio

See the step by step solution

Step by Step Solution

Step 1: Evaluation and explanation of director’s statement ‘a’

Confusing statement; Higher price is possible on higher dividends while holding everything else constant. But this is not possible as raising the dividend payout rate would lead to fall in growth rate.

Step 2: Explanation on relationship between increase in dividend payout and growth rate and book value ‘b’

(i) It reduces the sustainable growth because funds are not available for re-investment.

(ii) It leads to fall in sustainable growth rate owing to fall in plowback ratio.

Most popular questions for Business-studies Textbooks

Use the following case in answering Problems 29 – 32:

Mary Smith, a Level II CFA candidate, was recently hired for an analyst position at the Bank of Ireland. Her first assignment is to examine the competitive strategies employed by various French wineries.

Smith’s report identifies four wineries that are the major players in the French wine industry. The key characteristics of each are cited in Table 12.6. In the body of Smith’s report, she includes a discussion of the competitive structure of the French wine industry. She notes that over the past five years, the French wine industry has not responded to changing consumer tastes. Profit margins have declined steadily, and the number of firms representing the industry has decreased from 10 to 4. It appears that participants in the French wine industry must consolidate in order to survive.

Smith’s report notes that French consumers have strong bargaining power over the industry.

She supports this conclusion with five key points, which she labels “Bargaining Power of Buyers”:

  • Many consumers are drinking more beer than wine with meals and on social occasions.
  • Increasing sales over the Internet have allowed consumers to better research the wines, read opinions from other customers, and identify which producers have the best prices.
  • The French wine industry is consolidating and consists of only 4 wineries today compared to 10 wineries five years ago.
  • More than 65% of the business for the French wine industry consists of purchases from restaurants. Restaurants typically make purchases in bulk, buying four to five cases of wine at a time.
  • The land where the soil is fertile enough to grow grapes necessary for the wine production process is scarce in France.

After completing the first draft of her report, Smith takes it to her boss, RonVanDriesen, to review. VanDriesen tells her that he is a wine connoisseur himself and often makes purchases from the South Winery. Smith tells VanDriesen, “In my report, I have classified the South Winery as a stuck-in-the-middle firm. It tries to be a cost leader by selling its wine at a price that is slightly below the other firms, but it also tries to differentiate itself from its competitors by producing wine in bottles with curved necks, which increases its cost structure. The end result is that the South Winery’s profit margin gets squeezed from both sides.” VanDriesen replies, “I have met members of the management team from the South Winery at a couple of the wine conventions I have attended. I believe that the South Winery could succeed at following

both cost leadership and a differentiation strategy if its operations were separated into distinct operating units, with each unit pursuing a different competitive strategy.” Smith makes a note to do more research on generic competitive strategies to verify VanDriesen’s assertions before publishing the final draft of her report.

If the French home currency were to greatly appreciate in value compared to the English currency, what is the likely impact on the competitive position of the East Winery?

a. Make the firm less competitive in the English market.

b. No impact, since the major market for East Winery is England, not France.

c. Make the firm more competitive in the English market.

Icon

Want to see more solutions like these?

Sign up for free to discover our expert answers
Get Started - It’s free

Recommended explanations on Business-studies Textbooks

94% of StudySmarter users get better grades.

Sign up for free
94% of StudySmarter users get better grades.