Pepsico Case Study

Answers to Concepts Review and Critical Thinking Questions

1. Dividend policy deals with the timing of dividend payments, not the amounts ultimately paid. Dividend policy is irrelevant when the timing of dividend payments doesn’t affect the present value of all future dividends.

2. A stock repurchase reduces equity while leaving debt unchanged. The debt ratio rises. A firm could, if desired, use excess cash to reduce debt instead. This is a capital structure decision.

3. The chief drawback to a strict dividend policy is the variability in dividend payments. This is a problem because investors tend to want a somewhat predictable cash flow. Also, if there is information content to dividend announcements, then the firm may be inadvertently telling the market that it is expecting a downturn in earnings prospects when it cuts a dividend, when in reality its prospects are very good. In a compromise policy, the firm maintains a relatively constant dividend. It increases dividends only when it expects earnings to remain at a sufficiently high level to pay the larger dividends, and it lowers the dividend only if it absolutely has to.

4. Friday, December 29 is the ex-dividend day. Remember not to count January 1 because it is a holiday, and the exchanges are closed. Anyone who buys the stock before December 29 is entitled to the dividend, assuming they do not sell it again before December 29.

5. No, because the money could be better invested in stocks that pay dividends in cash which benefit the fundholders directly.

6. The change in price is due to the change in dividends, not due to the change in dividend policy. Dividend policy can still be irrelevant without a contradiction.

7. The stock price dropped because of an expected drop in future dividends. Since the stock price is the present value of all future dividend payments, if the expected future dividend payments decrease, then the stock price will decline.

8. The plan will probably...