Question

[Question 1] RJR Nabisco had experienced slow growth of revenues over the past few years. In response to stockholder pressure, it announced a significant increase in dividends paid to stockholders financed by the sale of some of its assets. What would you expect the stock price reaction to the announcement, and why? Will the asset sale and increase of payout improve firm performance?

[Question 2] Using the information in previous question, RJR Nabisco also had $10 billion in bonds outstanding at the time of the dividend increase. How would you expect the bondholders to react to the announcement? Why?

Answer 1

RJR Nabisco has been already facing slow growth in the revenue over few years. If such is the case, generally company would provide less dividends to shareholders. Given the scenario of shareholder pressure, dividend has been increased. As per trend in the market, if a company increases dividend, in next subsequent years, it should continue with increased dividend. Now, pressure is on RJR Nabisco to continue providing increased dividend over next years. Also, company has sold its assets for dividend distribution. It means the amount is not from operating profit. This will project company in a negative way in stock market. Hence, stock price will fall down. Whether sale of asset increases performance or not depends on how valuable the asset was to company. In general, it will hamper the performance.

2.    Since RJR Nabisco had $10 billion in bonds outstanding. It will impact bondholders in negative way. Hence, the bond prices will go down due to lower in demand. The bond will not be traded much in market as it is riskier to hold such bond because of company's operations.