14. (6 points) You are the CFO of a mid-sized, publicly traded U.S. corporation that
develops software for the retail industry. The firm has been in existence for twenty years.
Initial growth was explosive, but over the last four to six years both your firm’s and the
industry’s growth rates have stabilized. Thanks to your efficient management, the firm
has shown consistent profits over this period.
The CEO has expressed an interest in instituting a dividend for the first time.
(a) Compare and contrast the signaling model and agency cost model for corporate
dividends. Describe what outcomes would be predicted under each if your firm
instituted a dividend.
(b) Describe the firm-specific factors to be considered in deciding whether or not to
institute a dividend. Relate these factors to your firm’s situation and indicate
whether or not they support the CEO’s idea.
(c) Recommend a dividend policy for the corporation and support your answer.
COURSE 8: Fall 2005 - 15 - STOP
Finance Segment
Afternoon Session
15. (5 points) You are the CFO for TUNA Life Insurance Company. TUNA has three major
blocks of business: an annuity line, a life insurance line, and an individual disability line.
Below are statistics for the three lines of business:
Line of
Business Pre-tax Return
on Assets (ROA)
Allocated
Debt
Capital
Allocated
Equity Capital
Annuity 9% $90 million $10 million
Life Insurance 10% $70 million $30 million
Individual Disability 11% $50 million $50 million
TUNA currently pays 7% to service its debt. Equity investors require a 13% return. The
marginal tax rate for TUNA is 30%.
(a) Calculate the Economic Value Added (EVA) for each business unit. Show your
work.
(b) TUNA’s chief actuary wants to implement product pricing changes so that all
lines of business have a positive EVA. Assuming that the allocated debt and
equity capital do not change, establish minimum ROAs for each business line to
achieve. Show your work.
(c) Explain the advantages and disadvantages of an EVA financial management
system for monitoring business line performance.
**END OF EXAMINATION**
AFTERNOON SESSION

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