Question

The Giant Machinery has the current capital structure of 65% equity and 35% debt. Its net income in the current year is $250,000. The company is planning to launch a project that will requires an investment of $175,000 next year. Currently the share of Giant machinery is $25/share.

Required:

a) How much dividend Giant Machinery can pay its shareholders this year and what is dividend

payout ratio of the company? Assume the Residual Dividend Payout Policy applies.

b) If the company is paying a dividend of $2.50/share and tomorrow the stock will go ex-dividend. Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 15%.

c) Little Equipment for Hire is a subsidiary in the Giant Machinery and currently under the liquidation plan due to the severe contraction of operation due to corona virus. The company plans to pay total dividend of $2.5 million now and $ 7.5 million one year from now as a liquidating dividend. The required rate of return for shareholders is 12%. Calculate the current value of the firm’s equity

in total and per share if the firm has 1.5 million shares outstanding. (

Answer 1

Answer:

Note:

A) Under the residual dividend payout policy, the company will pay off all the residual earnings as dividends after covering the capital expenditures. Thus, in the given question, assumed the company will maintain the same debt-equity ratio, and hence 65% of the investment will be financed by equity which is reduced from the net income and residual is given as dividend.

B) Ex-dividend price = Share Price before dividend - (Dividend per share * (1-tax rate))

C) The current value of a firm's equity equals the present value of all future dividends. Since the company is providing liquidating dividend in year 1, it implies there will be no future dividends.

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