Question

The Quick Buck Company is an all-equity firm that has been in existence for the past three years. Company management expects that the company will last for two more years and then be dissolved. The firm will generate cash flows of $550,000 next year and $840,000 in two years, including the proceeds from the liquidation. There are 20,000 shares of stock outstanding and shareholders require a return of 12 percent.

1. What is the current price per share of the stock?

2. The board of directors is dissatisfied with the current dividend policy and proposes that a dividend of $650,000 be paid next year. To raise the cash necessary for the increased dividend, the company will sell new shares of stock. How many shares of stock must be sold? What is the new price per share of the existing shares of stock?

Answer 1

a. Calculate the current price of the stock as follows:

Year (1)	Cash flow (2)	PVIF @ 12% (3)	PV of cashflows (4) = (2) × (3)
1	$550,000	0.8929	$491,071.43
2	$840,000	0.7972	$669,642.86
		Value of the firm	$1,160,714.29

Number of shares outstanding = 20,000 shares

Therefore, the current price of the stock is $58.04.

b. Calculate the number of shares to be sold as follows:

New dividend proposed = $650,000

Old dividend = $550,000

Therefore, 1722.9 shares are to be sold.

Calculate the existing share price of the stock as follows:

Year (1)	Cash flow (2)	PVIF @ 12% (3)	PV of cashflows (4) = (2) × (3)
1	$650,000	0.8929	$580,357.14
2	$840,000	0.7972	$669,642.86
		Value of the firm	$1,250,000

Number of shares outstanding = 20,000 shares

Therefore, the current price of the stock after increase in dividend is $57.54

Note: The column 3 is calculated as follows:

Value of firm is sum of the PV of cashflows.