Question

Consolidated Pasta is currently expected to pay annual dividends of $10 a share in perpetuity on the 2.7 million shares that are outstanding. Shareholders require a rate of return of 10% from Consolidated stock. a. What is the price of Consolidated stock? (Do not round intermediate calculations.) b. What is the total market value of its equity? (Enter your answer in millions.) Consolidated now decides to increase next year’s dividend to $20 a share, without changing its investment or borrowing plans. Thereafter the company will revert to its policy of distributing $10 million a year. c. How much new equity capital will the company need to raise to finance the extra dividend payment? (Enter your answer in millions.) d. What will be the total present value of dividends paid each year on the new shares that the company will need to issue? (Enter your answer in millions.) e. What will be the transfer of value from the old shareholders to the new shareholders? (Enter your answer in millions.

Answer 1

(a). Price of the consolidated stock = Dividend / rate of return

here , Dividend =$10, rate of return =10%=0.1

= $10/0.1=$100

Hence , Price of the consolidated stock is =$100 answer.

(b). Total market value of the equity = share price *No. of shares outstanding

Share price found above is $100, No. of shares =2.7 millions

= 100 * 2.7 millions

=270 millions

Total market value of the equity =$270 millions answer.

(c). Finance needed for extra dividend payment= Difference in dividends * no. of shares

= ($20-$10) * 2.7 millions

= $10 * 2.7 millions

= 27 millions answer.

(d).Dividend next year = $20,

Dividend thereafter= $10

so, Present value =

  

  

= 109.09

so,Present value of dividend=$109.09 answer.

(e).

Transfer of wealth from old shareholders= 0

New total shares= Existing shares + Funds raised/Market price at the time of issue

New total shares= 2,700,000 + 27,000,000/109.09= 2,947,502.062

New Market Value = 2,947,502.062 *109.09= $321,543,000

Existing market value = $27 millions < New market value. Hence, no transfer of wealth.