Question

Question 6

Net profit of Lily Fashion House Ltd in the current year is $2,575, 000. The company is planning to launch a project that will requires an investment of $745 000 next year. Today the company’s stock has market value of $22/share. Lily Fashion House has the current capital structure of 60% in equity and 40% in debt. Required:

1. The company is paying a cash dividend of $4.50/share plus an extra-cash dividend of $1.5/share. Tomorrow the stock will go ex-dividend. Explain why there is ex-dividend date and ex-dividend price? Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 25%?
2. How much dividend Lily Fashion House can pay its shareholders this year and what is dividend payout ratio of the company. Assume the Residual Dividend Payout Policy applies?
3. Floral Textile Ltd. is a daughter company of the Lily Fashion House Group and currently under a liquidation plan due to severe business contraction caused by the COVID 19 pandemic. The company plans to pay total dividend of $3.5 million now and $ 8.5 million one year from now as a liquidating dividend. The required rate of return for shareholders is 13.5%. Calculate the current value of the firm’s equity in total and per share if the firm has 2.5 million shares outstanding?

Answer 1

A. Ex dividend date means the date after the date the dividend is given and the ex dividend price means the price which does not include the dividend amount in it. It is needed because from the time the dividend is declared to the time the dividend is paid, the investors know that the dividend cash flow is assured and they add that to the price to reflect the actual returns on the stock. Any on who purchases the stock after declaration but before payment of dividend would also be entitted to the dividend as well.

Once the dividend is paid, the price is adjusted (dividend amount is removed) since the returns have already been distributed and future investors will not be able to get that amount.

Dividend is also taxable. Hence, the investors will only take the net dividend they receive after the payment of taxes as the actual cash flow.

The current company stock price of $ 22 reflects the dividend which is to be paid tomorrow morning. Dividend to be paid is 4.5 + 1.5 = $6. Reducing tax burden (25%) we get the actual dividend in the hands of investors as 6*0.75 = $4.50. Adjusting the Stock price today by that amount = $22 = $4.50 = $17.50 is the ex-dividend price.

B. The company needs to save an amount of $ 745,000 for the next year investment. Under Residual Dividend Payout Policy, the remaining amount of profit, after keeping aside capital expenditure amounts can be distributed as dividends. Therefore, the maximum amount Lily can share as dividend is $ 2,575000 - $745,0000 = $1,830,000.

Dividend Payout Ratio = Amount of Dividend Paid / Net Income = 1,830,000 / 2,575,000 = 71.07%

C. The 8.5 Mill to be paid to customer will need to be discounted to the current price after adjusting for taxes. Hence, the present value of future dividend = 8.5Mil * 0.75 /(1+ 13.5%) =$ 5.62 Mill

Adding the tax adjusted current value of dividend = $2.63 Mill

Therefore, total equity value of Floral Textile = 2.63 + 5.62 = $ 8.24 Million

Hence, Per share value of Floral Textile = 8.24 / 2.5 = $3.30