Question

a. The board of directors of Moon plc decided at present (year 0) to dissolve the company in two years (year 2). The company has 20,000 shares in circulation and the cost of capital is 9 percent. This is an all-equity firm and the Chief Financial Officer knows with certainty the future cash flows. The company expects to receive $10,600 in year 1 and another $108,000 in year 2. All cash flows received by the company will be distributed as dividends.
Calculate the current share price ignoring taxes. Suppose you own 200 shares in Moon plc and your preference is to have equal dividends in year 1 and year 2. Explain how you can achieve this by creating homemade dividends. Show how your desired position can be achieved. Calculate the present value of your cash flow under the original scenario and also the case of equal dividends.

b. Next, assume you desire to receive only $3 dividend per share in year 1. Using the information in part (a), calculate your homemade dividend in year 2 and the present value of your new cash flow. Plot and explain all three options.

Answer 1

1) Value of Shares in current scenario

Year	Today	1	2
Cashflow		10,600	1,08,000
Discount		CF/(1+COC)	CF2/(1+COC)^2
		9,725	90,901
Total	1,00,626
No of Shares	20,000
Value of Share	5.03

2) Homemade Dividend Strategy

Year	Today	1	2
Cashflow		10,600	1,08,000
Discount		CF/(1+COC)	CF2/(1+COC)^2
		9,725	90,901
Total	1,00,626	99,083
No of Shares	20,000	20,000
Value of Share	5.03	4.95
Year		1	2
200	Shares	106	1080
Formula		('total dividend/total shares)* no of share held
Equal Dividend	Y1 Div+Y2 Div/2	593
Year 1
Extra Money Required in Y1	487
Share Value at the end of Year 1	4.95
No of Shares to be sold	94.00
Proceeds from Share		466
Dividend from Exisiting Holding		106
Cashflow		572
Year 2
Shares Remaining	106.00
Dividend	572.40
Proceeds from Share		0
Cashflow		572

3) PV of Cashflow will be equal

PV of Cashflow	Original Scenario
Year	Today	1	2
Cashflow		10,600	1,08,000
200 Share Cashflow		106	1,080
Discount		CF/(1+COC)	CF2/(1+COC)^2
		97	909
Total	1,006
PV of Cashflow	Homemade Dividend
Year	Today	1	2
200 Share Cashflow		572	572
Discount		CF/(1+COC)	CF2/(1+COC)^2
		525	481
Total	1,006