Question

Consider Genron Corporation. The firms board is meeting to decide how to pay out $20 million in excess cash to shareholders. Genron has no debt, and its equity cost of capital equals its unlevered cost of capital of 12%. Genron has 10 million shares outstanding, and expects to generate future free cash flows of $48 million per year starting from next year. Assume the capital market is perfect and the cum-dividend price is $42 and ex-dividend price is $40. Suppose to pay the same amount of dividend in every year, Genron raised 28 million cash by selling new shares. Calculate the new cum-dividend price and ex-dividend price of Genron.

Answer 1

Step 1: Calculate Number of New Shares to be Issued

The number of new shares that can be issued with additional cash is calculated as follows:

Number of New Shares = Additional Money Needed/Current Share Price = 28/42 = .67 million shares

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Step 2: Calculate Revised Dividend Per Share

The value of revised dividend per share is determined as below:

Revised Dividend Per Share = Total Value of Cash Flows/Total Outstanding Shares after New Issue = 48/(10+.67) = $4.50 per share

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Step 3: Calculate New Cum-Dividend and Ex-Dividend Share Price

The value of new cum-dividend price and ex-dividend price of Genron is arrived as below:

New Cum-Dividend Share Price = Revised Dividend Per Share + Revised Dividend Per Share/Unlevered Cost of Capital = 4.50 + 4.50/12% = $42

New Ex-Dividend Share Price = Initial Share Price = $42 (increase in dividend will have no benefit to the shareholders. Additional amount of cash to finance dividend will result in issuance of new shares, thereby, bringing down the value of dividend per share to $4.50. Therefore, ex-dividend price will continue to be at $42)