Question

1) Describe two signals, one pro, one con, a company may send to the markets when they initiate a regular dividend.

2) List one advantage and one disadvantage of using leverage in the corporate capital structure.

3)Pemaprint PLC is considering a production line. The new equipment for the line will cost $1,565,000. In addition, net working capital will increase by $115,000 and remain at the level for the life of the project. The new line is expected to generate cash flow for the next four years of $365,000, $480,000, $590,000 and $760,000. Pemaprint's discount rate for the project is 10.79%. The net present value of the project is closed to:

a) $66,342
b) $93,812
C) $55,142

Answer 1

1) Paying regular dividends when send signals that:

Pro: The shareholders like consistent funds in the form of dividends. So, the shareholders like dividend paying share. So, this share will be popular among the investors.

Cons: The company might not be having sufficient growth opportunities , that is why they are distributing excess earnings in the form of dividends.

2) Advantage of leverage: Leverage is cheaper and it provides a interest tax shield to the company.

Disadvantage: The disadvantage of leverage is that it might increase the bankruptcy costs of the company as too much debt can hurt the financials of a company and lead to bankruptcy due to the increases interest costs.

3) CF0 = $1,565,000 + $115,000 (initial investment + working capital investment)

= $168,0000

CF1= $365,000

CF2 = $480,000

CF3= $590,000

CF4= $760,000 + $115,000 ( 4th year cash flows + working capital investment recovery)

= $875,000

I/Y = 10.79

So, NPV = $55,142.05

= $55,142

So, the correct option is option C.