The Giant Machinery has the current capital structure of 65% equity and 35% debt. Its net income in the current year is $250,000. The company is planning to launch a project that will requires an investment of $175,000 next year. Currently the share of Giant machinery is $25/share.

The Giant Machinery has the current capital structure of 65% equity and 35% debt. Its net income in the current year is $250 000. The company is planning to launch a project that will requires an investment of $175 000 next year. Currently the share of Giant machinery is $25/share. Required: a. How much dividend Giant Machinery can pay its shareholders this year and what is dividend payout ratio of the company. Assume the Residual Dividend Payout Policy applies? b. If the company is paying a dividend of $2.50/share and tomorrow the stock will go ex-dividend. Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 15%? c. Little Equipment for Hire is a subsidiary in the Giant Machinery and currently under the liquidation plan due to the severe contraction of operation due to corona virus. The company plans to pay total dividend of $2.5 million now and $ 7.5 million one year from now as a liquidating dividend. The required rate of return for shareholders is 12%. Calculate the current value of the firm’s equity in total and per share if the firm has 1.5 million shares outstanding?

Answer:

A.) $136,250 ; 54.5%

B.) $22.875

C.) 7.27

Explanation:

Given the following :

Investment plan = $175,000

Capital structure:

Equity = 65%, Debt = 35%

Income = $250,000

Capital project takes priority before the residual income is shared as Dividend, according to the residual Dividend payout policy.

DEBT component of investment :

35% × 175,000 = $61,250

Equity component = 65% × 175000 = $113,750

Dividend = Income - Equity

Equity here is the amount to be reinvested.

Dividend = $(250,000 - 113,750) = $136,250

Dividend payout ratio = Dividend / income

= $136,250 / 250,000 = 0.545 = 54.5%

B.) current price = $25/share

Dividend = 2.50/share

Tax rate = 15% = 0.15

Outstanding shares = 1,500,000

E-Dividend price :

[current price - (Dividend(1 - tax rate)]

[$25 -($2.50(1-0.15)]

$25 - ($2.50(0.85)

$25 - $2.125 = $22.875

C.)

Payment now (D0) = $2.5 million

Payment after 1 year = $7.5 million

Rate of return = 12% = 112% = 1.12

current value per share is calculated by:

(Current value of shares / shares outstanding)

Current value : (D0 + (D1 × 1.12))

$2,500,000 + ($7,500,000 × 1.12)

= 2500000 + 8400000 = 10900000

Current value per share:

10900000 / 1500000 = 7.27