You are the financial controller of an unlevered firm, AXE Ltd. The company has one more year on its license to operate.
Posted: Mon Nov 15, 2021 5:09 pm
You are the financial controller of an unlevered firm, AXE Ltd.
The company has one
more year on its license to operate. The license grants the company
a tax-free status.
The company’s net cash flow is $50,000 per annum. The Board of
Directors of AXE
Ltd is considering two alternatives has decided to pay cash
dividends. The first
alternative is to issue $50,000 now and the same sum next year. The
second
alternative is issue $60,000 now and $38,500 next year. The
additional $10,000
required to meet the payout now will be funded by a new equity
issue. The company
and its shareholders make a risk-free return of 15 percent on their
investments.
Required:
(a) Calculate the value of the company’s equity under each
alternative.
(4 marks)
(b) Demonstrate that the shareholders of AXE Ltd derive the same
future value of the
cash dividends at the end of year 1.
(4 marks)
(c) In view of Miller and Modigliani (1961), comment on your
answers in the above
parts.
(7 marks)
The company has one
more year on its license to operate. The license grants the company
a tax-free status.
The company’s net cash flow is $50,000 per annum. The Board of
Directors of AXE
Ltd is considering two alternatives has decided to pay cash
dividends. The first
alternative is to issue $50,000 now and the same sum next year. The
second
alternative is issue $60,000 now and $38,500 next year. The
additional $10,000
required to meet the payout now will be funded by a new equity
issue. The company
and its shareholders make a risk-free return of 15 percent on their
investments.
Required:
(a) Calculate the value of the company’s equity under each
alternative.
(4 marks)
(b) Demonstrate that the shareholders of AXE Ltd derive the same
future value of the
cash dividends at the end of year 1.
(4 marks)
(c) In view of Miller and Modigliani (1961), comment on your
answers in the above
parts.
(7 marks)