QUESTION TWO You have the assignment to advise the CEO of Caddaric Ltd, a private company that specializes in industrial

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QUESTION TWO
You have the assignment to advise the CEO of Caddaric Ltd, a
private company that specializes in industrial surveillance
services, on a planned payout for the firm's investors. The firm
has no debt and has accumulated cash beyond the required
reinvestment needs, so the CEO feels it makes sense to return some
of its cash to the shareholders.
The following table sets out the information about the firm's
balance sheet.
BE311-5-SP/3
Total assets Cash
Fixed assets Equity
Value Cost of capital
£20m 10% £5m -- £15m --
£20m 10%
The number of shares outstanding in Caddaric Ltd is 20m, so the
price per share is £1.
The risk-free rate is 3%, and the average return on the market
index is 7%. The firm expects to grow at a rate of 4% each
year.
Your report to the CEO should address the following points:
a) Payout to shareholders could take several forms.
Explain the differences and similarities between cash dividend
payments and stock repurchases.
(10 marks)
b) The discounted dividend model suggests a relationship
between the price per share, the
dividend yield, and the dividend growth. What dividend payment
per share should the investors expect if this model is correct next
year?
(10 marks)
c) The firm doesn't currently have debt on its balance
sheet. Your report should address the
relative advantages and disadvantages of corporate borrowing as
an alternative way of creating a payout, as corporate debt implies
a payout to the firm's debtholders in the form of interest
payments. In particular, you should address this question in light
of the trade-off theory of borrowing and the pecking order theory
of financing.
(15 marks)
d) Suppose the CEO aims for a payout of £1.2m next year.
What is the expected price on ex-
dividend day next year if the firm pays £1.2m as cash dividends?
In contrast, what is the expected number of shares after a £1.2m
share repurchase operation next year?
(15 marks)