Answer Happy

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)