1. MM suggest that investors are indifferent whether a firm pay dividends. However, investors in many countries prefer d

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1. MM suggest that investors are indifferent whether a firm pay
dividends. However, investors in many countries prefer dividend
paying stocks to those without paying dividends. Does this
preference contradict MM’s theory of irrelevancy of dividend
policy? How can you explain the preference?
2. United Frypan plc is financed through bonds and ordinary
shares. The bonds were issued five years ago at a par value of £100
(total funds raised £30m). They carry an annual coupon
payment of £10, are due to be redeemed in four years and investors
currently require a yield of 6%. The firm also has 3,000,000
ordinary shares outstanding at the trading price of £45.54.
Currently, United Frypan plc is reviewing its capital budget for
the next year. It has paid a £1 dividend per share for the past
several years, and its shareholders expect the dividend to remain
constant for the next several years. The company forecasts
that it will require £13 million to fund all of its profitable
projects (i.e. those with a positive NPV) and its net income will
be £12m for the next year.
Required:
a)
What is the current capital structure of United
Frypan? (Hint: Use market values of debt and equity)
b)
If the firm follows the residual dividend model and maintains its
current capital structure, what will be the company’s dividend per
share and payout ratio for the next year?
c)
Suppose the firm’s management decides to
continue to pay the £1 per share and maintain its target capital
structure and capital budget. What is the minimum amount of new
common stock that the company would have to issue to meet each of
its objectives?
3. Big Industries has the following market-value balance sheet.
The stock currently sells for $20 a share, and there are 1,000
shares outstanding. The firm will either pay a $1 per share
dividend or repurchase $1,000 worth of stock. Ignore taxes.
Assets
Liabilities and Equity
Cash
$2,000
Debt
$10,000
Fixed assets
28,000
Equity
20,000
Required:
4. ABC plc is all-equity financed and has 1 million shares
outstanding. The firm has a current period cash flow of £4.2
million and pays no dividends. The present value of the company’s
future cash flow is £72 million. Assume the dividend tax rate is
zero.
(a) What is the share price of ABC.plc?
(b) Suppose that the firm announces its plan to pay out 40 per
cent of its current cash flow as cash dividends to its
shareholders. How could you achieve a zero payout policy on your
own, if you own 1,000 shares of ABC equity?