The Mann Company belongs to a risk class for which the appropriate discount rate

Question

The Mann Company belongs to a risk class for which the appropriate discount rate is 15 percent. Mann currently has 168,000 outstanding shares selling at $125 each. The firm is contemplating the declaration of a $4 dividend at the end of the fiscal year that just began. Assume there are no taxes on dividends. Answer the following questions based on the Miller and Modigliani (MM) model, which is discussed in the text a. What will the price of the stock be on the ex-dividend date if the dividend is declared? Price of the stock b. What will the price of the stock be at the end of the year if the dividend is not declared? Price of the stock c. If Mann makes $5 million of new investments at the beginning of the period, earns net income of $3.20 million, and pays the dividend at the end of the year, how many shares of new stock must the firm issue to meet its funding needs? (Do not round intermediate calculations.) Number of shares to be issued shares d. Is it realistic to use the MM model in the real world to value stock? Yes No

Explanation / Answer

a)

The price of the stock on the ex dividend by the value of the dividend

Price of stock = 125 - 4

Price of stock = $121

b)

If the dividend was not declared, the price would remain $125

c)

Mann must finance through the sale of shares worth 125

It must sell 5,000,000 / 125 = 40,000 shares

d)

The MM model is not realistic since it does not account for taxes, uncertainty over future cash flows, investors’ preferences, signaling effects, and agency costs.

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