Background: Portman Industries just paid a dividend of $2.00 per share. Portman

Question

Background:

Portman Industries just paid a dividend of $2.00 per share. Portman expect the coming year to be very good, and its dividend is expected to grow by 15% over the year. After the next year, though, Portman's dividend is expected to grow at a constant rate of 6.0% per year. The risk-free rate is 6% and the market risk premium is 4%. Portman's beta is 1.1 and their current intrinsic value is: $53.49.

Questions:

1) Portman has 500,000 shares outstanding and Judy Davis, and investor, holds 40,000 shares. Suppose Portman is considering issuing 100,000 new shares at a price of $50 per share. If the new shares are sold to outside investors, how much will Judy's investment in Portman be diluted on a per-share basis?


2) Judy could be protected by dilution if the corporate charter contains a (pick one: bond indenture, preemptive right, takeover, proxy or founders share) provision. If Judy fully exercised that provision and avoided dilution, she would hold (pick one: 52,000 shares, 48,000 shares, 44,000 shares, 56,000 shares or 40,000 shares) worth (pick one: $2,539,600 , $2,590,400 , $2, 644,000 , $2,490,800 or $2,700,000) after the new stock issue.

Thanks!

Explanation / Answer

1)

D0 = $2

D1 = 2*1.15 = $2.3

D2 = D1*1.06....and then continues

also re = rf + (rm - rf)*

re = 6 + 4*1.1

= 10.4%

value of future dividends in year 1 =P83/(0.104-0.06) = $55.41

Po = D1/1.104 + 55.41/1.104

= $52.27

market value of equity = 500000*52.27 = $26135000

Judy's share = 40000*52.27/26135000 = 0.08 = 8%

now new 100000 shares are being sold to new investors at $50

ergo, MV of equity = 26135000+100000*50 = $31135000

judys share = 40000*52.27/(31135000) = 6.72%

hence investment be diluted by (8-6.72) = 1.28%

2)

she would hold 48,000 shares worth $2,490,800 after the new stock issue.

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