Random Corp. has outstanding 155 million shares with a total market value of $25

Question

Random Corp. has outstanding 155 million shares with a total market value of $250 million. Financial analysts expect the firm to pay $10.7 million of dividends next year, and every following year in the perpetuity. However, the company announces all of a sudden that next year's dividend will be increased to $50 million and that the extra cash will be raised immediately by an issue of shares. After that, the amount paid out each year will be as previously forecasted. At what price will the new shares be issued in year 1?

Explanation / Answer

Hi,

Please find the answer as follows:

Let us assume that the number of new shares to be issued = X

Price of New Share = P1

Total Nmber of Shares to be issued after year 1 = (155000000 + x)

Total Value of the Firm = Total Market Value + Dividend = 250000000 + 10700000 = 260700000

P1 = Total Value/Number of New Shares

P1 = 260700000/(155000000 + X)

The dividend payment of (50000000 - 10700000) is financed by the issue of new shares, indicating P1*X = 39300000

Using this value in the above forumla of P1:

P1*(155000000 + X) = 260700000

155000000P1 + P1*X = 260700000

155000000P1 + 39300000 = 260700000

P1 = (260700000 - 39300000)/155000000 = 1.428 or 1.43

Price of new share would be 1.43 per share.

Thanks.

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