Consolidated now decides to increase next year’s dividend to $20 a share, withou

Question

Consolidated now decides to increase next year’s dividend to $20 a share, without changing its investment or borrowing plans. Thereafter the company will revert to its policy of distributing $10 million a year.

How much new equity capital will the company need to raise to finance the extra dividend payment?(Enter your answer in millions.)

What will be the total present value of dividends paid each year on the new shares that the company will need to issue? (Enter your answer in millions.)

What will be the transfer of value from the old shareholders to the new shareholders? (Enter your answer in millions.)

Is this figure more than, less than, or the same as the extra dividend that the old shareholders will receive?

Consolidated Pasta is currently expected to pay annual dividends of $10 a share in perpetuity on the 2.0 million shares that are outstanding. Shareholders require a 8% rate of return from Consolidated stock.

Explanation / Answer

a)Price of Consolidated Stock = Dividend/Cost of equity = $10/0.08 = $125

b)Total Market Value = Number of shares x Market Price = 2 million x $125 = $250,000,000

c) Currently, consolidated has 2 million shares outstanding, so the total forecast dividend payment in each year with old plan is 2 million x $10 = $20,000,000

With new plan of paying dividend of $20, total amount to be paid as dividend = 2 million x $20 = $40,000,000

So, new equity capital required = $40,000,000 - $20,000,000 = $20,000,000

d) The new equity holders will also require a return of 8%. So, amount paid to new shareholders every year: $20,000,000 x 8% = $1,600,000

PV of dividends paid to new shareholders = $1,600,000/0.08 = $20,000,000

e) That will be equl to the PV of dividends paid to new shareholders.

f) the same

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