Consolidated Pasta is currently expected to pay annual dividends of $10 a share
ID: 2737821 • Letter: C
Question
Consolidated Pasta is currently expected to pay annual dividends of $10 a share in perpetuity on the 2.1 million shares that are outstanding. Shareholders require a 10% rate of return from Consolidated stock. a. What is the price of Consolidated stock?
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?
c.How much new equity capital will the company need to raise to finance the extra dividend payment? (Enter your answer in millions.)
Explanation / Answer
Solution.
a. What is the price of Consolidated stock.
Dividend / Required return
= $10 / 10% = $100
B. What is the price of Consolidated stock.
Dividend / Required return
= $20 / 10% = $200
C. How much new equity capital will the company need to raise to finance the extra dividend payment.
Desired payment = 2.1 x $10 = $210,000,000
No of share = $210,000,000 / $200 = 1,050,000 share or 1.5 million.
D. What will be the total present value of dividends paid each year on the new shares that the company will need to issue.
PV of dividend payment = $210,000,000 x 0.9090 = $190,890,000
E. Transfer of value from the old shareholders to the new shareholders.
Pre issue = 2.1 M x $100 = $210.00
After issue new share = $210.00 / ( 2.1 M + 1.5 M ) = $58.33
Value transfer = $100 - $58.33 = $41.67.
F . Less than
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