(20 marks) a) Is the following statement true of false? Explain. According to th

Question

(20 marks)

a) Is the following statement true of false? Explain.

According to the Clientele Effect, investors like high dividends because a fimr can boost its share price by having a higher dividend payout ratio. (5 marks)

b) B2B company has $1,080 million in common stock outstanding. Its unlevered cost of equity is 10%. Moreover, B2B also has $540 million in 5% coupon rate bond outstanding. The bonds are selling at par. If the corporate tax rate is 35%.

i) Calculate the weighted average cost of capital (WACC) of B2B. (6 marks)

ii) B2b has decided to issue $270 million in common stock and use the proceeds to buy back $270 million in its bond. According to the M&M proposition with tax, what are the new B2B's WACC and new cost of equity? (6 marks)

iii) B2B has just announced a 20% stock dividend when the market value of its common stock is $108 per share. Calculate the new market price of B2B's shares after the stock dividend. (3 marks)

Explanation / Answer

1. True, as per clientele effect the price of the stock moves according to the policy of its dividend payout ratio and it's reinvestment opportunities . As for growth companies price goes up when they reinvest and for value companies price goes up when they pay dividends.

2. WACC

Ke 10% , weight of equity 0.666  

Kd 5%(1-0.35) , Weight of debt 0.333

WACC= 10*0.666 + 3.25*0.333= 7.7325%

2. Weights of equity = 0.8333, ke= 10%

Weight of debt = 0.167 , kd= 3.25%

WACC= 0.833* 10% + 0.167*3.25= 8.872%

3. Dividend per share= 108*0.20= 21.6$

The value of the share goes down by the equal price, new price= 108-21.6= 86.4$

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