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3 a) Martin & Sons (M&S) currently is an all equity firm with 40,000 shares of stock outstanding at a market price of $25 a
3 a) Martin & Sons (M&S) currently is an all equity firm with 40,000 shares of stock outstanding at a market price of $25 a share. The company's earnings before interest and taxes are $80,000. M&S has decided to add leverage to their financial operations by issuing $500,000 of debt with a 7 percent interest rate. This $500,000 will be used to repurchase shares of stock. You own 1,000 shares of M&S stock. M&S has a 100% dividend payout ratio, implying that all earnings are paid out to the shareholders. Assume that you can also borrow and lend at 7%. i) What is your dollar earning when M&S is un-levered? (2 marks) ii) If you want to have the same dollar earning after M&S gets levered, what should you do? (2 marks) b) Suppose you hold 10 shares in ABC Inc. The company will offer a $11 per share dividend at the end of year 1 and a liquidating dividend of $24.20 at the end of year 2. Your required return is 10% per annum and you wish to have equal cash flows each year. Show how you could accomplish this by using Homemade Dividends. (4 marks)
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