Question
A company is considering doubling current capacity while at the same time increasing the proportion of net income paid to shareholders in the form of
A company is considering doubling current capacity while at the same time increasing the proportion of net income paid to shareholders in the form of dividends. The company will use debt to fund the expansion. Financial statement information for both before and after the expansion is provided in the table below. Dividends were just paid today (T=0). All numbers, including shares outstanding, are reported in millions. Use the following information for Parts h,i,j and k.
| Before | After |
Pretax Income | 200 | 250 |
Net Income | 150 | 200 |
Dividends | 105 | 60 |
Shares Outstanding | 10 | 9 |
Total Assets | 500 | 600 |
Total Equity | 400 | 400 |
h. After the expansion, which of the following statements is (are) TRUE:
I. The companys payout ratio will be equal to the companys retention ratio II.
II. The company payout ratio will be the same as companys retention ratio before the expansion
III. III. The company will have a higher ROE, in part because there is more debt in the companys capital structure
A) I
B) II
C) III
D) II, III
E) None of the statements
i. Before the expansion, the company has a share price of $120.00. According to the Dividend Discount Model where dividends grow in perpetuity at a rate related to dividend payout and return on equity, the cost of equity is:
A) 36.0%
B) 35.0%
C) 21.0%
D) 20.0%
E) 19.0%
j. Ignore the cost of equity you calculated in Part i. After the expansion, assume the increased debt in the capital structure causes the cost of equity to rise to 40.0%. According to the Dividend Discount Model where dividends grow in perpetuity at a rate related to dividend payout and return on equity, the share price of the stock is closest to:
A) $23
B) $36
C) $133
D) $136
E) $180
k. Ignore the cost of equity you calculated in Part i. Assume the increased debt in the capital structure causes the cost of equity to rise from 16.0% to 24.0% and the cost of debt to rise from 4.0% to 9.0%. In response to these changes in capital structure, the WACC for the firm:
A) Decreased by 4.85%
B) Increased by 4.85%
C) Increased by 5.00%
D) Increased by 5.40%
E) Increased by 7.60%
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