An all-equity company has 100,000 shares outstanding. The company has a perpetual annual earnings of $100,000 and follows a 100% payout policy. The current share price is $10 and the required return on common equity is 10%. The company needs $100,000 at the end of the next year for an investment project which is expected to generate $10,000 per year in future. The company has two alternatives to finance the investment outlay:

1.Maintain the 100% payout policy and issue $100,000 worth of new shares.

2.Omit the next years dividends and finance the investment with that amount.

Compute the current share price under the two alternatives

An investor holding 10,000 shares of the company in previous example wants the company to take second alternative but the company goes for first. What action the investor should take?

What if the investor likes the first plan but company follows the second?

For the information given in previous example, now assume that the cost of equity under the second alternative is expected to be 12%. This increase in COE is because the dividends are deferred to future and hence are risky and as a result the stockholders require a higher compensation.

Compute the current share price under the two alternatives.