Fundamentals of Corporate Finance, 8^th edition, Brealey, Myers, Marcus,

(Chpt 17, Q15, LO3)

3.Go back to the first Hewlard Pocket balance sheet (see Table 17.1 in the text). Pocket needs to hold on to $50,000 of cash for a future investment. Nevertheless, it decides to pay a cash dividend of $2 per share, and to replace the cash with a new issue of shares. After the dividend is paid and the new stock is issued:

Original Balance Sheet

Cash$150,000Debt$0

Other Assets950,000Equity1,100,000

Value of Firm1,100,0001,100,000

Shares outstanding = 100,000

Price per share=$1,100,000 / 100,000 = $11

To pay out $2 dividend, the total shares outstanding is multiplied by $2 to get a payout of $200,000. As $50,000 needs to remain in cash, there is only $100,000 available, so the other $100,000 must be raised by selling new shares.

At $11 a share, the total number of shares that need to be sold is $100,000 / $11 = 9,090.909 (rounded to 9, 091).

Cash is reduced by $100,000 and increased by the $1 extra from the sale of new shares that was not used for the dividend for a new total of$50,001, and Equity is reduced by $200,000 and increased by $100,001 for a new total of $1,000,001.

After dividend and new share issue

Cash$50,001Debt$0

Other Assets950,000Equity1,000,001

Value of Firm$1,000,001$1,000,001

Shares outstanding = 109,091

Price per share= $1,000,001 / 109,091 = $9.166 (rounded to $9.17)

a.What will be the price per share? $9.17

b.What will be the total value of the company?$1,000,001

c.What will be the total value of the stock held by new investors?

9,091 new shareholders x $9.17 price per share = $83,364.47

d.What will be the wealth of the existing investors including the dividend payment?

100,000 original shares outstanding x $9.17 price per share = $917,000

$917,000 + $200,000 = $1,117,000

Verify answers please.