Manzanares has 3 million shares outstanding with a total market value of $300 million. There are no taxes. The firm is expected to pay $3 million of dividends next year and thereafter the amount is expected to grow by 10 per cent in perpetuity. Nevertheless, the Board of Directors, who believe that it is possible to increase the value of the firm by switching the dividend policy, announces that in year 2 the dividend will be increased by $3 million and that the extra cash will be raised immediately by an issue of shares.In year 1 the dividend will be $3 millionand afteryear 2, the total amount paid out each year will be as previously forecasted under the current dividend policy.

a) At what price will the new shares be issued in year two? Assume that new shares are issued at a fair price.

b) How many shares will the firm need to issue in year two?

c) What will be the share market price just before the year two dividend payment under the alternative dividend policy? Assume that the share price is cum-dividend.

ANSWERS:

a) $120

b) 25,000 shares.

c) $122.1

I do not understand how to do part c.