Midlife Crisis Inc. (MCI) has two assets: 1,600 in cash and an investment project. The cash is invested in the risk-free asset which earns 5% per year. The project requires an investment of 800 today and generates an expected cash flow of 1,600 one year from now. This opportunity recurs perpetually each year. Thus, for example, one year from now MCI can again invest 800 and generate 1,600 one year subsequent to that investment. MCI has 800 shares outstanding. The market equity risk premium is 5% per year, and the investment project has a CAPM beta of 1. Assume a Modigliani and Miller world. When answering this question, state any additional assumptions you may need to make. Show your calculations. (a) Should MCI invest in the project? Explain. (5 marks) (b) Suppose MCIs CFO decides to pursue the project. What is the value of MCI? (5 marks) (c) Suppose MCIs CFO decides to take the project and always pay out all free cash flow as a dividend. What is MCIs cum-dividend price

expected to be one year from now? (4 marks) (d) MCIs investment banker suggests that MCI instead pays out the 1,600 in cash as a dividend today, reverting to the CFOs proposed dividend policy described in part (c) in one year. In order to continue to invest in the project, MCI must raise equity immediately after the dividend is paid to raise the cash needed for the project. How many shares must be issued to new shareholders? (4 marks) (e) Describe both the dollar amount and timing of the expected dividend stream to old shareholders under the investment bankers proposal. Has old shareholder wealth changed? (3 marks) (f) If MCI no longer operates in a Modigliani-Miller world, dividend policy may no longer be irrelevant. Carefully discuss the various ways MCI's dividend policy may affect their valuation. (4 marks)