Question 3

(a) A cake manufacturer is currently in the midst of evaluating the value of one of its divisions, the Grain Division. The Grain Divisions weighted average cost of capital is 11%. The divisions financial statements stated that its capital structure contains only debt and equity, with a debt market value of RM13,000,000. The divisions estimated free cash flow each year from 2017 through 2020 is given below:

Year (t) Free cash flow

(FCFt)

RM

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2017 950,000

2018 1,350,000

2019 1,550,000

2020 1,650,000

Beyond 2020 to infinity, the free cash flow is expected to grow at 4% annually.

Required:

1. Use the free cash flow valuation model to estimate the value of the entire Grain Division. (8 marks)
2. Use your finding in part (i) and other data provided to find Grain Divisions common stock value. (2 marks)
3. Assuming that the Grain Division as a public company will have 500,000 shares outstanding, use your finding in part (ii) to calculate its value per share. (2 marks)

(b) Discuss the relevance of corporate dividend policy on the shareholder's wealth of public enterprises. Provide examples to support your answer. (13 marks)