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Question 3 Honey Ltd is a holding company that owns and controls a number of companies. The Board of Directors is currently reviewing its methods
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Honey Ltd is a holding company that owns and controls a number of companies. The Board of
Directors is currently reviewing its methods for estimating the cost of capital and the dividend
policy for one of its subsidiaries Lemonade Ltd Details are provided below.
Lemonade Ltd
For the most recent year end December the company reported a profit after tax of $
million. Honey expects this level of profit to continue into the foreseeable future with no growth
forecasted. The current dividend payout ratio is with no growth. The cost of equity for
this company has recently been calculated at
The finance team has proposed two alternative strategies that would impact on the growth rate
in profits, the return required by the holders of equity shares and the dividend payout ratio. The
proposed strategies are summarised below.
Required:
a Prepare a table that shows the estimated market value of equity for Pan Ltd that would result
from adopting each of the three strategies Current; Proposed WX; and Proposed WQ
Your answers should be calculated to the nearest million dollars.
marks
b Briefly analyse your findings in part a
c Critically evaluate the practicality of Modigliani and Miller's dividend irrelevancy theory
in the current market environment.
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