Question 4

Milk Boy is a local dairy products manufacturer. The company is preparing a financial plan for the coming year and has the following independent production projects under consideration:

Suppose the above projects have the same risk as that of the companys existing operation. Also, the chief financial officer of Milk Boy estimates that earnings after tax in this financial year will be $125 million. Milk Boy has 20 million ordinary shares outstanding and the cost of capital (WACC) of the company is 16.50%. The board would like to maintain a debt-to-equity ratio (D/E) of 3. Answer the following questions:

a) Based on the above information, determine which project(s) should be accepted by the company. Calculate the firms total planned capital expenditure for the coming year.

b) Suppose Milk Boy follows a residual dividend policy. What will be the companys dividend per share?

c) Provide TWO major disadvantages of a strict residual dividend policy. How does a compromise dividend policy differ from a strict residual dividend policy?

Project Initial investmentInternal rate of (S million) 70 95 80 50 65 return (%) 16.00% 17.00% 13 .00% 20.00% 18.00%