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Question 4 The CFO of Wilden Industries is reviewing the planned capital expenditure projects for the upcoming financial year. Several large investment proposals have
Question 4 The CFO of Wilden Industries is reviewing the planned capital expenditure projects for the upcoming financial year. Several large investment proposals have been assessed and the company's management has decided that total outlays for capital projects in the next year will be $16 million. Next year's pre-tax net income is projected to be $12.5 million. Wilden Industries currently has 2 million shares outstanding, with a current market price of $20 per share and $10 million in outstanding debt. Any new debt issued will attract an interest rate of 8% per annum. The company's tax rate is 35%. The CFO is examining the impact that the following financing proposals will have on the company: a) Issuing $16 million in new debt to finance the proposed capital projects. All net income would continue to be paid out as dividends. b) Adopting a residual dividend policy to finance the proposed projects. Current debt/equity levels are expected to be maintained. c) Retaining all earnings and using the funds to finance the proposed projects. Any funding shortfall would be met by issuing new bonds. Question 4 (Continued) Required: (i) For each of the above three strategies calculate and discuss the impact on the company's earnings per share and dividend per share ratios. (12 marks) (ii) Explain the meaning of the dividend clientele effect and the signaling effect why they should be considered in the company's financing decision. (8 marks)
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