Question

The firm you are CEO of has a current period cash flow of 1.0 million and pays no dividend. The present value of the company’s future cash flows is $2.5 million. The company is entirely financed with equity and there are 350,000 shares outstanding. Assume the dividend tax rate is 0.  What is the share price of your firm?

Suppose you and the board announce a plan to pay out 70 percent of the current cash flows as a dividend to its shareholders. How can a shareholder, who owns 1000 shares, achieve a zero pay-out policy on their own?

A) Share price = $10.00, purchase 250 shares

B) Share price = $10.00, purchase 200.00 shares

C) Share price = $7.14, purchase 388.89 shares

D) Share price = $10.00, purchase 206.90 shares

Answer 1

1). Share Price = [Current Cash Flow + PV of expected cash flows] / Number of shares outstanding

= [$1,000,000 + $2,500,000] / 350,000

= $3,500,000 / 350,000 = $10

2). Dividend per share = [Current Cash Flow * Payout Ratio] / No. of shares outstanding

= [$1,000,000 * 0.70] / 350,000 = $700,000 / 350,000 = $2

Dividends paid to shareholder = Dividend per share * shares owned = $2 * 1,000 = $2,000

Ex-dividend share price = share price - dividend per share = $10 - $2 = $8

Number of shares to buy = Dividends paid to shareholder / Ex-dividend stock price

= $2,000 / $8 = 250 shares

So, Option "A" is correct.