Question

The Giant Machinery has the current capital structure of 65% equity and 35% debt. Its net income in the current year is $250,000. The company is planning to launch a project that will requires an investment of $175,000 next year. Currently the share of Giant machinery is $25/share. Required: a) How much dividend Giant Machinery can pay its shareholders this year and what is dividend payout ratio of the company? Assume the Residual Dividend Payout Policy applies. (4 marks) b) If the company is paying a dividend of $2.50/share and tomorrow the stock will go ex-dividend. Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 15%. (2 marks) c) Little Equipment for Hire is a subsidiary in the Giant Machinery and currently under the liquidation plan due to the severe contraction of operation due to corona virus. The company plans to pay total dividend of $2.5 million now and $ 7.5 million one year from now as a liquidating dividend. The required rate of return for shareholders is 12%. Calculate the current value of the firm’s equity in total and per share if the firm has 1.5 million shares outstanding. (4 marks

Answer 1

Answer:

The amount of dividend Giant Machinery can  pay its shareholders this year =   $136,250

The Dividend Payout ratio of the company = 54.50%

Ex-dividend price = $22.875

The current value of the firm's equity in total  = $9196428.571

The current value of the firm's equity per share = $6.131

Step-by-step explanation:

Given that:

The Current Capital Structure = 65% equity and 35% debt.

The net income in the current year = $250,000

Also, the company is planning to launch a project that will requires an investment of  $175,000 next year.

The current share price = $25/share

(a)

The first objective is to determine how much dividend Giant Machinery can pay its shareholders this year and what is dividend payout ratio of the company.

The amount of dividend Giant Machinery can  pay its shareholders this year= Net profit - Investment amount × (percentage of equity)

= 250,000 - 175,000 × (65%)

= 250,000 - 113,750

= $136,250

The dividend payout ratio of the company.can be calculated as follows:

Dividend Payout ratio of the company $= \mathbf{\dfrac{ total \ \ dividends}{total \ \ earning}}$

We all know that the net income in the current year is the  Total Earning which is 250,000

Thus;

The Dividend Payout ratio of the company $= \mathbf{\dfrac{ 136250}{250000}}$

The Dividend Payout ratio of the company = 0.545

The Dividend Payout ratio of the company = 54.50%

b).

If the company is paying a dividend of $2.50/share and tomorrow the stock will go ex-dividend.

Also, assuming:

the tax on dividend =  15%.

We are to calculate the ex-dividend price tomorrow morning.

To calculate the ex-dividend price tomorrow morning; we use the relation:

Ex-dividend price which is the result of the difference between the current price and dividend multiply by the difference between the 1 and the tax on the dividend

i.e

Ex-dividend pric = current price - Dividend × (1 - tax on dividend)

Given that :

The current share price = $25/share

Therefore;

Ex-dividend price = $25 - $2.5 × ( 1 - 15%)

Ex-dividend price = $25 - $2.5 × ( 1 - 0.15)

Ex-dividend price = $25 - $2.5  × 0.85

Ex-dividend price = $25 - $2.125

Ex-dividend price = $22.875

C)

From the  information given in the part C of the question:

the company now plans to pays a total dividend of $2.5 million.= $ 2,500.000

Let say the year the dividend was paid was 0 year

and 7.5 million one year from now as a liquidating dividend.

So; the dividend paid in year 1 now = 7.5 million = $ 7,500,000

The required rate of return for shareholders is 12%

Outstanding share of the firm = 1.5 million = $1,500,000

We are to calculate  the current value of the firm’s equity in total and per share if the firm has 1.5 million shares outstanding.

To start with the current value of the firm’s equity in total;

The current value of the firm's equity in total =$\mathbf{amount \ of \ dividend \ paid \ in \ 0 \ year + \dfrac {amount \ of \ dividend \ paid \ in \ 1 \ year } { 1+required \ rate \ of \ return } }$= $\mathbf{2,500,000 + \dfrac{7,500,000 }{1+ 0.12} }$

$=\mathbf{2,500,000 + \dfrac{7,500,000 }{1.12} }$

= 2,500,000 + 6696428.571

= $ 9196428.571

The current value of the firm's equity per share =$\mathbf{ \dfrac{ current \ value \ of \ the \ firm's \ equity \ in \ total}{ Outstanding \ share }}$

$\mathbf{= \dfrac{9196428.571}{1500000}}$

= $6.130952381

≅ $6.131

The current value of the firm's equity per share = $6.131