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)

Complete 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? 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%? 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?

Answer:

a) Total dividend for the current year = $136,250

Dividend Payout Ratio = 0.545

b) Ex-dividend price = $22.875

c) Total current value = $9,196,428.57

Current value per share = $6.13

Step-by-step explanation:

a) Equity = 65%

Debt = 35%

Net Income for year 0 = $250,000

proposed Investment for year 1 = $175,000

Current price = $25/share

Tax on dividend = 15%

Total dividend for year 0 = 250000 - (65% of 175000)

Total dividend for year 0 = 250000 - 113750

Total dividend for the current year = $136,250

Dividend Payout Ratio = total dividends / total earning

Dividend Payout Ratio = 136250/250000

Dividend Payout Ratio = 0.545

b) Dividend = $2.5 / share

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

Substituting the appropriate values:

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

Ex-dividend price = 25 - 2.125

Ex-dividend price = $22.875

c) Current value of the firm = Dividend paid in year 0 + (Dividend to be paid in year 1/discount rate)

Dividend paid in year 0 = $2,500,000

Dividend to be paid in year 1 = $7,500,000

Discount rate = 12%

Total current value = 2,500,000 + (7,500,000 / 1.12)

Total current value = $9,196,428.57

Numbe of shares = 1,500,000

Current value per share = Total current value / number of shares

Current value per share = 9,196,428.57/1,500,000

Current value per share = $6.13