Assume perfect capital markets. A firm is currently financed 80% by equity and 20% by debt. Free cash flows are £9 million per year and are expected to remain constant forever. The firm's levered equity beta is 1. The firm has 40 million shares outstanding. The firm's debt is risk-free and yields 5%. The market risk premium is 5%. There are no taxes. a) What is the total firm value? What is the price of each share? b) Suppose that the firm decides to raise an additional £5 million in debt and to use the proceeds to pay a cash dividend to stockholders. This debt is risk- free. What is the expected return on equity after the firm completes these transactions? What is the new share price? Are shareholders better or worse off as a result of the change in capital structure? Explain your answer. c) Let us abandon the assumption that there are not taxes. Suppose there are corporate taxes. Explain in words (no calculations required) how a £5 million debt issue paid out as a dividend to stockholders would affect shareholder wealth. In other words, are shareholders better or worse off as a result of the change in capital structure when there are corporate taxes? You can assume that the debt remains risk free.
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
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