Components Manufacturing Corporation (CMC) has an all-common-equity capital structure. It has 200,000 shares of $2 par value common stock outstanding. Future growth at a 6% rate is considered realistic, but that level would call for an increase in the dividend payout. Further, it now appears that new investment projects with at least the 14% rate of return required by CMC’s stockholders (rs = 14%) would amount to only $800,000 for 2009 compared to a projected $2,000,000 of net income. Required: Assuming that the acceptable 2009 investment projects would be financed entirely by earnings retained during the year and assuming that CMC uses the residual dividend model, calculate DPS in 2009. What payout ratio does your answer to Part a imply for 2009? If a 60% payout ratio is maintained for the foreseeable future, what is your estimate of the present market price of the common stock?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Components Manufacturing Corporation (CMC) has an all-common-equity capital structure. It has 200,000 shares of $2 par value common stock outstanding. Future growth at a 6% rate is considered realistic, but that level would call for an increase in the dividend payout. Further, it now appears that new investment projects with at least the 14%
Required:
Assuming that the acceptable 2009 investment projects would be financed entirely by earnings retained during the year and assuming that CMC uses the residual dividend model, calculate DPS in 2009.
What payout ratio does your answer to Part a imply for 2009?
If a 60% payout ratio is maintained for the foreseeable future, what is your estimate of the present market price of the common stock?
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