Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £100m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk-free rate. The relevant numbers are provided in the following table (in £ m): Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his risk constant. 1) What fraction of A’s equity can he buy with the money raised from the sale of the 5% stake in B and his personal debt? 2) What is the profit from this arbitrage (in £m)?
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.
Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £100m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk-free rate. The relevant numbers are provided in the following table (in £ m):
Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his risk constant.
1) What fraction of A’s equity can he buy with the money raised from the sale of the 5% stake in B and his personal debt?
2) What is the profit from this arbitrage (in £m)?
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