Telfony Inc. expects an EBIT of $4,000,000 for the current year. The firm\'s cap

Question

Telfony Inc. expects an EBIT of $4,000,000 for the current year. The firm's capital structure consists of 40% debt and 60% equity, and its marginal tax rate is 40%. The cost of equity is 16%, and the company pays a 10% rate on its $10,000,000 of long-term debt. 1,000,000 shares of common stock are outstanding. For the next year, the firm expects to fund one large positive NPV project costing $2,000,000 and it will fund this project in accordance with its target capital Structure.

A.) If the firm follows a residual distrivutuion policy (with all distributions in the form of dividends) and has no other projects, what is its expected dividend payout ratio and the dividend paid out per share?

b.) Comparer and contrast tax-preference, bird-in-hand, and clinetele effect theoriesof dividend policy.

Explanation / Answer

1) EAT for Current Year $ EBIT        4,000,000 Less:- Interest        1,000,000 10% on $ 10000000 EBT        3,000,000 Less:- Tax @ 40%        1,200,000 EAT        1,800,000 Fund Required for next year project $ 2000000, out of which 40% will be financed by Debt and 60% by equity Therefore amount required by equity = $ 2000000 X 60% = $ 1200000 Therefore Earning Available for Distribution = 1800000- 1200000 = $ 600000 Dividend per share = 600000/1000000 = $ 0.60 per share Value of Equity Share = 10000000 X 60/40 = $ 15000000 Value per share = $ 15000000/1000000 = $ 15 per share Dividend pay out ratio = 0.60/15= 4%

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