The Quick Buck Company is an all-equity firm that has been in existence for the

Question

The Quick Buck Company is an all-equity firm that has been in existence for the past three years. Company management expects that the company will last for two more years and then be dissolved. The firm will generate cash flows of $880,000 next year and $1,370,000 in two years, including the proceeds from the liquidation. There are 37,000 shares of stock outstanding and shareholders require a return of 13 percent.

a. What is the current price per share of the stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Share price            $

b. The Board of Directors is dissatisfied with the current dividend policy and proposes that a dividend of $980,000 be paid next year. To raise the cash necessary for the increased dividend, the company will sell new shares of stock.

How many shares of stock must be sold? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Shares sold            

What is the new price per share of the existing shares of stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

New share price            $

Explanation / Answer

A

Value of the firm = Present value of cash flows

= 880000/ 1.13^1 + 1370000/ 1.13^2

= 1851672

Share price = 1851672/ 37000 = $50.05

B

Dividend increase = New dividend – old dividend

= 980000- 880000

= 100000

Number of share required to fund the increase = 100000/ Current price of shares

= 100000/ 50.05

= 1998 shares

C

In year 2, dividends to be given to new shareholders= 100000 * 1.13 =

113000

Amount of dividend to be paid to current shareholders in year 1 = 980000

Amount of dividend to be paid to current shareholders in year 2 = 1370000 - 113000

= 1257000

Value of firm = 980000/1.13^1 + 1257000/ 1.13^2 = 1851672

Price of shares = 1851672/ 37000 = $50.05

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