2.1 Bopomo Corporation’s has $20 mill ion in excess cash. The firm expects to ge

Question

2.1 Bopomo Corporation’s has $20 mill ion in excess cash. The firm expects to generate future free cash flows of $48 mi llion per year. The firm is 100% equity financed, and its equity cost of capital is 12%. Th e firm has 10 mil lion shares outstanding. The firm is evaluating two options on how t o pay out to shareholders this year: 1) paying dividend of $2 per share using the exexisting$20 million cash, and 2)paying a dividend of $4 per share,and raising additional$28 million cash by s Consider a perfect capital market where corporate and personal taxes, costs of bankruptcy or financial distress do not exist. Demonstrate that either way of the dividend policy is irrelevant to the share price of the firm

Explanation / Answer

Enterprise value = 48 / 12% = 400 M

Market value = 400 + 20 = 420 M

Share price = 420 / 10 = 42

paying dividend of $2 per share

dividend = 10*2 = 20

Market value = 420 - 20 = 400 M

Share price = 400 / 10 = 40

paying dividend of $4 per share

dividend = 10*4 = 40

Market value = 420 - 40 = 30 M

Share price = 380 / 10 = 38

In perfect market share price reduces by the amount of dividend

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