Question 2 Bopomo Corporation\'s has $20 million in excess cash. The firm expect

Question

Question 2 Bopomo Corporation's has $20 million in excess cash. The firm expects to generate future free cash flows of $48 million per year. The firm is 100% equity financed, and its equity cost of capital is 12%. The firm has 10 million shares outstanding 2.1 The firm is evaluating two options on how to pay out to shareholders this year: 1) paying dividend of $2 per share using the existing $20 million cash, and 2) paying a dividend of $4 per share, and raising additional $28 million cash by selling new shares. ...continued overleaf 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 (30%)

Explanation / Answer

Dear Student, Lets summaraise the question Cash in hand = $ 20 million Free cash flows= $ 48 million Capital structure = 100% equity Cost of capital = 12% Number of equity shares out standing = 10 million Total value of the firm = 20+48 = $ 68 Million Book value per share = 68/10 = 6.8 If dividend is 2 per share Market value = 2/12% = 16.67 If company rise 28 million by selling $ 4 per share as dividend than the company market share = 4/12% = 33.33 If company will paid $ 4 dividend it will increasing the expectations on the company . But the actual market value is less than the expected market value. Not better to pay $ 4 dividend per share

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