a) Finance the expansion with debt. b) Finance the expansion with 50 percent externally generated equity and 50 percent internally generated equity. This alternative would necessitate a dividend cut for this year only. c) Finance the expansion with a mix of debt and equity. Under this alternative, dividends would not be cut. Rather, any equity needs in excess of that which could be provided internally would be raised through a sale of new common stock. Evaluate these various financing alternatives with reference to their effects on the dividend policy and common stock values of the company.
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.
Question 5
The Joe Company has experienced a slow (3 percent per year) but steady increase in earnings per share. The firm has consistently paid out an average of 75 percent of each year’s earnings as dividends. The stock market evaluates Joe primarily on the basis of its dividend pay-out because growth prospects are moderate. Joe’s management presents a proposal to the board of directors that would require the investment of RM50 million to build a new plant in the rapidly expanding Ipoh market. The expected annual return on the investment in this plant is estimated to be in excess of 30 percent, more than twice the current company average. To finance this investment, a number of alternatives are being considered. They include the following:
a) Finance the expansion with debt.
b) Finance the expansion with 50 percent externally generated equity and 50 percent internally generated equity. This alternative would necessitate a dividend cut for this year only.
c) Finance the expansion with a mix of debt and equity. Under this alternative, dividends would not be cut. Rather, any equity needs in excess of that which could be provided internally would be raised through a sale of new common stock.
Evaluate these various financing alternatives with reference to their effects on the dividend policy and common stock values of the company.
Step by step
Solved in 3 steps
