Megaware, Incorporated is a technology firm that was founded eight years ago by
ID: 2738257 • Letter: M
Question
Megaware, Incorporated is a technology firm that was founded eight years ago by John Thompson and Jill Dillman. Megaware manufactures various hardware and software components. Its products are used in personal computers and other peripheral devices. In addition to John and Jill, Nick Jones is also an owner of the firm, because he provided capital. Each of the three owns 20 percent of the company. The current employees own the remaining part of the company. The firm recently developed a new computer hardware component. The component is supposed to be more energy efficient and less costly to produce. After investigating the possibility of manufacturing the new hardware component, Megaware determined that constructing a new plant would be too costly. John, Jill, and Nick do not want to bring in another outside investor. So, Megaware has decided to sell the hardware component for an after-tax payment of $42 million.
Problem 1. John thinks that the firm should use the excess cash flow to pay a special one-time dividend to the investors. How will implementing this proposal affect the value of the company, as well as the stock price?
Problem 2. Jill believes that the firm should use the excess cash flow to pay off debt and expand its manufacturing capability. How would implementing this proposal affect the company?
Problem 3. Nick contends that a share repurchase will increase the company's ROA, ROE, and P/E ratio. Do you agree? How will a share repurchase affect the value of the firm?
Problem 4. John, Jill, and Nick have discussed a proposal to commence a regular dividend payment to stockholders. Evaluate this plan.
Problem 5. The dividend growth model is used by many investors to value stock. Using the dividend-payout ratio, and the sustainable growth rate equation in the dividend growth model, calculate the price of a share of stock today, using the following dividend growth model equation. Then use your results to explain whether the firm should pay a dividend or expand its manufacturing capability.
*The dividend-payout ratio is one minus b, where b is the retention ratio; the dividend next year will be the earnings next year, E1, times one, minus
the retention ratio: P0 = E1(1–b).
*The sustainable growth rate is the return on equity times the retention ratio: Rs – ROE x b.
*The dividend growth model equation for calculating the price of a share of stock today is:
P0 = E1(1–b)
Rs – ROE x b
Problem 6. Does the way a company is organized (as a corporation, LLC, or another structure) determine whether the company should pay a dividend?
Explanation / Answer
Please find the answer from 1-4
1)John thinks that the firm should use the excess cash flow to pay a special one-time dividend to the investors. How will implementing this proposal affect the value of the company, as well as the stock price?
Implementing this proposal would adjust the value of the company and stock price downwards ie if company is reducing its cash balance by paying out special dividend the stock price as well as the book value of the company would reduce by the amount special dividend issued.
2)Jill believes that the firm should use the excess cash flow to pay off debt and expand its manufacturing capability. How would implementing this proposal affect the company?
By paying off the entire debt cash flow for investing in the expansion would get reduced by the same amount further more the company would have to look for financing options for the same amt . There will be no effect on the liabilities but cash would reduce.
3) Nick contends that a share repurchase will increase the company's ROA, ROE, and P/E ratio. Do you agree? How will a share repurchase affect the value of the firm?
The company’s cash balance would reduce also the liabilities would increase in form of treasury stock account
4)John, Jill, and Nick have discussed a proposal to commence a regular dividend payment to stockholders. Evaluate this plan
By going in for regular dividend the company may excess money for future investments is available but the future investment opportunities might not be there . The excess would be laying idle.The amount dividend should be set at a level which can be maintained in future . If the dividend level is too low it can be paid later in form of special dividend