Refer to table 17.1. Pocket needs to hold on to $50,000 of cash for a future inv
ID: 2826367 • Letter: R
Question
Refer to table 17.1. Pocket needs to hold on to $50,000 of cash for a future investment. Nevertheless it decides to pay a cash dividend of $2 per share and to replac the cash with a new issue of shares. After the dividend is paid and the new stock is issued: A- what will be the price per share? B- what will be the total value of the company? C- what will be the total value of the stock held by new investors? D- what will be the wealth of the existing investors including the dividend payments?Please show all work.
Explanation / Answer
Greetings,
A) Cash available = 150000
Cash needed for future expenses = 50000 Cash dividend proposed = 100000*2 = 200000 Hence total cash requirement = 250000
Therefore shares to be issued for 250000 - 150000 = 100000
Dividend will be paid on old shares only, hence value of the firm before issue of new shares = 1100000 - 200000 = 900000
Share price after dividend = 900000/100000 = 9/share
New shares to be issued = 100000/9 = 11111
Share price after dividend and share issue will remain to be 9 per share as issue of shares is made at market price.
B) Value of the Company = (100000+11111)*9 = 1000000
C) Value of the stock of new investors = 100000
D) Wealth of existing investors will remain to be 1100000 including dividend. Wealth is not affected by dividend declaration in a perfect market. Further if new shares are issued at market price, there is no change in the wealth of existing investors.