Little Oil has outstanding one million shares with a total market value of $20 million. The...

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Little Oil has outstanding one million shares with a totalmarket value of $20 million. The firm is expected to pay $1 millionof dividends next year, and thereafter the amount paid out isexpected to grow by 5% a year in perpetuity. Thus the expecteddividend is $1.05 million in year 2, $1.1025 million in year 3, andso on. However, the company has heard that the value of a sharedepends on the flow of dividends, and therefore it announces thatnext year’s dividend will be increased to $2 million and that theextra cash will be raised immediately afterwards by an issue ofshares. After that, the total amount paid out each year will be aspreviously forecasted, that is, $1.05 million in year 2 andincreasing by 5% in each subsequent year
a. At what price will the new shares be issuedin year 1? (Do not round intermediatecalculations. Round your answer to the nearestwhole number.)
New share price           $
b. How many shares will the firm need to issue?(Do not round intermediate calculations. Round your answerto the nearest whole number.)
Number of shares
c-1. What will be the expected dividendpayments on the new shares at t₂? (Donot round intermediate calculations. Enter your answer in dollarsnot in millions. Round your answer to the nearest wholenumber.)
Total dividend           $
c-2. What will be paid out to the oldshareholders at t₂? (Do not roundintermediate calculations. Enter your answer in millions not indollars. Round your answer to the nearest wholenumber.)
Total dividend           $   million
d-1. What is the present value of the cashflows to current shareholders under the revised dividend policy?(Do not round intermediate calculations. Enter your answerin millions not in dollars. Round your answer to the nearest wholenumber.)
Present value           $   million

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4.2 Ratings (827 Votes)

Value per share D1 cost of equity dividend growth rate Value per share Market value no of shares 20000000 1000000 20 D1 1 and constant dividend growth rate 5 20 1 cost of equity 5 Cost of equity 120 5 10 If the firm See Answer

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Transcribed Image Text

Little Oil has outstanding one million shares with a totalmarket value of $20 million. The firm is expected to pay $1 millionof dividends next year, and thereafter the amount paid out isexpected to grow by 5% a year in perpetuity. Thus the expecteddividend is $1.05 million in year 2, $1.1025 million in year 3, andso on. However, the company has heard that the value of a sharedepends on the flow of dividends, and therefore it announces thatnext year’s dividend will be increased to $2 million and that theextra cash will be raised immediately afterwards by an issue ofshares. After that, the total amount paid out each year will be aspreviously forecasted, that is, $1.05 million in year 2 andincreasing by 5% in each subsequent yeara. At what price will the new shares be issuedin year 1? (Do not round intermediatecalculations. Round your answer to the nearestwhole number.)New share price $b. How many shares will the firm need to issue?(Do not round intermediate calculations. Round your answerto the nearest whole number.)Number of shares c-1. What will be the expected dividendpayments on the new shares at t2? (Donot round intermediate calculations. Enter your answer in dollarsnot in millions. Round your answer to the nearest wholenumber.)Total dividend $c-2. What will be paid out to the oldshareholders at t2? (Do not roundintermediate calculations. Enter your answer in millions not indollars. Round your answer to the nearest wholenumber.)Total dividend $ milliond-1. What is the present value of the cashflows to current shareholders under the revised dividend policy?(Do not round intermediate calculations. Enter your answerin millions not in dollars. Round your answer to the nearest wholenumber.)Present value $ million