A firm is all-equity financed and operates in a world without taxes or other frictions and that is semi-strong form efficient. It has perpetual earnings of $2.5 million and currently has 300,000 shareholders. Its cost of equity is 12%. The firm is considering issuing new equity to finance a special dividend to its current shareholders of $2/share.
a. how many new shares would the firm need to issue in order to pay this dividend?
b. would the current shareholders want management to issue this dividend? Demonstrate why or why not mathematically. (Hint-show what their total wealth both when the firm issue the dividend and when it does not.)
c. Would your answer to part B be different if management were considering issuing debt rather than equity? Why or why not? (Note: no calculations are required for this part)
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