Question

Net profit of Lily Fashion House Ltd in the current year is $2,575, 000. The company is planning to launch a project that will requires an investment of $745 000 next year. Today the company’s stock has market value of $22/share. Lily Fashion House has the current capital structure of 60% in equity and 40% in debt. Required: a. The company is paying a cash dividend of $4.50/share plus an extra-cash dividend of $1.5/share. Tomorrow the stock will go ex-dividend. Explain why there is ex-dividend date and ex-dividend price? Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 25%? b. How much dividend Lily Fashion House can pay its shareholders this year and what is dividend payout ratio of the company. Assume the Residual Dividend Payout Policy applies? c. Floral Textile Ltd. is a daughter company of the Lily Fashion House Group and currently under a liquidation plan due to severe business contraction caused by the COVID 19 pandemic. The company plans to pay total dividend of $3.5 million now and $ 8.5 million one year from now as a liquidating dividend. The required rate of return for shareholders is 13.5%. Calculate the current value of the firm’s equity in total and per share if the firm has 2.5 million shares outstanding?

I have asked same question 3 times, and all the answers are different. Please do carefully and do correct one.

Answer 1

a) Ex-dividend date is required by the company to decide on the list of shareholders at that particular point of time who are eligible for dividends. since, shares are changing hands every now and then it is required to have a cut-off date. Ex-dividend price is required to remove arbitrage opportunity. Since the shareholders will have a benefit of dividend while those buying after the ex-dividend date won't have and so there price is reduced to make the cost of investing equal.

Current market price = $22

Dividend paid = $6

Tax on dividend = 25%

so, Actual benefit to shareholders = $6*(1-25%) =$4.5

Ex-Dividend price = $22-$4.5 = $17.5

b) Since the company follows the residual dividend policy, the dividend paid will be net profit less than investment requirements.

Dividend Paid = $2,575,000 - $745,000 = $1,830,000.

Dividend Pay-out ratio = $1,830,000/$2,575,000 = 71.06%

c) For Floral Textile,

Dividend Paid now = $3,500,000

Dividend to be paid next year = $8,500,000

PV of dividend paid next year = $8,500,000/ (1+13.5%) = $7,488,986.78

PV of total dividend paid = $10,988,986.78 which is also the current value of firm's total equity in total.

Current value of Per share = $10,988,986.78/3,500,000 = $3.1397 = $3.14