Question

At time 0, a firm is valued at $1,000 and has no debt. Its equity consists of 100 common shares worth $10 each. The expected rate of return for the firm is 5% in time 1 and 6% in time 2.

1.At time 1, the firm decides to issue dividends of $2 per share to existing shareholders, by issuing new shares. (A. 15 Pts) How many new shares does it have to issue? (B. 15) What is the issuing price of the new shares?

2.At time 2, the firm decides again to issue dividends of $2 per share to existing shareholders, by issuing new shares. (C. 15) How many new shares does it have to issue? (D. 15) What is the issuing price of the new shares?

3.For the original stockholders (holding shares at time 0), (E. 10) please show their rates of return for time 1 and time 2.

4.For the stockholders who bought new shares at time 1, (F. 10) please show their rate of return for time 2.

Please Help in solving question 4 only.

Answer 1

ANSWER DOWN BELOW. FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

Question 4 only:

Price of share at year 1:

Value of Equity = Equity Value Now * (1 + Year 1 Return).

Value of Equity= 1000 * (1.05).

Value of Equity Before Dividend = 1050.

Value of Equity After Dividend = $8.5

Price of Stock = $8.5 per share.

Buying price is $8.5 per share. (At the end of year 1).

Year 2:
Rate of growth = 6%

New price (with growth) = 8.5(1.06)
$9.01

There is a dividend of $2 per share.

Total = 9.01+2 = 11.01

Rate of return = (11.01-8.5)/8.5

= 29.53% (ANSWER).