Question

Hewlard Pocket’s market value balance sheet is given.

Assets						Liabilities and Shareholders’ Equity
A. Original balance sheet
Cash		$	150,000			Debt		$	0
Other assets			950,000			Equity			1,100,000
Value of firm		$	1,100,000			Value of firm		$	1,100,000
Shares outstanding = 100,000
Price per share = $1,100,000 / 100,000 = $11

Pocket needs to hold on to $62,000 of cash for a future investment. Nevertheless, it decides to pay a cash dividend of $2.60 per share and to replace cash as needed 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? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b. What will be the total value of the company? (Enter your answers in whole dollars, not in millions.)

c. What will be the total value of the stock held by new investors? (Enter your answers in whole dollars, not in millions. Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.)

d. What will be the wealth of the existing investors including the dividend payment? (Enter your answers in whole dollars, not in millions. Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.)

Answer 1

Part a)

Step 1: Calculate Value of Equity After Payment of Dividend

The value of equity after payment of dividend is determined as follows:

Value of Equity after Payment of Dividend = Value of Original Equity - Dividend = 1,100,000 - 100,000*2.60 = $840,000

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Step 2: Calculate Price Per Share After Payment of Dividend

The per price per share after payment of dividend is calculated as below:

Price Per Share After Payment of Dividend = Value of Equity after Payment of Dividend/Number of Outstanding Shares = 840,000/100,000 = $8.40 per share

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Step 3: Calculate Cash Balance After Payment of Dividend and Total Amount of Cash Needed

The value of cash balance after payment of dividend and amount of cash needed is arrived as follows:

Cash Balance After Payment of Dividend = Dividend - Current Cash Balance = 260,000 - 150,000 = $110,000

Total Amount of Cash Needed = Cash Balance After Payment of Dividend + Cash Needed for Future Investment = 110,000 + 62,000 = $172,000

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Step 4: Calculate Number of New Shares to be Issued

The number of new shares to be issued is calculated as follows:

Number of New Shares to be Issued = Total Amount of Cash Needed/Price Per Share After Payment of Dividend = 172,000/8.40 = 20,476 shares

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Step 5: Calculate Value of New Equity and Price Per Share

The value of new equity and price per share is arrived as below:

Value of New Equity = Original Equity After Payment of Dividend + Cash Realized from Sale of New Common Stock = (1,100,000 - 260,000) + 172,000 = $1,012,000

Price Per Share = Value of New Equity/Total Outstanding Shares = 1,012,000/(100,000 + 20,476) = $8.40

Answer for Part a) is $8.40.

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Part b)

The total value of the company is determined as below:

Total Value of the Company = Price Per Share*Number of Shares = 8.40*(100,000 + 20,476) = $1,012,000

Answer for Part b) is $1,012,000.

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Part c)

The total value of the stock held by new investors is arrived as follows:

Total Value of the Stock Held by New Investors = Number of New Shares*Price Per Share = 20,476*8.40 = $172,000

Answer for Part c) is $172,000.

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Part d)

The wealth of the existing investors including the dividend payment is calculated as below:

Wealth of the Existing Investors including the Dividend Payment = Original Shares*Price Per Share + Dividend Payment = 100,000*8.40 + 260,000 = $1,100,000

Answer for Part d) is $1,100,000.