Question

Given the information below (in millions):

Value of operation. $4,000

Short-term investments $150

Debt $550

Value of preferred stock $50

Number of shares. 100

Demonstrate that the stock price will drop by exactly the amount of dividend per share in the model if this firm pays dividend. Assume that the firm plans to use its short-term investment account to fund the dividend payment

Answer 1

Solution:-

Value per share= (Value of operations + Short-term investments - debt - preferred stock)/No. of shares = (4,000+150-550-50)/100= $35.5

Now let's assume that the company pays a dividend of $1 per share. So, the total dividend would be $100 (i.e. $1*100 shares). The short-term investments would drop by $100 ($150 to $50) due to the dividend payment.

The new value per share is calculated as follows:

Value per share= (Value of operations + Short-term investments - debt - preferred stock)/No. of shares = (4,000+50-550-50)/100= $34.5

Decline in value per share= $35.5 - $34.5 = $1 per share

Thus, as we can see the value per share has been declined by $1 and is equivalent to the dividend paid per share.