5.1.2 Correction_to_Problem_1_in_Lecture_09

5.1.2 Correction_to_Problem_1_in_Lecture_09 - Correction to...

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Unformatted text preview: Correction to Problem 1 Correction in Lecture 09 in There were 2 linked errors in this problem that I did not pick up until looking at it with fresh eyes in the lecture: All steps of the WACC are affected (Not just MCC2 and MCC3) therefore we should recalculate rS as well as rE The thing that drives the change in rS and rE is the change in size of D1 with a new dividend payout ratio. Therefore we need to know N, which is simple Total dividend divided by the old per share D1 1 Problem 1 Yolanda Skateboards forecasts the following information for next year: NPAT = $4 m Dividend payout ratio d = 40% Weighting of equity wS = 25% D1 = $1 P0 =$20 g =5% rRF = 6% = 1 β rM =10% Flotation costs are super expensive at 10% of the share price Required: (a) What is the BPEQUITY with when d = 40% ? (b) What are the costs of equity rS and new equity rE if d = 40%? (c) What is the new BPEQUITY if d = 60% ? (d) What are the costs of equity rS and new equity rE if d = 60% 2 BP = ∆RE NPAT × ( 1 − d ) = ws ws $4m × ( 1 − 0.4 ) = 0.25 = $9.6m Solution 1 (a) and (b) rS = rRF + β ( rM − rRF ) = 0.06 + 0.04 = 0.1 or 10% = 0.06 +1( 0.1 − 0.06 ) D1 1 rE = +g= + 0.05 P0 ( 1 − F % ) 20 ( 1 − 0.1) ) 1 + 0.05 18 = 0.0555g + 0.05 = = 0.1055g or 10.56% rounded 3 OR... D 1 rS = 1 + g = + 0.05 P0 20 = 0.05 + 0.05 = 0.1 or 10% Solution 1 page 2 Part (c) with initial working Part for Part (d) for BP = ∆RE NPAT × ( 1 − d ) = ws ws = $4m × ( 1 − 0.6 ) 0.25 = $6.4m 1 D1 NEW ≠ D1 OLD so must be calculated First , find the value of N (number of shares ) Total Old Dividend = NPAT × d = $4m × 0.4 = $1, 600, 000 Given D1 OLD = $1 N = 1.6m shares Total New Dividend = NPAT × d = $4m × 0.6 = $2.4m ⇒ D1 NEW = 2, 400, 000 1, 600, 000 = $1.5 With the new “d”, the size of D changes, because a new amount of total dividend is divided among the same number of existing shares 4 rS NEW = D1 NEW P0 +g Solution 1 page 3 Part (d) 1.5 = + 0.05 20 = 0.075 + 0.05 = 0.125 or 12.50% rE NEW = D1 NEW +g S NEW P0 ( 1 − F % ) 1.5 = + 0.05 20 ( 1 − 0.1) 1.5 = + 0.05 18 = 0.0833333• + 0.05 ≈ 0.1333 or 13.33% rounded to 2dp. Note that r must be calculated with the discounted dividend model and not with the original SML equation using beta. One suspects that if the 5 Two Effects of a rise in Dividend Payout Two Ratio “d” on WACC Schedule Ratio WACC Rise in all MCCs due to rise in rS and rE from rise in d WACC1 WACC0 BPEQUITY 0 BPEQUITY 1 $$ Reduction of BPEQUITY due to rise in d 6 ...
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This note was uploaded on 12/23/2009 for the course BCOM FINC 202 taught by Professor Warwickanderson during the Spring '09 term at Canterbury.

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