Ch 14 - SolutionstoEndofChapterProblems 141

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Solutions to End-of-Chapter Problems 14-1 70% Debt; 30% Equity; Capital budget = $3,000,000; NI = $2,000,000; PO = ? Equity retained = 0.3($3,000,000) = $900,000. NI $2,000,000 – Additions to RE      900,000 Earnings remaining $1,100,000 Payout =  14-2 P 0  = $90; Split = 3 for 2; New P = ? 14-3 NI = $2,000,000; Shares = 1,000,000; P = $32; Repurchase = 20%; New P 0  = ? Repurchase = 0.2  ×  1,000,000 = 200,000 shares. Repurchase amount = 200,000  ×  $32 = $6,400,000. EPS Old  =  =  = $2.00. P/E =  = 16 × .
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EPS New  =  =  = $2.50. Price New  = EPS new   ×  P/E = $2.50(16) = $40. 14-4 DPS after split = $0.75. Equivalent pre-split dividend = $0.75(5) = $3.75. New equivalent dividend = Last year’s dividend(1.09) $3.75 = Last year’s dividend(1.09) Last year’s dividend = $3.75/1.09 = $3.44. 14-5 Retained earnings= Net income (1 – Payout ratio) = $5,000,000(0.55) = $2,750,000. External equity needed: Total equity required = (New investment)(1 – Debt ratio) = $10,000,000(0.60) = $6,000,000. New external equity needed = $6,000,000 – $2,750,000 = $3,250,000. 14-6 Step 1: Determine the capital budget by selecting those projects whose returns are greater than  the project’s risk-adjusted cost of capital. Projects H and L should be chosen because IRR > WACC, so the firm’s capital budget  = $10 million. Step 2: Determine how much of the capital budget will be financed with equity. Capital Budget  ×  Equity % = Equity required. $10,000,000  ×  0.5 = $5,000,000. Step 3: Determine dividends through residual model. $7,287,500 – $5,000,000 = $2,287,500. Step 4: Calculate payout ratio. $2,287,500/$7,287,500 = 0.3139 = 31.39%.
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14-7 a. Total dividends 09 = Net income 09   ×  Payout ratio = $1,800,000  ×  0.40 = $720,000. DPS
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Ch 14 - SolutionstoEndofChapterProblems 141

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