Dividend Framework: Solutions
Problem 1
a. Dividend Payout Ratio = (2 * 50)/480 =
20.83%
b. Free Cash Flows to Equity this year
Net Income
480
$
 (Cap Ex  Depr ) (1DR)
210
$
 (Chg in WC) (1DR)
35
$
FCFE
235
$
Dividends as % of FCFE = 100/235 =
42.55%
c.
Note: I changed the riskfree rate to a long term bond rate of 8.5% in the problem.
Project
Investment
Beta
IRR
Cost of Equity
A
$190 mil
0.6
12.00%
11.80%
B
$200 mil
0.8
12.00%
12.90%
C
$200 mil
1
14.50%
14.00%
D
$200 mil
1.2
15.00%
15.10%
E
$100 mil
1.5
20.00%
16.75%
Accept projects A, C and E. The total investment is $ 490 million.
d. Estimation of FCFE next year
Net Income
540
$
 (Cap Ex  Depr) (1DR)
168
$
 (Chg in WC) (1DR)
35
$
FCFE
337
$
e. I may not pay this amount as dividends because of my concerns that I would not be able to maintain these dividends. I
would also hold back some cash for future projects, if I feel that investment needs could vary substantially over time.
f. If $ 125 million is paid out as dividends, the cash balance will increase by $ 212 million [$337$125]
Problem 2
a. Estimate the FCFE.
Investable Funds
100.00
$
 (Cap Ex ) (1DR)
52.50
$
 Chg in WC (1DR)

$
= FCFE
47.50
$
I am assuming, since there is no information to the contrary, that these projects have risk characertistics similar to the firm.
Capital Expenditures
Cost of Equity =
15%
Aftertax Cost of Debt =
6%
Debt Ratio = 500/(500+1500) =
25%
Cost of Capital = (.18) (.75) + .06 (.25) =
13%
Accept projects A, B, C and D: They have returns on capital that exceed the cost of capital.
Total Capital Expenditures =
70
Page 1
This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentDividend Framework: Solutions
Since the returns are on capital, the comparison has to be to cost of capital.
b. The company should return $ 47.5 million to its stockholders.
Problem 3
First, estimate the cost of capital,
Cost of Equity =
22%
Aftertax Cost of Debt =
6%
Debt Ratio = (100/(100+500))
16.67%
Cost of Capital =
19.33%
Second, calculate the NPV of the three projects,
In changed the EBIT on the second problem to $ 15 million per year.
This is the end of the preview. Sign up
to
access the rest of the document.
 Spring '11
 Kroger
 Working Capital, Corporate Finance, Net Income, Generally Accepted Accounting Principles, Dividend yield

Click to edit the document details