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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
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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.
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 Spring '11
 Kroger

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