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# ch11sol.stern.nyu.edu - Chapter 11 A Framework for...

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Chapter 11: A Framework for Analyzing Dividend Policy Problem 1. Current Projected EBITDA 1200 1350 Less Depreciation 200 250 EBIT 1000 1100 Less Interest Expenses 200 200 EBT 800 900 Less Taxes 320 360 Net Income 480 540 Free Cash Flow Computation EBIT 1000 1100 Less Interest 200 200 Less Taxes 320 360 Less (Cap. Exp.- Depr.) x (1- proportion financed by debt) 210 168 Less (Change in Working Cap.) x(1- prop. financed by debt) 35 35 Free Cash Flow to equity 235 337 a. The current payout ratio = (2x50m.)/480 =0.208333 b. It's currently paying out 100/95 =42.55% of free cash flow to equity Project Investment Beta IRR (Using Cash flows to equity) Reqd. return to equity A \$190m. 0.6 12.00% 11.80% accept B \$200m. 0.8 12.00% 12.90% reject C \$200m. 1 14.50% 14.00% accept D \$200m. 1.2 15.00% 15.10% reject E \$100m. 1.5 20.00% 16.75% accept c. The required rate of return on equity = .085 + 1(.055) = .14 or 14%. Projects C, D and E are NPV>0 projects according to this yardstick

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The total capital expenditure needs for next year are: 200 + 100 + 190 = 490 m. d. The maximum amount available is 337m. e. We are told that the investment opportunities for the firm are changing. It is unclear exactly what this means. However, if this implies uncertainty, the firm might not want to pay out 100% of its free cash flow to equity. f. Cash balance next year = Cash balance this year 100 Plus Free Cash flow to equity 337 Less Dividends next year 125 = 312 Problem 2. a. Change in FCFE = Reduction in prod. Costs 20000 plus reduction in inventory 15000 Plus addnl depreciation 2400 less capital expenditures 12000 less addnl taxes 13040 (tax rate)x(cost reductions-depreciation) = 12360 b. The amount of depreciation will decrease over time because we are using (accelerated) MACRS depreciation. The inventory reduction will contribute to cash flow only in the first year since there will not be any incremental reductions in inventory after this year. Problem 3. a. No, because there would be double taxation, i.e. both at the corporate level and at the personal level. b. In that case, it might be preferable to increase dividends now. The alternative would be to either take a large capital gain when the business would be sold, or a large dividend just before the business is sold. Hence, unless there are other capital losses that can be offset only by capital gains, it would be preferable to take larger dividends now.
Problem 4. Project Investment Requirement After-tax return on capital A 15 27% B 10 20% C 25 16% D 20 14% E 30 12% The afer-tax cost of debt = 12%(1-0.5) = 6% The cost of equity = .08 + 1.25(0.055) = 14.875% The market value of debt = \$500m. The market value of equity = 15(100) = \$1500 m.

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ch11sol.stern.nyu.edu - Chapter 11 A Framework for...

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