solution

The balance sheet for JTA plc. is shown here in market value terms. There are 4,000 million shares outstanding.

Market Value Balance Sheet (£ mil.)
Cash	£9,557	Equity	£12,450
Fixed Assets	£10,223	Liabilities	7,330
Total	£19,780	Total	£19,780

The company has declared a dividend of £0.90 per share, the equity goes ex-dividend tomorrow.

Tasks:

a)

i.Ignoring any tax effects, show what price the shares would be selling for today?

ii.What will they sell for tomorrow?

iii.What will the market value balance sheet look like after the dividends are paid?

b)

BTA plc, a technology products firm, is debating whether to convert its all-equity capital structure to one that has 30% debt. Currently there are 4,000 shares outstanding and the share price is £52. EBIT is expected to remain at £24,000 per year forever. The interest rate on new debt is 9% and there are no taxes.

i.Under the current capital structure, show the cash flow fora shareholder of the firm who owns 1000 shares of equity, assuming the firm has a dividend payout rate of 20%

ii.What will the shareholder’s cash flow be under the new capital structure of the firm? Assume the investor will keep her 1000 shares

c)

Explain how you would estimate the cost of capital for a new investment project if its risk is different from the rest of the company? How would you estimate the overall cost of capital for a project when the company has debt in its capital structure? Explain how you could estimate the cost of debt given that the company’s debt is publicly held.

d)

Critically explain the importance of dividends and how dividend policy can affect the type of investors in the company but is irrelevant when estimating the company’s value.