FI-516 WEEK 1 HOMEWORK ASSIGNMENT Junqing Wang 05/06/2012

Problem Based on Chapter 14, Residual Dividends Middlesex Plastics Manufacturing had 2011 Net Income of $15.0 Million. Its 2012 Net Income is forecast to increase by 8%. The companys capital structure has been 35% Debt and 65% Equity since 2010, and the company plans to maintain this capital structure in 2012. The company paid $3.0 Million cash dividends in 2011. The company is planning to invest in a major capital project in 2012. The capital budget for this project is $12.0 Million in 2012. 1. If Middlesex increases its cash dividends in 2012 at the same rate of growth as its Net Income rate, what will be the total 2012 dividend payout in Dollars? The total 2012 dividend payout in dollars = 3 X (1+0.8) = $3.24 million 2. What is the 2012 dividend payout ratio if the company increases its dividends at 8%? The dividend payout ratio in 2012 = 3.24 / (15 x 1.08) = 20% 3. If the company follows a residual dividend policy, and maintains its 35% Debt level in its capital structure, and invests in the $12.0 Million capital budget in 2012, what would be the Residual Dividend level (in Dollars) in 2012? What would be this Residual Dividends payout ratio? Net Income in 2012 is: (15.0 X 1.08) = $ 16.20 million Capital Budget in 2012: $12.0 X 65% = $ 7.8 Million Residual Dividends in 2012: $16.2 Million - $7.8 Million = $8.4 Million. Residual Dividends Payout Ratio: $8.4 / $16.2 = 51.85% 4. How much additional capital (Debt and/or Equity) will the company have to raise from outside sources in 2012 if it invests in this capital project, and follows a residual dividend policy?

The company invests this capital project totally need $12.0 Million. The company can fund from Retained Earnings $7.8 Million, so it has to raise $4.2 Million from outside sources. 5. What would be the prudent dividend policy for 2012? Pay dividends at the current dividend growth rate of 8%, or pay the residual dividend amount. The company should continue to increase its cash dividends at 8% in 2012, and maintain its 20% Dividend Payout Ratio. It should maintain the remaining cash as Retained Earnings. Maintaining the 20% dividend payout rate gives the company both stability and flexibility in its future dividend policies. Problem 19-3 (Chapter 19) on Warrants This problem is posted on page 781 of the textbook. a. Exercise value = Current price - Strike price.

(1)

(2) (3) (4) b.

Purchase Stock Price Price $ 20 $25 25 25 30 25 100 25

Exercise Value [-$5,0] = 0 0 5 75

Total bonds value $1,000 = debt value of bond + warrants value = VB + 50 x ($3) VB = $1,000 - $150 = $850. $850 =

t 1 (1 rd )

20

I
t

$1,000 (1 rd ) 20

t 1 (1.12)

20

I
t

$1,000 (1.12) 20

N = 20; I/YR = 12%; PV = 850; FV = 1000; Solve for PMT = 99.92 similar $100. Therefore, the company would set a coupon interest rate of 10 %( $100/1000), producing an annual interest payment I = $100.