Newcastle Autos plc has a current period cash flow of 4.2 million and pays no dividends. The

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Newcastle Autos plc has a current period cash flow of £4.2 million and pays no dividends. The present value of the company’s future cash flows is £72 million. The company is entirely financed with equity and has 1 million shares outstanding. Assume the dividend tax rate is zero.

(a) What is the share price of Newcastle Autos’ equity?

(b) Suppose the board of directors of Newcastle Autos announces its plan to pay out 40 per cent of its current cash flow as cash dividends to its shareholders. How could you achieve a zero payout policy on your own, if you own 1,000 shares of Newcastle Autos equity?

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a The share price of Newcastle Autos equity can be calculated using the present value of the companys future cash flows and the number of shares outstanding Share price Present value of future cash flows Number of shares outstanding 72 million 1 million shares 72 per share b If the board of directors of Newcastle Autos announces its plan to pay out 40 per cent of its current cash flow as cash dividends to its shareholders the dividend per share would be Dividend per share Current cash flow per share x Dividend payout ratio 42 million 1 million shares x 04 168 per share If you own 1000 shares of Newcastle Autos equity you would receive a total dividend of 1680 1000 shares x 168 per share To achieve a zero payout policy on your own you could sell your 1000 shares of Newcastle Autos equity at the current share price of 72 per share This would generate proceeds of 72000 You could then use these proceeds to purchase a bond or another investment that yields a return equivalent to the dividend yield of Newcastle Autos For example if you purchase a bond with a face value of 72000 and a coupon rate of 4 per cent you would receive annual interest payments of 2880 72000 x 4 This would be equivalent to the 1680 dividend you would receive from holding 1000 shares of Newcastle Autos equity Alternatively you could choose to reinvest the dividend payments from your 1000 shares of Newcastle Autos equity into additional shares of the company ...View the full answer

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