Ready plc is financed entirely by equity capital with a required return of 13 per cent. Ready's business is such that as sales increase, working capital does not change. Ready currently has £10m in cash not needed for business operations that could be used to pay a dividend immediately. Under current policy, post-tax earnings (and free cash flow) of £10m per year are expected to continue indefinitely. All earnings in future years are expected to be paid out as dividends in the year of occurrence.
Calculate
a. The value of the company before the current dividend is paid from the £10m of cash.
b. The value of the company if the current dividend (time 0) is missed and the retained earnings are put into investments (with the same risk as current set of projects) yielding an extra £2m per year to infinity in addition to the current policy's earnings. What happens to earnings and cash flow? Is this good or bad investment?
c. The value of the company if half of the current dividend is missed and the retained earnings are put into investment yielding £0.5m per year to infinity. What happens to earnings and cash flows? Is this good or bad investment?