Erinwood is an all equity firm with 8,500,000 shares of common stock outstanding. The company expects...
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Erinwood is an all equity firm with 8,500,000 shares of common stock outstanding. The company expects to earn $5.5 million per year in perpetuity and has $4.5 million of cash that is planning to use to pay an immediate dividend. The unlevered cost of capital for the company is 12%, while cost of debt is 5%. Erinwood is considering starting a new project. The project will cost $5 million and will create an additional cash flow of $600,000 in perpetuity. Assume perfect financial markets and no taxes. a) If the company decides to finance the project with cash reserves and not to pay the dividend, what would be the company value and the new price per share? (8 Marks) b) Now assume that the company prefers to distribute immediately the available cash as a dividend and then issue new shares to finance the project. How many shares will be issued? (6 Marks) c) Finally, assume that the company still prefers to distribute immediately the available cash as a dividend, but wants to issue perpetual debt to finance the project. What would be the new company value and the new price per share? (8 Marks) d) Compute the return on equity for the three possible alternatives. Which financing alternative will be preferred by equity holders? Why? (8 Marks) Erinwood is an all equity firm with 8,500,000 shares of common stock outstanding. The company expects to earn $5.5 million per year in perpetuity and has $4.5 million of cash that is planning to use to pay an immediate dividend. The unlevered cost of capital for the company is 12%, while cost of debt is 5%. Erinwood is considering starting a new project. The project will cost $5 million and will create an additional cash flow of $600,000 in perpetuity. Assume perfect financial markets and no taxes. a) If the company decides to finance the project with cash reserves and not to pay the dividend, what would be the company value and the new price per share? (8 Marks) b) Now assume that the company prefers to distribute immediately the available cash as a dividend and then issue new shares to finance the project. How many shares will be issued? (6 Marks) c) Finally, assume that the company still prefers to distribute immediately the available cash as a dividend, but wants to issue perpetual debt to finance the project. What would be the new company value and the new price per share? (8 Marks) d) Compute the return on equity for the three possible alternatives. Which financing alternative will be preferred by equity holders? Why? (8 Marks)
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