Let Rocksteady Industries be an all-equity firm in a Modigliani-Miller world with 500 shares outstanding and a cost of equity of r_E = 0.15. Suppose that it has announced a dividend of 12 per share equal to its expected annual earnings.

1. (a) Calculate the stock price and total value of the firm.

2. (b) Suppose that Rocksteady realizes lower than expected earnings of 3, 000, but does not expect this to impact its future cash flows. It does not want to reduce its dividend and decides to issue new shares to make up the difference. How many new shares will be issued and at what price? What is the payoff to existing shareholders?

3. (c) Suppose that Debbie owns 100 shares and disagrees with the firm’s policy of maintaining a dividend of 12, preferring instead to receive a lower payout than having her shares diluted. What could she do to achieve her desired outcome?

4. (d) Now suppose that Rocksteady instead realizes higher than expected earnings of 9, 000. It decides to keep the dividend at 12 and use the remainder to buy back shares. How many shares will be repurchased and at what price? What is the payoff to the remaining shareholders?

5. (e) Once again, Debbie is dissatisfied by the firm’s policy and would have preferred a proportionally higher dividend to the buyback. How many shares should she sell back to the firm to replicate her desired outcome?

Answer rating: 100% (QA)

Let Rocksteady Industries be an allequity firm in a ModiglianiMiller world with 500 shares outstanding and a cost of equity of r E 015 Suppose that it ... View the full answer