TEME is a manufacturer of toy construction equipment. If it pays out all of its earnings as

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Question:

TEME is a manufacturer of toy construction equipment. If it pays out all of its earnings as dividends, it will have earnings of 0.3 million per quarter in perpetuity. Suppose that the discount rate, expressed as an effective annual rate (EAR), is 16%. TEME pays dividends quarterly.

1) What is the value of TEME if it continues to pay out all of its earnings as dividends? Assume that the next dividend is paid one quarter from now.

2) Suppose that TEME is considering a one-time expansion into toy xylophones. It is estimated that this will cost 1M. Assume that this cost will be incurred at the end of the year, one year from now. As a result of expansion, earnings in subsequent quarters (i.e. starting in 1 year and 1 quarter from now) would be 0.05 million higher than without the expansion.

Calculate the value of TEME if it undertakes the investment.