Question

The Quick Buck Company is an all-equity firm that has been in existence for the past three years. Company management expects that the company will last for two more years and then be dissolved. The firm will generate cash flows of $800,000 next year and $1,250,000 in two years, including the proceeds from the liquidation. There are 35,000 shares of stock outstanding and shareholders require a return of 13 percent.

Required:
a. What is the current price per share of the stock?
b. The Board of Directors is dissatisfied with the current dividend policy and proposes that a dividend of $910,000 be paid next year. To raise the cash necessary for the increased dividend, the company will sell new shares of stock.
c. How many shares of stock must be sold?
d. What is the new price per share of the existing shares of stock?

Answer 1

Answer and Explanation:

a. The computation of the current price per share is shown below:

Current price per share = Value of Firm ÷ Number of stock outstanding

where,

Value of Firm is

= $800,000 ÷ 1.13 + $1,250,000 ÷ 1.13^2

= $1,686,897.96

And, the number of outstanding shares is 35,000 shares

So, the current share price is

= $1,686,897.96 ÷ 35,000 shares

= $48.20

c. The computation of the shares of stock sold is shown below:

No of shares of stock must be sold is

= ($910,000 - $800,000) ÷ 48.20

= $2,282.16

c. The computation of the new price per share of stock is shown below:

Current price per share = Value of Firm ÷ Number of stock outstanding

where,

Value of Firm is

= $910,000 ÷ 1.13 + $1,250,000 ÷ 1.13^2

= $1,784,243.09

And, the number of outstanding shares is 35,000 shares and $2,282.16

So, the current share price is

= $1,784,243.09 ÷ 35,000 shares + $2,282.16

= $47.86