Dividends received = $43,000($30,000/$300,000) Dividends received = $4,300 So the return the shareholder expects is: R = $4,300/$30,000 R = .1433 or 14.33% b. To generate exactly the same cash flows in the other company, the shareholder needs to match the capital structure of ABC. The shareholder should sell all shares in XYZ. This will net $30,000. The shareholder should then borrow $30,000. This will create an interest cash flow of: Interest cash flow = .10($30,000) Interest cash flow = –$3,000 The investor should then use the proceeds of the stock sale and the loan to buy shares in ABC. The investor will receive dividends in proportion to the percentage of the company’s share they own. The total dividends received by the shareholder will be: Dividends received = $73,000($60,000/$600,000) Dividends received = $7,300 The total cash flow for the shareholder will be: Total cash flow = $7,300 – 3,000 Total cash flow = $4,300 The shareholders return in this case will be: R = $4,300/$30,000 R = .1433 or 14.33% c. ABC is an all equity company, so: RE = RA = $73,000/$600,000 RE = .1217 or 12.17% To find the cost of equity for XYZ we need to use M&M Proposition II, so:
Dividends received = $43,000($30,000/$300,000) Dividends received = $4,300 So the return the shareholder expects is: R = $4,300/$30,000 R = .1433 or 14.33% b. To generate exactly the same cash flows in the other company, the shareholder needs to match the capital structure of ABC. The shareholder should sell all shares in XYZ. This will net $30,000. The shareholder should then borrow $30,000. This will create an interest cash flow of: Interest cash flow = .10($30,000) Interest cash flow = –$3,000 The investor should then use the proceeds of the stock sale and the loan to buy shares in ABC. The investor will receive dividends in proportion to the percentage of the company’s share they own. The total dividends received by the shareholder will be: Dividends received = $73,000($60,000/$600,000) Dividends received = $7,300 The total cash flow for the shareholder will be: Total cash flow = $7,300 – 3,000 Total cash flow = $4,300 The shareholders return in this case will be: R = $4,300/$30,000 R = .1433 or 14.33% c. ABC is an all equity company, so: RE = RA = $73,000/$600,000 RE = .1217 or 12.17% To find the cost of equity for XYZ we need to use M&M Proposition II, so:
Problem%20Set-Leverage%20and%20Capital%20Structure.docx