Problem 1: Fidelity company has a target capital structure that consists of 40 percent debt and 60 percent equity. The company's capital budget for next year is $10 million. Axel expects net income of $8 million. The company's cost of capital is 12 percent.
a. How much will the company pay out in dividends if it follows a residual dividend policy?
b. What is the company's dividend payout ratio if it pays the dividends calculated above?
c. Is it likely the company will follow a residual dividend policy? Why or why not?
d. If the company decided to pay out $4.5 million in dividends, how much would it need to raise in equity outside the company?
e. Should the company go ahead with a project of average risk that generates a 10 percent rate of return? Why or why not?
Problem 2: Ladle Corporation entered into an agreement with its investment banker to sell 15 million shares of the company's stock with Ladle netting $270 million dollars from the offering. The expected price to the public was $20 per share.
The out-of-pocket expenses incurred by the investment banker were $5,000,000.
a. What profit or loss would the investment banker incur if the issue were sold to the public at an average price of $25 per share?
b. What profit or loss would the investment banker incur if the issue were sold to the public at an average price of $15 per share?
If the investment banker agrees to handle the issue on a best efforts basis, earning 7.5 percent of the proceeds, calculate the investment banker's profit or loss if all 15 million shares are sold at an average price of $15. How much will the company receive?