Consolidated Pasta is currently expected to pay annual dividends of $10 a share in perpetuity on the 2.2 million shares that are outstanding. Shareholders require a 8% rate of return from Consolidated stock.
Consolidated now decides to increase next year’s dividend to $20 a share, without changing its investment or borrowing plans. Thereafter the company will revert to its policy of distributing $10 million a year.
How much new equity capital will the company need to raise to finance the extra dividend payment?
What will be the total present value of dividends paid each year on the new shares that the company will need to issue?
What will be the transfer of value from the old shareholders to the new shareholders?