InTech, a computer software firm that has never paid dividends before, is considering whether it should start doing so. This firm has a cost of equity of 22 percent and a cost of debt of 10 percent (the tax rate is 40 percent). The firm has $100 million in debt outstanding and 50 million shares outstanding, selling for $10 per share. The firm currently has net income of $90 million and depreciation charges of $10 million. It also has the following projects available:
|
Project
|
Initial Investment
|
Annual EBIT
|
Salvage
|
Lifetime
|
Depreciation
|
|
1
|
$10 million
|
$1 mil
|
$500,000
|
5 years
|
$2.5 mil
|
|
2
|
$40 million
|
$5 mil
|
$1 million
|
10 years
|
$10 mil
|
|
3
|
$50 million
|
$5 mil
|
$1 million
|
10 years
|
$10 mil
|
The firm plans to finances its future capital investment needs using 20 percent debt.
a. Which of these projects should the firm accept?
b. How much (if any) should the firm pay out as dividends?