Consider Polonius Company as an example of using this framework. Polonius Company has $2 billion in cash on the balance sheet, invested in risk free Treasuries earning 4%. Polonius stock is traded on the NYSE with 200 million shares outstanding with a market price of $20/share. The company has been averse to issuing any debt in the past, so it has no debt. The beta of the stock is 0.6. The market risk premium is 6%.
Next, Polonius decides to pay out the $2 billion of cash to the shareholders of the firm as a one- time cash dividend.
What is the new beta of Polonius’s total assets (TA)?
What is the new beta of Polonius’s common stock (βE)?
What is the new required rate of return on common stock (rE)?
What is the new stock price per share and are the shareholders better off/worse off/neither.