Captain Mo runs a commercial fishing unit consisting of a fleet of 20 boats. His regular net earnings per year are $15,000,000, and his company has 1,000,000 shares outstanding.
Suppose that he decides to purchase a newer, faster, and more productive fishing vessel. That is, his new boat can locate, catch, and stockpile more fish per hour, and do so with less time required for periodic maintenance, than any of his present boats. The new boat will enable the fleet to catch and deliver to the market more fish per day, and consequently collect more revenue.
The new boat costs $5,000,000, and this amount must be paid out in full at time 0. After allowing for periodic maintenance, the net increase in the fleet's annual earnings as a consequence of the new boat is equal to $800,000 starting at time 1.
The rate of interest is 10%/year.
Each year Captain Mo pays his entire net earnings to his shareholders as divi- dends, unless he uses a part of those earnings to finance a new project.
(a) What is the sequence of payments that Captain Mo will receive from the project?
(b) What is the net present value of the project?
(c) Describe how Captain Mo would finance the project by borrowing from a bank. What is the price per share before and after the project? What are the dividends per share before and after the project? What is the capital gain each shareholder will receive (per share) when Captain Mo purchases the new shipping vessel?
(d) Describe how Captain Mo would finance the project by issuing new shares. What is the price of a share at time 0? How many new shares must he issue? What will be the new dividend rate? How will the present value of a share held before Captain Mo announces the project change?
(e) Describe how Captain Mo would finance the project by using retained earn- ings. What will be the dividend per share at time 0? What is the ex dividend price of a share at time 0? What is the capital gain per share at time 0?