MBA-Level Corporate Finance Assignment – Dividends & Stock Buybacks

Scenario for Question 1

1. The Frontczak Company is expecting to generate (after tax) a Net Income of $250 million annually and indefinitely (in perpetuity), and this amount is paid out annually as dividends.The company’s stock has a beta of 1.2, the risk free rate or return (RFR) is 4% and the market risk premium (MRP) is 6%.The company is financed at a debt-to-value ratio of 0.4.  The company can borrow at a pre – tax cost of 6%, and the tax rate is 35%.  There are 10 million shares of common stock outstanding.

a)               What is the stock price?

Answer:

Re = Rf + β (Rm – Rf) = 0.04+1.2*0.06 = 0.112 or, 11.2%

Growth, g = 0

Dividend per share, D1 = 250 million/ 10 million =$25

Therefore, stock price, P0 = D1/ (Re – g) = 25/0.112 =$223.21

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