Old shareholders under the investment banker proposal

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Reference no: EM131569844

Micromanaged Catering Inc. (MCI) has two assets: £1,600 in cash and an investment project. The cash can be invested in the risk-free asset that earns 5% per year. The project requires an investment of £800 today and generates an expected cash flow of £1,600 one year from now. This opportunity recurs perpetually each year. Thus, for example, one year from now MCI can again invest £800 and generate £1,600 one year subsequent to that investment. MCI has 800 shares outstanding. The market equity premium is 5% per year, and the investment project has a beta equal to 1. The Modigliani and Miller assumptions hold for Parts (i)-(v) below.

i. Should MCI invest in the project? Explain.

ii. Suppose MCI's CFO decides to pursue the project. What is the value of MCI?

iii. Suppose MCI's CFO decides to take the project and always pay out all free cash flow as a dividend. What is MCI's cum-dividend price expected to be one year from now?

iv. MCI's investment banker suggests that MCI instead pays out the £1,600 in cash as a dividend today, reverting to the CFO's proposed dividend policy described in part (iii) in year one. In order to continue to invest in the project, MCI must raise equity immediately after the dividend is paid. How many shares must be issued to new shareholders?

v. Describe both the pound amount and timing of the expected dividend stream to old shareholders under the investment banker's proposal. Has old shareholder wealth changed relative to their position in part (ii)?

Reference no: EM131569844

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