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Problem 1 (28 marks) Carter Construction Company has a debt to equity ratio of 3

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Problem 1 (28 marks)
Carter Construction Company has a debt to equity ratio of 3. New investments for
the year would cost $36 million. The firm expects net earnings of $12 million this
year.
a) Calculate the debt and equity financing required for the new investments,
dividends paid, and external debt and equity financing required if the firm follows a
residual dividend policy and wants to maintain its debt to equity ratio. (12 marks)
b) Calculate the dividends paid and external debt and equity financing required if
the firm has a fixed payout ratio of 60% and it wants to maintain its debt to equity
ratio. (8 marks)
c) Calculate the dividends paid and external debt and equity financing required if
the firm has a policy of growing dividend at a steady rate of 3% every year and it
wants to maintain its debt to equity ratio. The last dividends paid are equal to $10
million. (8 marks)

 

Problem 2 (21 marks)
Piper Paper Products (PPP) Limited's stock is currently trading at $23 per share. PPP
is considering a 15 percent stock dividend. Equity accounts are shown below:

 

Common stock (585,000 shares) $585,000
Retained earnings $3,720,000
Total owner's equity $4,305,000

a) How many new shares will be distributed as a result of the stock dividend? (2
marks)

b) Show how the equity accounts will change as a result of the stock dividend? (5
marks)

c) Assuming a perfect market, what will the share price be after the stock dividend?
(2 marks)

d) Suppose the company instead decides on a three-for-one stock split. The firm's
80 cent per share cash dividend on the new (post-split) shares represents an
increase of 5 percent over last year's dividend on the pre-split stock. What effects
does this have on the equity accounts? What was last year's dividend per share?
(12 marks)