The firm is capitalized by 100,000 shares of common stock which trade at the beginning of the period at 10 per share. The expected net income in period one is 200,000 and the firm has declared a cash dividend of 1 per share, to be paid at the end of the period. The firm’s cost of equity is 20%. Ignore personal taxes. Hint: think of a relationship between today’s price and next period’s price in the dividend discount model.1. what is the ex-dividend share price? what would have been the end-of-period stock price if the firm skipped the dividend?2. how many shares of common stock will the firm have to sell at the ex-dividend price in order to undertake an investment project which requires an investment equivalent to I(1)=200,000?3. what is the value of the firm just after the new issue? what would have been the value of the firm if it skipped the dividend and used the retained earnings to finance the investment?
Dividend discount model
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