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BE311-5-SP3 5m QUESTION TWO You have the assignment to advise the CEO of Caddaric Ltd, a private company that specializes in industrial surveillance services, on a planned payout for the firm's investors. The firm has no debt and has accumulated cash beyond the required reinvestment needs, so the CEO feels it makes sense to return some of its cash to the shareholders. The following table sets out the information about the firm's balance sheet. Value Cost of capital Total assets 20m 10% Cash Fixed assets 15m Equity 20m 10% The number of shares outstanding in Caddaric Ltd is 20m, so the price per share is l. The risk-free rate is 3%, and the average return on the market index is 7%. The fim expects to grow at a rate of 4% cach year. Your report to the CEO should address the following points a) Payout to shareholders could take several forms. Explain the differences and similarities between cash dividend payments and stock repurchases. (10 marks) b) The discounted dividend model suggests a relationship between the price per share, the dividend yield, and the dividend growth. What dividend payment per share should the investors expect if this model is correct next year? (10 marks) c) The firm doesn't currently have debt on its balance sheet. Your report should address the relative advantages and disadvantages of corporate borrowing as an alternative way of creating a payout, as corporate debt implies a payout to the firm's debtholders in the form of interest payments. In particular, you should address this question in light of the trade-off theory of borrowing and the pecking order theory of financing. (15 marks) d) Suppose the CEO aims for a payout of 1.2m next year. What is the expected price on ex- dividend day next year if the firm pays 1.2m as cash dividends? In contrast, what is the expected number of shares after a 1.2m share repurchase operation next year? (15 marks) [TOTAL: 50 MARKS

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