Newcastle auto plc has a current cash flow of 4.4 million and pays no dividends. The Present value of the company ´s future cash flows is 74 million. The company is entirely financed with equity and has 800.000 shares outstanding. Assume the dividend tax is zero.
Question 1. What is the share price of the Newcastle Auto´s equity?
Question 2. Suppose the board of directors of Newcastle Autos announces it´s plan to pay out 60% of it´s current cash flow as cash dividends to it´s shareholders. How could you achieve a zero payout policy on your own, if you own 1.000 shares of Newcastle Autos equity?
To answer your questions:
Question 1:
To find the share price of Newcastle Auto's equity, we can use the formula:
Share price = Present value of future cash flows / Number of shares outstanding
Share price = 74 million / 800,000
Share price = $92.50
Therefore, the share price of Newcastle Auto's equity is $92.50.
Question 2:
If Newcastle Autos announces a plan to pay out 60% of its current cash flow as cash dividends, and you own 1,000 shares of Newcastle Autos equity, you can achieve a zero payout policy on your own by reinvesting all the cash dividends you receive.
Assuming the current cash flow remains the same at 4.4 million, and the dividend payout ratio is 60%, the cash dividend per share would be:
Cash dividend per share = Current cash flow * dividend payout ratio / Number of shares outstanding
Cash dividend per share = 4.4 million * 60% / 800,000
Cash dividend per share = $33
As you own 1,000 shares, your total cash dividend amount would be:
Total cash dividend amount = Cash dividend per share * Number of shares you own
Total cash dividend amount = $33 * 1,000
Total cash dividend amount = $33,000
To achieve a zero payout policy, you would reinvest this entire cash dividend amount back into purchasing additional shares of Newcastle Autos equity. By doing this, you will effectively retain your earnings within the company and not receive any cash dividends.
To calculate the share price of Newcastle Auto's equity, we need to divide the present value of the company's future cash flows by the number of shares outstanding.
Question 1: Share Price Calculation
1. The present value of the company's future cash flows is given as $74 million.
2. The number of shares outstanding is stated as 800,000.
3. Divide the present value by the number of shares:
Share Price = Present Value / Number of Shares
Share Price = $74,000,000 / 800,000
Share Price = $92.50 per share
Therefore, the share price of Newcastle Auto's equity is $92.50.
Question 2: Achieving a Zero Payout Policy
To achieve a zero payout policy as an individual shareholder of Newcastle Autos and own 1,000 shares, you would need to reinvest any cash dividends received back into buying more shares.
1. The current cash flow of Newcastle Auto is given as $4.4 million.
2. The board of directors plans to pay out 60% of the current cash flow as cash dividends.
Dividend Payout = 60% * Current Cash Flow
Dividend Payout = 0.60 * $4,400,000
Dividend Payout = $2,640,000
3. As an individual shareholder, you own 1,000 shares.
4. The dividend per share would be:
Dividend per Share = Dividend Payout / Number of Shares
Dividend per Share = $2,640,000 / 1,000
Dividend per Share = $2,640
5. With a zero payout policy, you would use the dividend received to purchase more shares.
Number of Shares Acquired = Dividend per Share / Share Price
Number of Shares Acquired = $2,640 / $92.50
Number of Shares Acquired ≈ 28.54 shares
6. Round the number of shares acquired to the nearest whole number:
Number of Shares Acquired ≈ 29 shares
7. After reinvesting the dividends to purchase more shares, you would have a total of:
Total Shares = Initial Shares + Shares Acquired
Total Shares = 1,000 + 29
Total Shares = 1,029 shares
By reinvesting the cash dividends received into purchasing additional shares, you can maintain a zero payout policy for your own investment in Newcastle Autos.