ERICA LESMANA (17/414139/EK/21541)

1. After a 5- for- 1 stock split, Strasburg Company paid a dividend of $ 0.75 per new share, which
represents a 9% increase over last year’s pre- split dividend. What was last year’s dividend per
share?

Since this represents a 9% increase over the prior year, the dividend on the pre-split share is
$3.75/1.09 = $3.44 per share

2. External Equity Financing: ​Northern Pacific heating and cooling Inc. has a 6 month backlog of
orders for its patented solar heating system. To meet this demand, management plans to expand
production capacity by 40% with a $10 million investment in plant and machinery. The firm wants to
maintain a 40% debt to total assets ratio in its capital structure. It also wants to maintain its past
dividend policy of distributing 45% of last years net income. In 2008, net income was $5 million.
How much external equity must Northern Pacific seek at the beginning of 2009 to expand capacity as
desired? Assume that the firm uses only debt and common equity in its capital structure.

Retained earnings = Net income (1 – Payout ratio)

= $5,000,000(0.55) = $2,750,000.

External equity needed:

Total equity required = (New investment)(1 – Debt ratio)
= $10,000,000(0.60) = $6,000,000.

New external equity needed = $6,000,000 – $2,750,000 = $3,250,000.

3. SunnyWay Company is considering three independent projects and each of them requires $5
million investment:
Project H (high risk) Cost of capital = 16% IRR = 20%
Project M (medium risk) Cost of capital = 12% IRR = 10%
Project L (low risk) Cost of capital = 8% IRR = 9%
The optimal capital structure is 50% debt and 50% equity. The expected net income (NI) is
$7,287,500. If the firm adopts the residual dividend model, what will be the firm’s dividend payout
ratio?

The firm should choose P ​ rojects H and L ​since​ IRR > cost of capital​ for both H and L, which means
that the firm needs to raise $10 million
According to the optimal capital structure:
$10 million*(0.5) = $5 million will be raised from debt
$10 million*(0.5) = $5 million will be raised from equity (retained from NI)

Dividends = NI - R/E = 7,287,500 - 5,000,000 = $2,287,500

Payout ratio = Dividends / NI = 2,287,500 / 7,287,500 = 31.39%