Practice Question:

JBL Co. has designed a new conveyor system. Management must choose among
three alternative courses of action: (1) The firm can sell the design outright to
another corporation with payment over 2 years. (2) It can license the design to
another manufacturer for a period of 5 years, its likely product life. (3) It can
manufacture and market the system itself; this alternative will result in 6 years of
cash inflows. The company has a cost of capital of 12%. Cash flows associated
with each alternative are as shown in the following table.

Alternative Sell License Manufacture

Initial investment (CF0) $200,000 $200,000 $450,000
Year (t) Cash inflows (CF)
1 $200,000 $250,000 $200,000
2 250,000 100,000 250,000
3 80,000 200,000
4 60,000 200,000
5 40,000 200,000
6 200,000

Evaluate the Projects and choose the best one and explain why you choose
that project?
EAA?
is the Modigliani and Miller Approach.

Theories
Capital Structure
Combination of Debt and Equity
Pecking Order Theory
Company Financing or Capital Generate:
1. Internal Financing cost is very very low
2. Debt cost is very low
3. Preferred Equity cost is low
4. Common Equity its cost is high

Sales
CGS
GP
-OE
EBIT 100,000 100,000
-Interest 40,000 60,000
EBT 60,000 40,000
Tax is 40% 24000 16000
of Earnings after tax
Signal Theory
Very high Dividend then What signal goes to market.
Good Signal then People will start investing stock prices will go upward

Company financing
Debt
Signal theory and pecking order theory relate.
Common Stock issue then what signals goes to the market.
Bad signal then what effect will be on stock prices. Ultimately low

 Information
 Sign or Gesture
 Indication
 Alert
 Idea
 Clue
 It could be positive or negative
 Direction
 Message
Modigliani and Miller:
Relevance theory
Dividends made any effect on Market Value of Shares
Dividend High Market Value will be high
Dividend low Market Value low

Irrelevance theory
Dividend effect on Book Value of Shares
Dividend is irrelevant to Book Value of Shares

Market value and Book Value

Book Value of Stock: Company 1st time stock sale Par Value
Market Value of Stock: Currently at which price Stock is
trading
Share sells at its book value, which is written on papers
Market Price

Dividend pay or not paying face value always remains same

Face value and dividends are irrelevant
Market price and dividends are relevant to each other

Cultus Sale: 430,000 Market price

Book Value: 180,000 Book Value
Year passed book value remains same
Year passed market value changes

Coca Cola : Dividend is $4 on each stock Demand inv=creases price

increase
Pepsi: Dividend $1.7 on each stock demand less ultimately price become
less
Market Timing Theory (Informational Context)
Information in the market that Coca Cola is making a new plant in South Punjab

Good signal means:

Market Movement Stock purchase or sale whenever traders get any
information

Anmol want to purchase stock

Recently news Coca Cola purchase a new plant in south Punjab\
News: Coca Cola Lahore manufacturing plant seize due to low quality
measures
Stock prices decrease
You want to purchase the stock
Pepsi New Plant in South Punjab
Bird In Hand Theory (Behavioral Aspect)
Investors see current dividend as less risky then future dividends or capital gains

Stock A : Dividend receive after 1 year $4 will be given

Stock B: Dividend receive after 5 year $25 will be given
h approach