microdrive assignment

microdrive assignment

Problems on Dividend Policy and Bonds

1. I would recommend Microdrive to keep the dividend constant at the level of 2011, assuming that Microdrive cannot change its Capital structure. Given the growth opportunities in the future Microdrive has increasing financial needs each year. To finance its assets Microdrive should rely more on its internal financing options rather than diluting equity.

Keeping the dividend constant will also signal that the company is investing in growth opportunities, thus keeping the shareholders expectation positive. This policy will also send a neutral signal to the shareholders and avoid the clientele effect. In my opinion investors who are expecting to receive very high dividends every year would sell the stock.

The company will also have a slightly higher leverage ratio if it plans to retain all its dividends. This will signal a higher firm value because shareholders will think that the company has growth opportunities and the manager is using debt to finance the growth in assets

Given the current cash flows of Microdrive it can be seen that Microdrive is issuing equity to meet its financing needs and dividend payout. If Microsoft continues with its current dividend policy then it ends up issuing 25 million of equity in the next 9 years. Once the shareholders realize this stock value will depreciate. The current policy of Microdrive is also unfavorable because by issuing equity to pay dividends the firm is losing money in taxes.

Thus by keeping the dividend constant Microdrive will save on taxes, keep the transaction cost of issuing equity low and neutralize the clientele effect.

2. Dividend payout ratio → 60%
Plough back ratio (b) → 40%
Return on equity → (279.22/2609.7) → 10.7
Dividend payout → (279.22*.60) → 166.20
Shares outstanding → 55.19 million
Dividend per share → (167.53/53.40) → 3.01
WACC → 10%
Growth (g) → b x ROE → 4.31%
Value of stock → Dividend/(cost of capital – Growth rate) → 3.01/(10%...

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