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A firm earns 1 million in year 0. Thereafter, it continues to earn 1 million a year in perpetuity. The financial manager of the firm is considering two choices regarding dividends:

i. Paying out all earnings as dividends, or

ii. Starting from year 0, investing 20% of its earnings each year in projects which earn 10% return

Assume that the opportunity cost of capital is 15%.

a. Under choice ii, how much dividends will be paid in year zero, year one, year two, year T.

b. What will be the value of the firm (year 0's dividends included) under policies i and ii?

c. What percentage of the value of the firm under policy ii is due to PVGO? How do you reconcile your answer with your result in part (a) which showed dividends growing over time.

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Basic Finance, Finance

Category:- Basic Finance
Reference No.:- M9997351

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