2014/9/25
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Assignment 2
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This assignment is due at the end of Module 4. While it primarily covers Modules 3 and 4, some questions may draw on previous modules. The time to complete this assignment is an estimated 57 hours if you have read and mastered the material in the module notes and required readings. Refer to the general instructions in Assignment 1 on how to prepare and submit your assignment.
Question 1 (17 marks)
Montreal Financial and Legal (MFL) has forecasted its earnings after interest and taxes and its investment needs for the next four years as shown in Exhibit MFL1.
Exhibit MFL1: MFL’s earnings after interest and taxes and investment needs Earnings ($) 900,000 950,000 1,200,000 1,250,000 Investment ($) 600,000 275,000 500,000 875,000
Year 1 2 3 4
MFL has a target capital structure of 35% debt/65% equity and 150,000 shares outstanding.
Required
a. (5 marks) Find the dividend per share (DPS) in each of the four years, and the expected DPS, standard deviation of DPS, and coefficient of variation of DPS over the fouryear period, if MFL pays out a constant 50% of its earnings per share (EPS) as dividends. b. (5 marks) Find the DPS in each of the four years, and the expected DPS, standard deviation of DPS, and coefficient of variation of DPS over the fouryear period, if MFL follows a residual dividend policy paying out 100% of available funds as dividends. c. (1 mark) Would a riskaverse investor prefer that MFL follow the constant payout ratio dividend policy of part (a) or the residual dividend policy of part (b)? Why? d. (4 marks) Suppose MFL wants to establish a constant dollar policy whereby it would pay out 85% of the
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