Reference no: EM132546572

1. The net income of Novis is 32,000 kroner (DKr). The company has 10,000 outstanding shares and 100 per cent payout policy. The expected value of the firm one year from now is DKr 1,545,600. The appropriate discount rate for Novis is 12 per cent, and the dividend tax rate is zero.

a) What is the current value of the firm, assuming the current dividend has not yet been paid?

b) What is the ex-dividend price of Novis's equity if the board follows its current policy?

c) At the dividend declaration meeting, several board members claimed that the dividend is too meager and is probably depressing Novis's price. They proposed that Novis should issue new shares to finance an increase of the current dividend to DKr 4.25.

c.1) Comment on the claim that the low dividend is depressing the share price. Support your arguments with calculations.

c.2) If the proposal is adopted, at what price will the new shares sell? How many will be sold?

2. Gamma Airlines has an asset beta of 1.5. The risk-free interest rate is 6%, and the market risk premium is 8%. Assume the capital asset pricing model is correct. Gamma pays taxes at a marginal rate of 35%. Draw a graph plotting Gamma's cost of equity and after-tax WACC as a function of its debt-to-equity ratio D/E, from no debt to D / E = 1.0. Assume that Gamma's debt is risk-free up to D / E = 0.25. Then the interest rate increases to 6.5% at D / E = 0.5, 7% at D / E = 0.8, and 8% at D / E = 1.0. You can assume that the firm's overall beta ( rA ) is not affected by its capital structure or the taxes saved because debt interest is tax-deductible.