ESMT MBA Program, 2015, Module 3 Corporate Finance

Professor Guillermo Baquero, PhD

Assignment 3

Problems on Dividend Policy and Bonds

Deadline: Monday, May 18th 2015, 13h59pm

Problem 1

Consider the financial structure and the dividend policy of Microdrive. Given Microdrives growth opportunities and competitive position, give your expert opinion as a financial advisor to the company on the following issues for the period 2011 to 2018:

a. Is Microdrive paying out too little as dividends? Or too much? Taking into account transaction costs, clientele effects and asymmetric information issues, would you advise to cut the dividend, increase the dividend or keep the level of dividend per share from 2011?

b. Assume that Microdrive does not pay any dividend for the period 2012 to 2017 and all retained earnings are reinvested. Also, assume that only in 2018 the company starts paying a dividend and that the payout ratio for 2018 is 60%. If dividends grow at the sustainable growth rate from 2018 onwards, use your long-term financial plan to calculate the value of the Microdrives stock at the end of 2018.

Problem 2

A firm considers borrowing around USD 7.4 million (present value) in the bond markets. There are two possibilities. The first is to issue 10000 bonds, with face value of USD 1000, maturity of 9 years, yield to maturity (YTM) of 8%, a 4% coupon rate, making semi-annual payments. The second possibility is to issue 10000 bonds with face value USD 100, maturity of 15 years, a YTM of 9.5%, 90% coupon rate, making semi-annual payments.

a. Which bond has the longest duration? b. If interest rates are expected to decrease, which bond issue is the best alternative for the firm?

Discuss. c. Which additional features would you advise the bond indenture to contain to protect the firm

against interest rate risk?