Question

Tangshan Mining Company must choose its optimal capital structure. Currently, the firm has a 40 percent debt ratio and the firm expects to generate a dividend next year of $4.89 per share and dividends are expected to grow at a constant rate of 5 percent for the foreseeable future. Stockholders currently require a 10.89 percent return on their investment. Tangshan Mining is considering changing its capital structure if it would benefit shareholders. The firm estimates that if it increases the debt ratio to 50 percent, it will increase its expected dividend to $5.24 per share. Because of the additional leverage, dividend growth is expected to increase to 6 percent and this growth will be sustained indefinitely. However, because of the added risk, the required return demanded by stockholders will increase to 11.34 percent. (a) What is the value per share for Tangshan Mining under the current capital structure

Answer 1

The value per share for Tangshan Mining under the current capital structure is $73.73.

Step-by-step explanation:

To find the value per share for Tangshan Mining under the current capital structure, we can use the dividend discount model (DDM). The DDM calculates the present value of all future dividends and the terminal value of the company. Under the current capital structure, Tangshan Mining is expected to generate a dividend of $4.89 per share next year, with a constant growth rate of 5%. Stockholders require a 10.89% return on their investment.

Using the DDM formula:

Value per share = Dividend / (Required return - Dividend growth rate)

Value per share = 4.89 / (0.1089 - 0.05) = $73.73

Therefore, the value per share for Tangshan Mining under the current capital structure is $73.73.

Answer 2

Tangshan Mining Company

The value per share for Tangshan Mining under the current capital structure is:

= $44.90

Step-by-step explanation:

a) Data and Calculations:

Debt ratio = 40%

Equity ratio = 60% (100 - 40)

Expected dividend per share next year = $4.89

Expected dividend growth rate = 5%

Stockholders' required rate of return = 10.89%

New capital structure:

Estimated debt ratio = 50%

Estimated equity ratio = 50% (100 - 50)

Projected dividend under new capital structure = $5.24

Projected dividend growth rate = 6%

Projected stockholders' required rate of return = 11.34%

Under current capital structure:

Value per share = Dividend/Required rate of return

= $44.90 ($4.89/10.89%)