A firm has a market value equal to its book value.Currently,the firm has excess cash of £500 and other assets of £9,500.Equity is worth £10,000.The firm has 250 shares outstanding and net income of £1,400.What will the share price be if the firm pays out its excess cash as a cash dividend?

Question

Quizplus · Accepted Answer

The current book value of equity is £10,000, which is also the market value. If the firm pays out the excess cash of £500 as a cash dividend, then the new book value of equity will be £9,500 (£10,000 - £500).

The new market value of equity will still be £10,000, since the payout of the cash dividend does not affect the value of the other assets.

Therefore, the new share price will be £40 (£10,000 / 250 shares).

So, the correct answer is B.

A Firm Has a Market Value Equal to Its Book