## P

The firm as a whole is thus worth 100 X \$173.55 = \$17,355.

Several members of the board of Wharton have expressed dissatisfaction with the current dividend policy and have asked you to analyze an alternative policy.

Alternative Policy: Initial Dividend Greater than Cash Flow Another possible policy is for the firm to pay a dividend of \$110 per share on the first date (Date 1), which is, of course, a total dividend of \$11,000. Because the cash flow is only \$10,000, an extra \$1,000 must somehow be raised. One way to do this is to issue \$1,000 worth of bonds or stock at Date 1. Assume that stock is issued. The new stockholders will desire enough cash flow at Date 2 so that they earn the required 10 percent return on their Date 1 investment.2

What is the value of the firm with this new dividend policy? The new stockholders invest \$1,000. They require a 10 percent return, so they will demand \$1,000 X 1.10 = \$1,100 of the Date 2 cash flow, leaving only \$8,900 to the old stockholders. The dividends to the old stockholders will be as follows:

0 0