The Caraway Seed Company sells specialty gardening seeds and products primarily to mail-order and Internet customers. The firm has $200,000 available for distribution as a cash dividend immediately and plans to shut down its business at the end of one year, at which time it will be prepared to pay a liquidating dividend of $1.2 million to the firm's stockholders. The firm's shareholders require a 10% rate of return for investing in the all-equity financed firm.
(a) Analyse the value of Caraway's equity if it pays out a $200,000 cash dividend today and plans to pay a $1.2 million liquidating dividend at the end of one year.
(b) If Caraway's board of directors decides to pay a $600,000 dividend today to its existing shareholders using an equity offering selling new shares of common stock to raise the additional $400,000 it needs to make the cash dividend, what will be the value of the existing shares of stock? Compare your result with part (a) and explain your answer.