GXG Co is an e-business which designs and sells computer applications (apps) for mobile phones. The company needs to raise $3,200,000 for research and development and is considering three financing options.

Option 1
GXG Co could suspend dividends for two years, and then pay dividends of 25 cents per share from the end of the third year, increasing dividends annually by 4% per year in subsequent years. Dividends in recent years have grown by 3% per year.

Option 2
GXG Co could seek a stock market listing, raising $3·2 million after issue costs of $100,000 by issuing new shares to new shareholders at a price of $2·50 per share.

Option 3
GXG Co could issue $3,200,000 of bonds paying annual interest of 6%, redeemable after ten years at par.

Recent financial information relating to GXG Co is as follows:

Under options 2 and 3, the funds invested would earn a before-tax return of 18% per year.

The profit tax rate paid by the company is 20% per year.

GXG Co has a cost of equity of 9% per year, which is expected to remain constant.

Required:

Using the dividend valuation model, calculate the value of GXG Co under option 1, and advise whether option 1 will be acceptable to shareholders.

(6 marks)