Melanee is a financial analyst in Bidget Corp. As part of her analysis of the an
ID: 2754486 • Letter: M
Question
Melanee is a financial analyst in Bidget Corp. As part of her analysis of the annual distribution poicy and its impact on the firm’s value, she makes the following calculations and observations:
The company generated a free cash flow of $120 million in it’s most recent fiscal year.
The firms cost of capital is 12% The firm has been growing at 8% for the past six years but is expected to grow at a constant rate of 7% in the future.
The firm has 30.00 million shares outstanding
The company has $320 million in debt and $200 million in preferred stock
Along with the rest of the financial team, Melanee has been part of board meetings and knows that the company is planning to distribute $105 million, which is invested in short term investments, to its shareholders by buying back stock from it’s shareholders. Melanee also observed that at this point aport from the $105 million in short term investments, the firm has no other nonoperating assets. Solve for:
Value of the firm’s operations-
Intrinsic value of equity immediately-
Intrinsic stock price immediately prior to the stock repurchase-
Number of shares repurchased-
Intrinsic value of equity immediately after the stock repurchase-
Intrinsic value price immediately after the stock repurchase-
If a firm pays a dividend of $0.59 per share, the firm’s stock price will also fall by $0.59 per share. This statement is ___ (true or false) because if a firm pays a dividend of $0.59 per share, the prices per share of the firm’s stock will also fall by $0.59 to ____ (avoid or encourage) any arbitrage opportunities.
Explanation / Answer
Value of firm's operation = Expected Earnings/ (Ke - g) = 120*1.07/(12-7)% = $ 2568 Million where Ke is cost of capital of 12 % and g is growth rate of 7%
Intrinsic value of Equity = Value of firm less debt less Preferred capital = 2568 - 320 - 200 = $2048 Million
Intrinsic stock price before repurchase = $2048/30 = $ 68.27
Number of share repurchased = 105 million /68.27 = 1.54 Million
Intrinsic value price after repurchase remain same $ 68.27
If a firm pays a dividend of $0.59 per share, the firm’s stock price will also fall by $0.59 per share. This statement is TRUE because if a firm pays a dividend of $0.59 per share, the prices per share of the firm’s stock will also fall by $0.59 to AVOID any arbitrage opportunities.