Consider the following situation: Jessica is a financial analyst in Blanche Inc.
ID: 2765209 • Letter: C
Question
Consider the following situation: Jessica is a financial analyst in Blanche Inc. As part of her analysis of the annual distribution policy and its impact on the firm's value, she makes the following calculations and observations: The company generated a free cash flow (FCF) of $150 million in its most recent fiscal year. The firm's cost of capital (WACC) is 14%. The firm has been growing at 6% for the past six years but is expected to grow at a constant rate of 5% in the future. The firm has 37.50 million shares outstanding. The company has $ 400 million in debt and $250 million in preferred stock. Along with the rest of the finance team, Jessica has been part of board meetings and knows that the company is planning to distribute $75 million, which is invested in short-term investments, to its shareholders by buying back stock from its shareholders. Jessica also observed that, at this point, apart from the $75 million in short-term investments, the firm has no other nonoperating assets. Using results from Jessica's calculations and observations, solve for the values in the following tables. Select the best answer provided in the selection list. Based on your understanding of stock repurchases, identify whether the following statement is true or false: When firms make distributions in the form of dividends, the stock price falls by the value of dividends per share (DPS) distributed, but the overall shareholder wealth does not decrease. This statement is because if a firm pays a dividend of $1 per share, the price per share of the firm's stock will also fall by $1 to any arbitrage opportunities.Explanation / Answer
a.Value of operations = FCF x (1+ abnormal growth) x(1+ normal growth)/(rate - normal growth)
b. Value of operations = ($150 million x(1+6%)x(1+5%))/(14% - 5%) = $1855 million
Intrinsic value of equity immediately prior to repurchases = value of operation - debt - preferred debt
= $1855 million - $400 million - $250 million = $1205 million
c. Intrinsic value of stock price immediately prior to repurchases = Intrinsic value of equity immediately prior to repurchases/ Shares outstanding ; $1205 million / 37.50 million = $32.13 per share
d. Share repurchased = $75 million / $32.13 = 2334267 shares =2.33 million shares
e. Value of operations = ($150 million x(1+6%)x(1+5%))/(14% - 5%) = $1855 million
Intrinsic value of equity immediately prior to repurchases = value of operation - debt - preferred debt + short term investment
= $1855 million - $400 million - $250 million + $75 = $1280 million
f. Intrinsic value of stock price immediately prior to repurchases = Intrinsic value of equity immediately prior to repurchases/ Shares outstanding ; $1280 million / (37.50 million+ 2.33 million) = $32.13 per share