Remember that the primary goal of a firm is to maximize shareholder wealth by in
ID: 2793877 • Letter: R
Question
Remember that the primary goal of a firm is to maximize shareholder wealth by increasing the firm's intrinsic value. It is thus important to understand the impact of distributions-both in the form of dividends or stock repurchases-on the firm's value. Consider the following situation: Kathy is a financial analyst in Demo You 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 $63 million in its most recent fiscal year. · The firm's cost of capital (WACC) is 15%. The firm has been growing at 10% for the past six years but is expected to grow at a constant rate of 8% in the future. The firm has 15.75 million shares outstanding. The company has $168 million in debt and $105 million in preferred stock Along with the rest of the finance team, Kathy has been part of board meetings and knows that the company is planning to distribute $120 million, which is invested in short-term investments, to its shareholders by buying back stock from its shareholders. Kathy also observed that, at this point, apart from the $120 million in short-term investments, the firm has no other nonoperating assets. Using results from Kathy's calculations and observations, solve for the values in the following tables. Select the best answer provided in the selection list.Explanation / Answer
Firm value = 63 * (1+8%) / (15% - 8%) = 972 million
Intrinsic value of equity = 972 - (168 - 120)- 105 = 819 million
Intrinsic share price = 819 / 15.75 = 52
Number of shares repurchased = 120 / 52 = 2.3077 million
Intrinsic value of equity = 819 - 120 = 699 million
Intrinsic share price = 699 / (15.75 - 2.3077) = 52
True and Avoid