Concept explainers
Repurchases and the DCF model House of Haddock has 5,000 shares outstanding and the stock price is $140. The company is expected to pay a dividend of $20 per share next year and thereafter the dividend is expected to grow indefinitely by 5% a year. The president, George Mullet, now makes a surprise announcement: He says that the company will henceforth distribute half the cash in the form of dividends and the remainder will be used to repurchase stock. The repurchased stock will not be entitled to the dividend.
- a. What is the total value of the company before and after the announcement? What is the value of one share?
- b. What is the expected stream of dividends per share for an investor who plans to retain his shares rather than sell them back to the company? Check your estimate of share value by discounting this stream of dividends per share.
a)
To determine: The total value of the company before and after the announcement and also the value of one share.
Explanation of Solution
Computation of value of company before and after the announcement:
The company value and stock price will be same after the announcement.
Therefore, the value of one share is $140.
b)
To determine: The expected stream of dividends per share for an investor who plans to retrain the shares rather than sell them back to the company.
Explanation of Solution
For year 1:
For year 2:
Following table shows the overall scenario of two years based on above calculations:
Year 1 | Year 2 | |
Annual repurchase amount($) | 50,000 | 52,500 |
Annual dividend amount ($) | 50,000 | 52,500 |
Discount rate (%) | 19.29 | 11.69 |
Stock price ($) | 167 | 186.52 |
Shares repurchased | 299 | 281 |
New outstanding shares | 4,701 | 4,419 |
Dividend per share ($) | 10.64 | 11.88 |
Table no.1
In all subsequent years, the total dividend and repurchase amount will increase by 5% and the number of shares decreasing by:
Therefore, the share price is as follows:
Want to see more full solutions like this?
Chapter 16 Solutions
PRIN.OF CORPORATE FINANCE
- Company B's board is meeting to decide how to pay out $20 million in excess cash to shareholders. The company has 10 million shares outstanding, no debt, faces an equity cost of capital = WACC = 12%, and expects to generate future free cash flows of $48 million per year forever that will be paid out to shareholders as dividends each period. Calculate each shareholders' wealth if the company decides to pay out the $20 million excess cash immediately by repurchasing stock. ( Hint: shareholder wealth = value of equity holding plus cash from repurchase.)arrow_forwardIMB has 1 million outstanding shares, currently trading at $10 each, and it is all-equity financed. Current earnings are $2 million, which also provide the company’s current cash holdings. At the next board meeting, the directors will be discussing whether to implement a new investment project, not yet known to the public. The project costs $1 million and it will generate expected earnings of $.5 million a year, in perpetuity starting one year from now. The appropriate discount rate for the project is 10%. If the project is not undertaken, the firm will pay a dividend of $2 a share. If the project is implemented, the firm must decide how to finance it. The board is considering two options: i) to finance the investment project by retaining earnings and paying only $1 dividend per share; ii) to keep the dividend at $2 per share, and to finance the project by issuing new equity. Shares are issued ex-dividend. Capital markets are perfect (no taxes).arrow_forwardXYZ Electronics Inc. is all equity financed and generates perpetual annual EBIT of $600. Assume that the EBIT, and all other cash flows, occur at year end and that we are currently at the beginning of a year. Assume that XYZ has a 100% payout rate, 5,000 shares outstanding, and that shareholders require a return of 5%. Assume that the tax rate is 0%. XYZ is considering an open market stock repurchase. It plans to buy 20% of its outstanding shares at the price of $4.00 per share. The repurchased shares will be cancelled. It will finance the repurchase by issuing perpetual bonds with a coupon rate (and yield) of 3%. Assume that the tax rate is 0%. If XYZ goes ahead with the repurchase, then what is the value of the company after the repurchase is complete?arrow_forward
- House of Haddock has 5,060 shares outstanding and the stock price is $146. The company is expected to pay a dividend of $26 per share next year and thereafter the dividend is expected to grow indefinitely by 3% a year. The president, George Mullet, now makes a surprise announcement: He says that the company will henceforth distribute half the cash in the form of dividends and the remainder will be used to repurchase stock. The repurchased stock will not be entitled to the dividend. a-1. What is the total value of the company before the announcement? a-2. What is the total value of the company after the announcement? a-3. What is the value of one share? b. What is the expected stream of dividends per share for an investor who plans to retain his shares rather than sell them back to the company? Check your estimate of share value by discounting this stream of dividends per share. Complete this question by entering your answers in the tabs below. Req A1 to A3 Req B a-1. What is the total…arrow_forwardPayout Policy. House of Haddock has 5,000 shares outstanding and the stock price is $100. The company is expected to pay a dividend of $20 per share next year, and thereafter, the dividend is expected to grow indefinitely by 5% a year. The president, George Mullet, now makes a surprise announcement: He says that the company will henceforth distribute half the cash in the form of dividends and the remainder will be used to repurchase stock. a. what should be the total value of the company before the announcement? b. what should be the total value after the announcement? c. what must be the expected rate of return on equity? d. what is the new growth rate in the dividend stream? (check your estimate of share value by discounting this stream of dividends per share)arrow_forwardAluworks Co. is expected to pay a $21.00 dividend next year. The dividend will decline by 10 percent annually for the following three years. In year 5, Aluworks will sell off assets worth $100 per share. The year 5 dividend, which includes a distribution of some of the proceeds of the asset sale, is expected to be $60. In year 6, the dividend is expected to decrease to $40 and will be maintained at $40 for one additional year. The dividend is then expected to grow by 5 percent annually thereafter. If the required rate of return is 12 percent, what is the value of one share of Aluworks?arrow_forward
- KBS enterprise is selling one of its division for $80million cash.At the upcoming quarterly board meeting, KBS board of directors are to decide whether to use the entire funds for a cash dividend or carry out a repurchase of 2million shares valued at $80million.both options will have some possible effects on the company. The company has a long term record of gradually increasing dividend.As the head of treasury, providing an in depth discussion of at least three factors that the board of directors would need to keep in perspective when making their final decisionarrow_forwardThe Link Resport & Spa Company has 75,000 shares of stock outstanding. The company is expected to have total earnings next year of $500,000. The company plans to reinvest $275,000 in projects earning an (equity) return of 15%, and to return the remainder of its earnings to shareholders in the form of dividends or stock repurchases. The first dividend or repurchse payments will be made exactly one year from today. In all future years, the market expects the company's reinvestment rate and the return on reinvested earnings to remain constant. The required return on equity is 12%. What is the value of the firm today, if it 1.) uses the remaining $225,000 to pay dividends, and will continue this payout policy (as a percent of earnings) in future years? 2) uses 40% of its annual payout to repurchase stock, and uses the remainder to pay divdends (and will continue this policy in future years)? Assume that the firm will use the remaining $225,000 to pay dividends (and will continue this…arrow_forwardRome Corporation invests in the research and development department and will not pay dividends for the next several years. Venetian Industries is interested in acquiring shares of Rome Corporation. Venetian's CEO has estimated Rome's available cash flows for the next 3 years: $7 million, $9 million, and $12 million. After the third year, available cash flow is expected to grow by 5% on a steady basis. Rome Corporation's weighted average cost of capital (WACC) is 7%, the market value of its debt and preferred stock totals $60 million. Rome Corporation has $22 million of non-operating assets and 9 million shares of common stock outstanding. Calculate the present value of expected available cash flows for the next 3 years. Determine the market value of Rome Corporation's operations. Calculate an estimate of the price per share of Rome Corporation.arrow_forward
- XYZ Soda Inc. is all equity financed and generates perpetual annual EBIT of $300. Assume that the EBIT, and all other cash flows, occur at year end and that we are currently at the beginning of a year. Assume that XYZ has a 100% payout rate, 1,500 shares outstanding, and that shareholders require a return of 5%. Assume that the tax rate is 0%. XYZ is considering an open market stock repurchase. It plans to buy 20% of its outstanding shares at the price of $4.00 per share. The repurchased shares will be cancelled. It will finance the repurchase by issuing perpetual bonds worth a total sum of $1,200 and a coupon rate (and yield) of 3%. Assume that the tax rate is 0%. If XYZ goes ahead with the repurchase, then what is its WACC after the repurchase is complete?arrow_forwardNewman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $3.68 per share and paid cash dividends of $1.98 per share (D0=$1.98). Grips' earnings and dividends are expected to grow at 25% per year for the next 3 years, after which they are expected to grow 5% per year to infinity. What is the maximum price per share that Newman should pay for Grips if it has a required return of 14% on investments with risk characteristics similar to those of Grips?arrow_forwardNewman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $3.29 per share and paid cash dividends of $1.59 per share (Do-$1.59). Grips' earnings and dividends are expected to grow at 25% per year for the next three years, after which they are expected to grow at 8% per year to infinity. What is the maximum price per share that Newman should pay for Grips if it has a required return of 16% on investments with risk characteristics similar to those of Grips?arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT