Dividends Policy

timer Asked: Apr 1st, 2016

Question description

Firm A is all equity with 100M shares outstanding. The firm has $150M in cash and expects future

free cash flows of $65M/year. The management plans to use the cash available to expand the

firm’s operations. The expansion will increase future free cash flows by 12%. Assume that the

appropriate annual discount rate for the firm is 10%.

1. Compute the current share price of Firm A. 

2. Compute the share price of Firm A if the company decides to use the cash available for a

share repurchase at no premium. Show your answer. 

3. Compute the share price of Firm A if the company decides to expand its operations. 

4. Comment on the results obtained in parts (2) and (3). 

5. Firm A believes that its shares are underpriced and that the true value is $10. The

management expects that new information will come out soon and investors will revise their

opinions and agree on a $10 share value for Firm A. If Firm A plans to use the $150M cash

for a share repurchase, should it wait until the new information comes out or not? Show

your answer. 

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