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: Elle is a financial analyst in Demo You Inc’s. 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 $45.00 million in its most recent fiscal year. • The firm’s cost of capital (WACC) is 14%. 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 11.25 million shares outstanding. • The company has $120.00 million in debt and $75.00 million in preferred stock. Along with the rest of the finance team, Elle has been part of board meetings and knows that the company is planning to distribute $120.00 million, which is invested in short-term investments, to its shareholders by buying back stock from its shareholders. Elle also observed that, at this point, apart from the $120.00 million in short-term investments, the firm has no other nonoperating assets. Using results from Elle’s calculations and observations, solve for the values in the following tables. (Note: Round your answers to two decimal places.) Value Value of the firm’s operations Intrinsic value of equity immediately prior to stock repurchase Intrinsic stock price immediately prior to the stock repurchase Value Number of shares repurchased Intrinsic value of equity immediately after the stock repurchase Intrinsic stock price immediately after the stock repurchase Based on your understanding of stock repurchases, identify whether the following statement is true or false: The stock price of a firm increases after the firm repurchases some of its shares. This statement is true/false because if the stock price changes after a firm conducts its share repurchase, then there will not be/will be arbitrage opportunities. Thus, the price of the stock remains the same after a repurchase.

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: Elle is a financial analyst in Demo You Inc’s. 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 $45.00 million in its most recent fiscal year. • The firm’s cost of capital (WACC) is 14%. 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 11.25 million shares outstanding. • The company has $120.00 million in debt and $75.00 million in preferred stock. Along with the rest of the finance team, Elle has been part of board meetings and knows that the company is planning to distribute $120.00 million, which is invested in short-term investments, to its shareholders by buying back stock from its shareholders. Elle also observed that, at this point, apart from the $120.00 million in short-term investments, the firm has no other nonoperating assets. Using results from Elle’s calculations and observations, solve for the values in the following tables. (Note: Round your answers to two decimal places.) Value Value of the firm’s operations Intrinsic value of equity immediately prior to stock repurchase Intrinsic stock price immediately prior to the stock repurchase Value Number of shares repurchased Intrinsic value of equity immediately after the stock repurchase Intrinsic stock price immediately after the stock repurchase Based on your understanding of stock repurchases, identify whether the following statement is true or false: The stock price of a firm increases after the firm repurchases some of its shares. This statement is true/false because if the stock price changes after a firm conducts its share repurchase, then there will not be/will be arbitrage opportunities. Thus, the price of the stock remains the same after a repurchase.

Cornerstones of Financial Accounting

4th Edition

ISBN:9781337690881

Author:Jay Rich, Jeff Jones

Publisher:Jay Rich, Jeff Jones

Chapter12: Fainancial Statement Analysis

Section: Chapter Questions

Problem 85PSA

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Consider the following situation:

Elle is a financial analyst in Demo You Inc’s. 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 $45.00 million in its most recent fiscal year.
•	The firm’s cost of capital (WACC) is 14%. 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 11.25 million shares outstanding.
•	The company has $120.00 million in debt and $75.00 million in preferred stock.

Along with the rest of the finance team, Elle has been part of board meetings and knows that the company is planning to distribute $120.00 million, which is invested in short-term investments, to its shareholders by buying back stock from its shareholders. Elle also observed that, at this point, apart from the $120.00 million in short-term investments, the firm has no other nonoperating assets.

Using results from Elle’s calculations and observations, solve for the values in the following tables. (Note: Round your answers to two decimal places.)

	Value
Value of the firm’s operations
Intrinsic value of equity immediately prior to stock repurchase
Intrinsic stock price immediately prior to the stock repurchase

	Value
Number of shares repurchased
Intrinsic value of equity immediately after the stock repurchase
Intrinsic stock price immediately after the stock repurchase

Based on your understanding of stock repurchases, identify whether the following statement is true or false:

The stock price of a firm increases after the firm repurchases some of its shares.

This statement is true/false because if the stock price changes after a firm conducts its share repurchase, then there will not be/will be arbitrage opportunities. Thus, the price of the stock remains the same after a repurchase.

Expert Solution

Step 1

Value of a firm's operations is calculated as the present value of all the expected future free cash flows.

Value of equity is value of firm minus value of debt and value of preferred stock.

Stock repurchase is also done to maximize shareholder's return.

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