Dividends Policy

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 under priced 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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