Question

Natsam Corporation has $250 million of excess cash. The firm has no debt and 500 million shares outstanding, with a current market price of $15 per share. Natsam’s board has decided to pay out this cash as a one-time dividend

. a. What is the ex-dividend price of a share in a perfect capital market?

b. If the board instead decided to use the cash to do a one-time share repurchase, in a perfect capital market what is the price of the shares once the repurchase is complete? c. In a perfect capital market, which policy, in part (a) or (b), makes investors in the firm better off?

Answer 1

Available Cash No of Shares Market Value per Share Hence Market Capitalisation of Shares Since, There is no debt, Market value of Shares-Market value of the Assets of the firm (A- L+C) 250 Million USD 500 Million 15 USD Million USD 4 7500 15 500 Scene (a) Since Dividend gained is equivalent to cost recovered for a investor in capital market, the ex dividend price 15 - 0.5 (250 Million USD /500 Million)[Dividend per share] -> 14.5 USD per share 10 Scene If board instead buys back shares at current market price, it will buy back 16.67 million Shares (250/15)[No of shares can be bought back- available fund / market value per share] 12 13 In a perfect capital market, part (a) i.e., pay back will be a better option for the investors, because since there is excess cash it means the management is not able to find an expansion opportunity for growth, hence paying off will enable the investor to divest the funds in a growing opportunity. on the other hand buy-back will lead to concentration of powers (voting right) which in general a investor in captial market dont expect. 14