Question

Erin is a financial analyst in Blanche Inc. 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 $60 million in its most recent fiscal year. The firm's cost of capital (WACC) is 14%. The firm has been growing at 5% for the past six years but is expected to grow at a constant rate of 4% in the future. • The firm has 15.00 million shares outstanding. • The company has $160 million in debt and $100 million in preferred stock. Along with the rest of the finance team, Erin has been part of board meetings and knows that the company is planning to distribute $ 60 million, which is invested in short-term investments, to its shareholders by buying back stock from its shareholders. Erin also observed that, at this point, apart from the $60 million in short-term investments, the firm has no other nonoperating assets. Using results from Erin's calculations and observations, solve for the values in the following tables. Select the best answer provided in the selection list. Value Value $624.00 million $364 million Value of the firm's operations Intrinsic value of equity immediately prior to stock repurchase Intrinsic stock price immediately prior to the stock repurchase Number of shares repurchased Intrinsic value of equity immediately after the stock repurchase Intrinsic stock price immediately after the stock repurchase $24.27

Answer 1

*The value of the firm's operations is calculated as below:

Value of Firm's Operations = Free Cash Flow*(1+Growth Rate)/(WACC - Growth Rate)

Using the values provided in the question, we get,

**Value of Firm's Operations = 60*(1+4%)/(14% - 4%) = $624

The intrinsic value of equity immediately prior to stock repurchase is determined as below:

Intrinsic Value of Equity Prior to Stock Repurchase = Value of Firm's Operations + Value of Non Operating Assets - Value of Debt - Value of Preferred Stock = 624 + 60 - 160- 100 = $424

***The intrinsic stock price immediately prior to stock repurchase is determined as below:

Intrinsic Stock Price before Stock Repurchase = Intrinsic Value of Equity Prior to Stock Repurchase/Number of Outstanding Shares before Repurchase = (424)/15 = $28.26

* The number of shares repurchased is calculated as follows:

Number of Shares Repurchased = Cash Used for Repurchase/Share Price = 60/28.26 = 2.12

** The intrinsic value of equity immediately after stock repurchase is determined as below:

Intrinsic Value of Equity After Stock Repurchase = Value of Firm's Operations - Value of Debt - Value of Preferred Stock = 624 - 160 - 100 = $364

*** The intrinsic stock price immediately after stock repurchase is determined as below:

Intrinsic Stock Price after Stock Repurchase = Intrinsic Value of Equity After Stock Repurchase/Number of Outstanding Shares after Repurchase = 364/(15- 2.12) = $28.26