Question

Your company has $1 million in free cash flow and is trying to determine how to allocate the capital among organic growth, dividends, and share buybacks. The company has the opportunity to engage in organic growth, which requires an investment of $1 million and has a NPV of $2.3 million. Alternatively, it can offer a $1 dividend to each of its one million shareholders. Or it could buy back 100,00 shares at $10 each. What should your company do? A. Use the 1 million for the organic growth project B. Distribute 1 Million in dividends C. Distribute 1 million through a share buyback program D. Offer a 0.50 dividend and use the remaining 500,000 to purchase 50,000 shares E. None of the above

Answer 1

Answer is A. Use the 1 million for the organic growth project.

If 1 million is used for the organic growth project then it will increase value for shareholders by $2.3 million which is the NPV of the project.

per share value incresed would be: NPV/no. of shares = $2.3/1 = $2.3.

If 1 million is distributed as dividends then every shareholder will receive only $1. If it's used for share buyback then only 100,000 shareholders will receive $10.

if it's used for $0.50 dividend and use the remaining 500,000 to purchase 50,000 shares then each shareholder will receive $0.50 and only 50,000 shareholders will receive $10.