Renegade Technologic has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Renegade’s unlevered cost of capital is 10% and there are 10 million shares outstanding. Renegade’s board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. (Note: Free Cash Flow = Operating cash flow – Net capital spending – Changes in net working capital)
Assume that Renegade uses the entire $50 million to repurchase shares. The amount of the regular yearly dividends in the future is closest to:
| Value of Equity | ||||||
| = Free Cash Flows / Cost of Capital | ||||||
| = $40 million / 10% | ||||||
| = $400 million | ||||||
| Market Value of Firm | ||||||
| = Value of Equity + Excess Cash | ||||||
| = $400 million + $50 million | ||||||
| = $450 million | ||||||
| Market Price Per Share | ||||||
| = Market Value of Firm / No of Shares Outstanding | ||||||
| = $450 million / 10 million | ||||||
| = $45 | ||||||
| No of Shares repurchased | ||||||
| = Excess Cash / Market Price Per Share | ||||||
| = $50 million / $45 | ||||||
| = 1111111 Shares | ||||||
| No of Shares after repurchase | ||||||
| = No of Shares before repurchase - Shares repurchased | ||||||
| = 10000000 - 1111111 | ||||||
| = 8888889 | ||||||
| Regular Yearly Dividend | ||||||
| = Free Cash Flow / Shares outstanding after repurchase | ||||||
| = $40 million / 8888889 | ||||||
| = $4.50 | ||||||
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