Question

OMI Ltd has $50 million in excess cash and no debt. The company expects to generate additional net after-tax cash flows of $40 million per year in subsequent years and will pay out these cash flows as a regular dividend for the foreseeable future. The company’s unlevered cost of capital is 10% and there are 10 million shares outstanding. Its board is meeting to decide whether to pay out the $50 million in excess cash as a special dividend or to repurchase the company’s shares. Assume that the board decides to use the entire $50 million in excess cash to repurchase its shares.

Calculate the market value of the company including the excess cash available today.

Calculate the company’s share price before the share repurchase.

Calculate the number of shares outstanding after the share repurchase.

Calculate the amount of the regular annual dividend per share that the company will be able to pay in the future.

Answer 1

1). Enterprise value = PV of free cash flows = 40/10% = 400 million

Market value = EV + excess cash = 400 + 50 = 450 million

2). Share price before repurchase = market value/number of shares = 450/10 = 45 per share.

3). Number of shares which can be purchased at 45 per share using $50 million cash is

50/45 = 1,111,111

Number of shares after share repurchase = number of shares before repurchase - number of shares repurchased

= 10,000,000 - 1,111,111 = 8,888,889 shares

4). If entire FCF is given put as dividend then dividend per share will be free cash flow/shares remaining

= 40*10^6/8,888,889 = 4.50 per share