Question

6. Dividends, repurchases, and firm value

Remember that the primary goal of a firm is to maximize shareholder wealth by increasing the firm’s intrinsic value. It is thus important to understand the impact of distributions—both in the form of dividends or stock repurchases—on the firm’s value.

Consider the following situation:

Jessica is a financial analyst in Smith and T Co. 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 $84 million in its most recent fiscal year.
•	The firm’s cost of capital (WACC) is 13%. The firm has been growing at 10% for the past six years but is expected to grow at a constant rate of 8% in the future.
•	The firm has 21.00 million shares outstanding.
•	The company has $224 million in debt and $140 million in preferred stock.

Along with the rest of the finance team, Jessica has been part of board meetings and knows that the company is planning to distribute $120 million, which is invested in short-term investments, to its shareholders by buying back stock from its shareholders. Jessica also observed that, at this point, apart from the $120 million in short-term investments, the firm has no other nonoperating assets.

Using results from Jessica’s calculations and observations, solve for the values in the following tables. Select the best answer provided in the selection list.

	Value
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

Based on your understanding of stock repurchases, identify whether the following statement is true or false:

If a firm pays a dividend of $0.59 per share, the firm’s stock price will also fall by $0.59 per share.

This statement is      because if a firm pays a dividend of $0.59 per share, the price per share of the firm’s stock will also fall by $0.59 to     any arbitrage opportunities.

Answer 1