Assume we are in a Modigliani-Miller (no tax) world. Exeter Corporation has $20 million in excess cash and has no debt. The firm expects to generate additional cash flow of $48 million per year in perpetuity. It has 10 million shares outstanding. Exeter Corporation decides to use the $20 million excess cash to repurchase shares in the stock market. After the share repurchase Exeter plans to distribute all of its annual cash flow as dividends every year. Exeter Corporation’s cost of capital is 12%. ( a) What would be the stock price reaction after the announcement of the plan? (b) Calculate the share price after the announcement. (c) How many shares can Exeter Corporation buy with its excess cash? (d) Show that the share price after the share repurchase transaction is identical to post-announcement price.
Assume we are in a Modigliani-Miller (no tax) world. Exeter Corporation has $20 million in excess cash and has no debt. The firm expects to generate additional cash flow of $48 million per year in perpetuity. It has 10 million shares outstanding. Exeter Corporation decides to use the $20 million excess cash to repurchase shares in the stock market. After the share repurchase Exeter plans to distribute all of its annual cash flow as dividends every year. Exeter Corporation’s cost of capital is 12%. (
a) What would be the stock price reaction after the announcement of the plan?
(b) Calculate the share price after the announcement.
(c) How many shares can Exeter Corporation buy with its excess cash?
(d) Show that the share price after the share repurchase transaction is identical to post-announcement price.
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