ETA is an all-equity firm with 50 million shares outstanding. It has $200 million in cash and expects future free cash flows of $80 million per year (with the next cash flow occurring in exactly one year's time). The Board of ETA can either use all excess cash to repurchase shares or for expansion. Suppose that ETA is able to invest the $200 million excess cash into a project that will increase the future free cash flows by 30% in year 1 (and cash flows stay constant at that level after year 1). This investment will not alter the risk of the business. ETA's cost of capital is 10% and assume that capital markets are perfect. If you were advising the board, what course of action would you recommend? Should ETA use the $200 million to expand or repurchase shares? Required: (a) Firm value with expansion is $ million. Note: Please provide your answer as an integer in million in the format of xxxx (for example, if the answer is $1,234.5 million, type in 1235). (b) If the board decides to pursue the expansion, the stock price is $ Note: Please provide your answer with two decimal points in the format of xx.xx (for example, if the answer is $12.345, type in 12.35). (c) If the board decides to use the excess cash for repurchase, the stock price is $ Note: Please provide your answer with two decimal points in the format of xx.xx (for example, if the answer is $12.345, type in 12.35). (d) Assume instead that the future free cash flows increase by g% in year 1 (and cash flows stay constant at that level after year 1). When this growth rate (g%) is lower than %***, the Board should decide to repurchase, because Select alternative ***Note: Please provid Select alternative answer is 12.345%, ty the expansion destroys shareholder value. the expansion creates shareholder value. ints in the format of xx.xx (for example, if the
ETA is an all-equity firm with 50 million shares outstanding. It has $200 million in cash and expects future free cash flows of $80 million per year (with the next cash flow occurring in exactly one year's time). The Board of ETA can either use all excess cash to repurchase shares or for expansion. Suppose that ETA is able to invest the $200 million excess cash into a project that will increase the future free cash flows by 30% in year 1 (and cash flows stay constant at that level after year 1). This investment will not alter the risk of the business. ETA's cost of capital is 10% and assume that capital markets are perfect. If you were advising the board, what course of action would you recommend? Should ETA use the $200 million to expand or repurchase shares? Required: (a) Firm value with expansion is $ million. Note: Please provide your answer as an integer in million in the format of xxxx (for example, if the answer is $1,234.5 million, type in 1235). (b) If the board decides to pursue the expansion, the stock price is $ Note: Please provide your answer with two decimal points in the format of xx.xx (for example, if the answer is $12.345, type in 12.35). (c) If the board decides to use the excess cash for repurchase, the stock price is $ Note: Please provide your answer with two decimal points in the format of xx.xx (for example, if the answer is $12.345, type in 12.35). (d) Assume instead that the future free cash flows increase by g% in year 1 (and cash flows stay constant at that level after year 1). When this growth rate (g%) is lower than %***, the Board should decide to repurchase, because Select alternative ***Note: Please provid Select alternative answer is 12.345%, ty the expansion destroys shareholder value. the expansion creates shareholder value. ints in the format of xx.xx (for example, if the
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:ETA is an all-equity firm with 50 million shares outstanding.
It has $200 million in cash and expects future free cash flows of $80 million per year (with the next cash flow
occurring in exactly one year's time). The Board of ETA can either use all excess cash to repurchase shares or for
expansion.
Suppose that ETA is able to invest the $200 million excess cash into a project that will increase the future free
cash flows by 30% in year 1 (and cash flows stay constant at that level after year 1). This investment will not
alter the risk of the business.
ETA's cost of capital is 10% and assume that capital markets are perfect.
If you were advising the board, what course of action would you recommend? Should ETA use the $200 million to
expand or repurchase shares?
Required:
(a) Firm value with expansion is $
million.
Note: Please provide your answer as an integer in million in the format of xxxx (for example, if the answer is
$1,234.5 million, type in 1235).
(b) If the board decides to pursue the expansion, the stock price is $
Note: Please provide your answer with two decimal points in the format of xx.xx (for example, if the answer is
$12.345, type in 12.35).
(c) If the board decides to use the excess cash for repurchase, the stock price is $
Note: Please provide your answer with two decimal points in the format of xx.xx (for example, if the answer is
$12.345, type in 12.35).
(d) Assume instead that the future free cash flows increase by g% in year 1 (and cash flows stay constant at that
level after year 1). When this growth rate (g%) is lower than
%***, the Board should decide to
repurchase, because Select alternative
***Note: Please provid Select alternative
answer is 12.345%, ty the expansion destroys shareholder value.
the expansion creates shareholder value.
ints in the format of xx.xx (for example, if the
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