Your firm currently has a large cash balance of $150M. It will generate a $40M free cash flow every year in perpetuity, starting at t=1. All free cash flows are paid out as dividends. Assume that your firm has an equity beta of 1.25 and 20M shares outstanding. The risk-free rate is 3 percent and the market risk premium is 6 percent. a) Suppose that your firm will pay out a dividend of $150M tomorrow. What is the cum-dividend price per share and ex-dividend price per share for your firm? b) Suppose instead that your firm uses the $150M to repurchase shares. How many shares do you repurchase? Calculate the price per share immediately following the repurchase.
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Your firm currently has a large cash balance of $150M. It will generate a $40M
a) Suppose that your firm will pay out a dividend of $150M tomorrow. What is the cum-dividend price per share and ex-dividend price per share for your firm?
b) Suppose instead that your firm uses the $150M to repurchase shares. How many shares do you repurchase? Calculate the price per share immediately following the repurchase.
(c) Suppose instead that you announce that you will cancel the $150M dividend at t=0 and the $40M dividends at t=1 and t=2 to make capital upgrades. This means that the free cash flows from t=3 onward will now be $60M because of these capital upgrades, and that there will be no free cash flows at t=0, t=1, or t=2. All free cash flows from t=3 onward will be paid out as dividends. What is the price per share today following this announcement? Were these capital upgrades a good idea?
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