Question

(a) Kim Corp. has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Kim Corp.’s cost of capital is 10% and there are 10 million shares outstanding. Kim Corp.'s board decided to use the entire $50 million to repurchase shares. Assume that you own 2,500 shares of Kim Corp. stock and that Kim Corp. uses the entire $50 million to repurchase shares. Assume Kim Corp. goes ahead with the share repurchase. What is the dollar value of regular annual dividends in the future?

(b）Use the numbers from part (a). Suppose you are unhappy with the company’s decision to repurchase and would prefer that Kim Corp. used the excess cash to pay a special dividend. Assume perfect capital markets. What trade you could place in order to receive the same amount of cash equivalent to Kim Corp. paying the special dividend?

Answer 1

a)
Enterprise Value = PV (Future FCF) = $40 million /10%	$         400.00	Million
Market value = Enterprise Value + cash = $400 + $50	$         450.00	Million
Share price = Market Value / Shares outstanding = $450 millions/ $10 millions	45	per share
Number of shares repurchased = $50 million/45 per share	1,111,111.11	shares
Shares outstanding = $10,000,000 - $1,111,111.11	8,888,888.89	shares
Dividend = $40,000,000/8,888,888.89	$             4.50	Per share
b)
Enterprise Value = PV (Future FCF) = $40/10%	$         400.00	Million
Market value = Enterprise Value + cash = $400 + $50	$         450.00	Million
Share price = Market Value / Shares outstanding = $450/ $10 millions	45	per share
Special dividend = $50 Million /10 million shares	5
Dividend that you want to receive to trade off = 2500 shares x $5	12500
Number shares to sell = $12500/$45  per share	277.78	shares