Question

Question 1 – Payout Policy

AMC Corporation currently has an enterprise value of $400 million and $100 million in excess cash. The firm has 10 million shares outstanding and no debt. Suppose AMC uses its excess cash to repurchase shares. After the share repurchase, news will come out that will change AMC’s enterprise value to either $600 million or $200 million.

Required:

1. What is AMC’s share price prior to the share repurchase?
2. What is AMC’s share price after the repurchase if its enterprise value goes up? What is AMC’s share price after the repurchase if its enterprise value declines?
3. Suppose AMC waits until after the news comes out to do the share repurchase. What is AMC’s share price after the repurchase if its enterprise value goes up? What is AMC’s share price after the repurchase if its enterprise value declines?
4. Suppose AMC management expects good news to come out. Based on your answers to requirements (2) and (3), if management desires to maximize AMC’s ultimate share price, will they undertake the repurchase before or after the news comes out? When would management undertake the repurchase if they expect bad news to come out?
5. Given your answer to requirement (4), what effect would you expect an announcement of a share repurchase to have on the stock price? Why?
6. do in the word file or excel file

Answer 1

1. Enterprise Value= (Equity +Debt) -Cash

=EV+Cash

=$400+$100=$500m

Therefore share price =$500m/10m=$50/share

2. AMC repurchases = $100m/$50 = 2m shares

8m remaining shares outsanding (and no excess cash)

If its EV goes up to $600m , Share Price = 600/8 = $75 per share

If its EV goes down to $200m, Share Price = 200/8 = $25 per share

The share price after the announcement will be $75 or $25

3 .If EV rises to $600m prior to repurchase, given its $100m in cash and 10m shares outstanding,

Therefore in the case of good news, AMC’s share price will rise to,

Share Price =(600 + 100) / 10m = $70 .

& If there are bad news ,

The Share Price =(200 + 100)/ 10m = $30

So,The share price will either be $70 or $30 .

4. In the case of Good news, given that $75 > $70, the company will make the share repurchase before the news arrive, trying to repurchase undervalued shares.

In the case of Bad news, given that $25 < $30, the company will wait until the news arrives and only after will repurchase the shares.

5. If management announces a share repurchase, investors should anticipate good news and the price will adjust to $75.