Repurchases and the DCF model

Repurchases and the DCF model Little Oil has 1 million shares outstanding with a total market value of $20 million. The firm is expected to pay $1 million of dividends next year, and thereafter the amount paid out is expected to grow by 5% a year in perpetuity. Thus, the expected dividend is $1.05 million in year 2, $1.1025 million in year 3, and so on. However, the company has heard that the value of a share depends on the flow of dividends, and therefore, it announces that next year’s dividend will be increased to $2 million and that the extra cash will be raised immediately afterward by an issue of shares. After that, the total amount paid out each year will be as previously forecasted—that is, $1.05 million in year 2 and increasing by 5% in each subsequent year.

a. At what price will the new shares be issued in year 1?

b. How many shares will the firm need to issue?

c. What will be the expected dividend payments on these new shares, and what therefore will be paid out to the old shareholders after year 1?

d. Show that the present value of the cash flows to current shareholders remains $20 million..

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Repurchases and the DCF model

Repurchases and the DCF model Hors d’Age Cheeseworks has been paying a regular cash dividend of $4 per share each year for over a decade. The company is paying out all its earnings as dividends and is not expected to grow. There are 100,000 shares outstanding selling for $80 per share. The company has sufficient cash on hand to pay the next annual dividend.

Suppose that, starting in year 1, Hors d’Age decides to cut its cash dividend to zero and announces that it will repurchase shares instead.

a. What is the immediate stock price reaction? Ignore taxes, and assume that the repurchase program conveys no information about operating profitability or business risk.

b. How many shares will Hors d’Age purchase?

c. Project and compare future stock prices for the old and new policies. Do this for years 1, 2, and 3.

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