Question

Kathy is a financial analyst in BTR Warehousing’s. As part of her analysis of the annual distribution policy and its impact on the firm’s value, she makes the following calculations and observations:
• The company generated a free cash flow (FCF) of $87.00 million in its most recent fiscal year.
• The firm’s cost of capital (WACC) is 13%. The firm has been growing at 10% for the past six years but is expected to grow at a constant rate of 8% in the future.
• The firm has 21.75 million shares outstanding.
• The company has $232.00 million in debt and $145.00 million in preferred stock.

Along with the rest of the finance team, Kathy has been part of board meetings and knows that the company is planning to distribute $120.00 million, which is invested in short-term investments, to its shareholders by buying back stock from its shareholders. Kathy also observed that, at this point, apart from the $120.00 million in short-term investments, the firm has no other nonoperating assets.

Using results from Kathy's calculations and observations, solve for the values in the following tables.

1. Value of the firm's operations.
a. 6,833.33
b.1,366.67
c. 68.33
d.1,421.33

2. Intrinsic value of equity immediately prior to stock repurchase.
a. 888
b. 948
c. 1276
d. 1153

3. Intrinsic stock price immediately prior to the stock repurchase.

a. 28.88
b. 41.50
c. 30.83
d. 37.50

4. Number of shares repurchased

a. 1.56
b. 1.95
c. 2.54
d. 3.32

5. Intrinsic value of equity immediately after the stock repurchase.

a. 888
b. 1306.67
c. 6773.33
d. 1038.67

6. Intrinsic stock price immediately after the stock repurchase.

a. 37.50
b. 30.83
c. 28.88
d. 41.50

Based on you understanding of stock repurchases, identify whether the following statement is true or false:

"The stock price of a firm increases after the firm repurchases some of its shares."

Answer 1

Answer and Explanation:

The computation is shown below.

1. Value of the firm operations is

= Free Cash Flow × (1 + Growth Rate) ÷ (WACC - Growth Rate)

= $87 million  × (1 + 8%) ÷ (13% - 8%)

= $1,879.20

This is the answer but the same is not provided in the given options

2.  The intrinsic value of equity immediately prior to stock repurchase is

= Value of Firm's Operations + Value of Non Operating Assets - Value of Debt - Value of Preferred Stock

= $1,879.20 + $120 - $232 - $145

= $1,622.20

This is the answer but the same is not provided in the given options

3.  The intrinsic stock price immediately prior to stock repurchase is

= Intrinsic Value of Equity Prior to Stock Repurchase ÷ Number of Outstanding Shares

= ($1,622.20) ÷ (21.75 million shares)

= $74.58

This is the answer but the same is not provided in the given options

4. The number of shares repurchased is

= Cash Used for Repurchase ÷ Intrinsic stock price

= $120  ÷ $74.58

= 1.61

This is the answer but the same is not provided in the given options

5. The intrinsic value of equity immediately after stock repurchase is

 = Value of Firm's Operations - Value of Debt - Value of Preferred Stock

= $1,879.20 - $232 - $145

= $1,502.20

This is the answer but the same is not provided in the given options

6. The intrinsic stock price immediately after stock repurchase is

= Intrinsic Value of Equity After Stock Repurchase ÷ Number of Outstanding Shares after Repurchase

= ($1,502.20)  ÷ (21.75 million shares - 1.61 million shares)

= $74.59

This is the answer but the same is not provided in the given options

This statement is false because if the stock price changes after a firm conducts its share repurchase, then there are arbitrage opportunities. Thus, the price of the stock remains the same after a repurchase