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Omicron Technologies 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. Omicrons unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron’s board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm’s stock.

(a) Omicron’s total market value is closest to:

(1) $500 million (2) $900 million (3) $400 million (4) $450 million


(b) Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. The amount of the special dividend is closest to:

(1) $5.00 (2) $9.00 (3) $4.00 (4) $4.50

(c) Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. The amount of the regular yearly dividends in the future is closest to:

(1) $4.50 (2) $5.00 (3) $4.00 (4) $9.00


(d) Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. Omicron’s cum-dividend price is closest to:

(1) $50.00 (2) $40.00 (3) $5.00 (4) $45.00


(e) Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. Omicron’s ex-dividend price is closest to:

(1) $40.00 (2) $5.00 (3) $50.00 (4) $45.00


(f) Assume that Omicron uses the entire $50 million in excess cash to repurchase shares. The number of shares that they repurchase is closest to:

(1) 1.0 million (2) 1.2 million (3) 1.1 million (4) 0.9 million


(g) Assume that Omicron’s uses the entire $50 million in excess cash to repurchase shares. The amount of the regular yearly dividends in the future is closest to:

(1) $9.00 (2) $5.00 (3) $4.50 (4) $4.00

(h) Assume that you own 2,500 shares of Omicron stock and that Omicron uses the entire $50 million to repurchase shares. Suppose that you are unhappy with Omicron’s decision and would prefer that Omicron used the excess cash to pay a special dividend. The number of shares that you would have to sell in order to receive the same amount of cash as if Omicron paid the special dividend is closest to:

(1) 275 (2) 310 (3) 125 (4) 250



(i) Assume that you own 2,500 shares of Omicron stock and that Omicron uses the entire $50 million to pay a special dividend. Suppose that you are unhappy with Omicron’s decision and would prefer that Omicron used the excess cash to repurchase shares. The number of shares that you would have to buy in order to undo the special cash dividend that Omicron paid is closest to:

(1) 125 (2) 275 (3) 250 (4) 310

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Irving Heathcote
Irving HeathcoteLv2
28 Sep 2019

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Omicron Technologies will generate free cash flows of $45 million per year, in perpetuity, and will pay out these free cash flows as regular dividends. Omicron has no debt. Omicron’s unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron's board decides use this year’s $45 million in free cash flows to repurchase shares of the firm's stock. The number of shares that Omicron will have outstanding following the repurchase is closest to: A) 8.8 million B) 1.2 million C) 9.0 million D) 8.9 million

Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200 million in cash and expects future free cash flows of $75 million per year. Management plans to use the cash to expand the firm’s operations, which will in turn increase free cash flows by 12%. Iota’s cost of capital is 10%. Assume that capital markets are perfect.

(a) The value of Iota if they use the $200 million to expand is closest to:

(1) $825 million (2) $688 million (3) $840 million (4) $950 million


(b) The value of Iota if they do not use the $200 million to expand and hold the cash instead is closest to:

(1) $840 million (2) $825 million (3) $950 million (4) $688 million


(c) The price per share of Iota if they use the $200 million to expand is closest to:

(1) $13.75 (2) $16.50 (3) $19.00 (4) $16.80


(d) The price per share of Iota if they do not use the $200 million to expand and hold the cash instead is closest to:

(1) $16.50 (2) $16.80 (3) $19.00 (4) $13.75


(e) The NPV of Iota’s expansion project is closest to:

(1) -$110 million (2) -$137.5 million (3) $0 (4) $75 million


(f) A member of Iota’s board of directors suggests that Iota’s stock price would be higher if they used the $200 million to repurchase shares instead of funding the expansion. If you were advising the board, what course of action would you recommend, expansion or repurchase? Which provides the higher stock price? Explain.

(g) Suppose that Iota is able to invest the $200 million in excess cash into a project that will increase future cash flows by 30%. If you were advising the board, what course of action would you recommend, investing the $200 million in an expansion project that will raise future free cash flows by 30% or use the $200 million to repurchase shares? Which provides the higher stock price? Explain.

Firm ABC' stock price is currently $100 and there are 1 million shares outstanding. All investors in firm ABC purchased their stock 5 years ago when the price was $50. ABC is sitting on top of $10 million in extra cash that it does not need to fund its operations. With the exception of possible income from this cash, the earnings of ABC are expected to be constant for the foreseeable future. The corporate tax rate is 35%, the personal tax rate on interest income is 30%, and the personal tax rate on dividends and capital gains is 15%. ABC is considering the following options:

(a) Pay the $10 million out in a special dividend today to investors who will invest the cash in T-bills offering an 8% return for the next 5 years.

(b) Pay the $10 million out in the form of a share repurchase today to investors who will invest the cash in T-bills offering an 8% return for the next 5 years

(c) Hold onto the cash and invest it in T-bills offering an 8% return. Pay the cash and interest out to investors in the form of a special dividend after 5 years.vv

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