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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.

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Irving Heathcote
Irving HeathcoteLv2
28 Sep 2019

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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

Year 1 2 3 4 5 Free Cash Flow $21 million $25 million $28 million $32 million $32 million

XYZ Industries is expected to generate the above free cash flows over the next five years, after which free cash flows are expected to grow at a rate of 3% per year. If the weighted average cost of capital is 6% and XYZ has cash of $12 million, debt of $48 million, and 72 million shares outstanding, what is General Industries' expected current share price? Answer in millions and round to the nearest cent.

Monsters Incorporated (MI) is ready to launch a new product. Depending upon the success of this product, MI will have a value of $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy and the cost of capital is equal to the risk-free rate, which is currently 5%. Assume that capital markets are perfect.

(a) The initial value of MI’s equity without leverage is closest to:

(1) $133 million

(2) $147 million

(3) $140 million

(4) $150 million

(b) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI’s debt is closest to:

(1) $125 million

(2) $111 million

(3) $100 million

(4) $116 million

(c) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI’s equity is closest to:

(1) $30 million

(2) $15 million

(3) $29 million

(4) $24 million

(d) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The total value of MI with leverage is closest to:

(1) $133 million

(2) $140 million

(3) $147 million

(4) $125 million

(e) Assuming that in the event of default, 20% of the value of MI’s assets will be lost in bankruptcy costs, the initial value of MI’s equity without leverage is closest to:

(1) $150 million

(2) $147 million

(3) $140 million

(4) $133 million

(f) Assume that in the event of default, 20% of the value of MI’s assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year. The total value of MI with leverage is closest to:

(1) $140 million

(2) $100 million

(3) $125 million

(4) $134 million

(g) Assume that in the event of default, 20% of the value of MI’s assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year. The present value of MI’s financial distress cost is closest to:

(1) $20 million

(2) $6.6 million

(3) $6.3 million

(4) $19 million

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