The Northwest Territories Bikini Company has cash flow from operations of $150 million and needs $105 million for investment purposes.Assume the firm has 15 million shares outstanding and its shares are presently trading at $15 per share.If the M&M conditions hold, what is the value of the firm after paying a $3 per share dividend?

Question

Quizplus · Accepted Answer

According to the M&M conditions, the value of the firm is determined by its cash flow from operations, not its investment decisions. Therefore, the value of the firm can be calculated as:

Value of firm = (Cash flow from operations - Investment) / Number of shares outstanding

Value of firm = ($150 million - $105 million) / 15 million = $3 per share

After paying a dividend of $3 per share, the share price will decrease by that amount to $12 per share. Therefore, the new value of the firm will be:

Value of firm = ($150 million - $105 million + $45 million) / 15 million = $225 million

Thus, the best choice is (C) $225 million.

The Northwest Territories Bikini Company Has Cash Flow from Operations