Northwest Territories Bikini Company has cash flows from operations of $150 million and needs $125 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 price per share after paying a $3 per share dividend?

Question

Quizplus · Accepted Answer

According to the M&M conditions, dividend payment does not affect the value of the firm. Therefore, the value of the firm before and after the dividend payment remains the same:
Value of the firm = Cash flows from operations / Required investment = $150 million / $125 million = $1.2 per share
Since the firm has 15 million shares outstanding, the total value of the firm is $18 million.
After paying a $3 per share dividend, the remaining value of the firm is $1.2 per share * 15 million shares - $3 per share * 15 million shares = $9 million.
The new price per share is the remaining value of the firm divided by the number of shares outstanding:
New price per share = $9 million / 15 million shares = $0.6 per share
The price per share after paying a $3 per share dividend is:
$15 per share - $3 per share + $0.6 per share = $12.6 per share, or about $13.67 per share rounded to the nearest cent. Therefore, the best choice is C.

Northwest Territories Bikini Company Has Cash Flows from Operations of $150