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Vezuvo Technologies has $75 million in excess cash and no debt. The firm expects to generate additional free cash flows of $50 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Vezuvo's unlevered cost of capital is 10% and there are 10 million shares outstanding. Vezuvo's board is meeting to decide whether to pay out its $75 million in excess cash as a special dividend or to use it to repurchase the firm's shares.
-A firm has $75 million of assets that includes $12 million of cash and 25 million shares outstanding. If the firm uses $12 million of cash to repurchase shares, what is the new price per share?
A)$1
B)$2
C)$3
D)$4

Question

Quizplus · Accepted Answer

Before the repurchase, the price per share is:
Price per share = Market value of equity / Number of shares outstanding
Market value of equity = Assets - Liabilities = $75M - 0 = $75M
Number of shares outstanding = 25M
Price per share = $75M / 25M = $3
After using $12 million of cash to repurchase shares, the new market value of equity is $75 million - $12 million = $63 million. The number of shares outstanding is reduced from 25 million to 25 million - ($12 million / $3 per share) = 21 million. Thus, the new price per share is:
Price per share = $63M / 21M = $3. Therefore, the best choice is to repurchase shares since the new price per share remains the same.

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