Question
Company A has 150m in cash and its other (operating) assets have a 520m book value. It has 100 million shares trading at 9 and
Company A has 150m in cash and its other (operating) assets have a 520m book value. It
has 100 million shares trading at 9 and no debt. The cash is in bank accounts and government
bonds yielding in total a very safe annual return of 2%, i.e., cash is forecast to generate
earnings of 3m by yearend. The operating assets are forecast to generate earnings of 52m
by yearend. An activist investor argues that all that cash is depressing the companys return
on equity (ROE) and its earnings per share (EPS), and advocates a large payout of some form.
Under pressure, management is considering three options: the status quo, a large dividend or
a large buyback.
m. Under the status quo (i.e., without paying out the cash), what is the market value of
the operating (i.e., non-cash) assets? What are the forecast ROE and EPS for the year?
n. Say management opted to use the cash to pay an exceptional 1.5 dividend per share.
(To simplify, say this occurs immediately). What would be the new ROE and EPS
forecasts? What would be the ex dividend stock price and the cum dividend stock
price?
o. Say management opted to use the cash in a self-tender share repurchase. (To simplify,
say this occurs immediately). The company would offer to buy up to 10 million shares
at 15 for a total of 150m (or less). If shareholders tendered (i.e., offered the
company) fewer than 10 million in total, the company would buy them all. If they
tendered more than 10 million shares, they would be rationed on a pro rata basis. For
instance, if shareholders tendered 20 million shares in total, each shareholder who
tendered some shares would in fact sell only half of those shares. Would more/fewer
than 10 million shares be tendered? How many shares would be repurchased? What
would be the stock price post-buyback? What would be the new forecast ROE and
EPS? What would be the pre-repurchase stock price after the announcement of the
repurchase?
p. Which of the three options, if any, achieve the activists goal of increasing ROE?
Explain. Which option, if any, achieve the activists goal of increasing EPS? Explain.
Which option makes shareholders better off?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started