Suppose that TR Inc. generates free cash flows of $20,000 today and $40,000 in one year, which will be distributed as dividends at the end of each year. The payment in one year is a terminal payout. The required rate of return on the company's equity is 10%. There are 10,000 shares outstanding. Ignore personal taxes. c) Suppose that an individual investor, Sarah, owns 1,000 shares of TR Inc. Suppose that the broker charges Sarah 5% of all transaction amounts. If Sarah were to prefer a 0% payout from TR Inc. until the firm is liquidated, show how Sarah replicates this on her own to achieve zero cash flow today. How many shares does Sarah need to repurchase (or sell) today? (4 points) d) Suppose now that TR Inc. generates total earnings of $100,000 during the year. And they are considering the following options to spend its free cash flow today $20,000: (i) pay a cash dividend of $20,000; (ii) use $20,000 of cash to repurchase shares of the company. Suppose that TR Inc. has 10,000 shares and its shares are currently trading at $5 per share. In making their decision, the board of directors would like to consider the impact of each of those options on the earnings per share (EPS) of the company. What will be the EPS under (i) and (ii) respectively? If you are a shareholder of the company who is in a high personal tax bracket and do not have a need for short term cash, which option would you like the company to choose and why? (4 points) Suppose that TR Inc. generates free cash flows of $20,000 today and $40,000 in one year, which will be distributed as dividends at the end of each year. The payment in one year is a terminal payout. The required rate of return on the company's equity is 10%. There are 10,000 shares outstanding. Ignore personal taxes. c) Suppose that an individual investor, Sarah, owns 1,000 shares of TR Inc. Suppose that the broker charges Sarah 5% of all transaction amounts. If Sarah were to prefer a 0% payout from TR Inc. until the firm is liquidated, show how Sarah replicates this on her own to achieve zero cash flow today. How many shares does Sarah need to repurchase (or sell) today? (4 points) d) Suppose now that TR Inc. generates total earnings of $100,000 during the year. And they are considering the following options to spend its free cash flow today $20,000: (i) pay a cash dividend of $20,000; (ii) use $20,000 of cash to repurchase shares of the company. Suppose that TR Inc. has 10,000 shares and its shares are currently trading at $5 per share. In making their decision, the board of directors would like to consider the impact of each of those options on the earnings per share (EPS) of the company. What will be the EPS under (i) and (ii) respectively? If you are a shareholder of the company who is in a high personal tax bracket and do not have a need for short term cash, which option would you like the company to choose and why? (4 points)
