Suppose XYZ Corp., a hypothetical firm, is considering how to pay out $50 million in excess cash to shareholders. XYZ has no debt and expects to generate free cash flow of $30 million per year in perpetuity, starting next year. After this year, all FCF gets paid out to shareholders as dividends. XYZs unlevered cost of capital is 10%, so its enterprise value is:

= =$30 0.10=$300 EV=PV(Future FCF)=($30 million)/0.10=$300 million

With the cash, XYZs market value is $350 million. It has 10 million shares outstanding.

Explain EV and MV?

XYZs board is considering 3 options for distributing the excess cash:

1)Use the $50 million to pay a cash dividend.

2)Repurchase $50 million of shares instead of paying a dividend.

3)Raise additional cash to pay a $100 million dividend.

What is the expected effect of each policy? What do shareholders prefer?