Reference no: EM133034484

Question - Consider an all-equity financed firm, with 1 million shares outstanding, a required return on equity of 10%, and expected earnings of $10 million/year, in perpetuity, all of which will be paid out to shareholders.

Assume that the firm expects to use $5 million of earnings every year to buy back equity and the remaining $5 million of earnings to pay out dividends. Assume that, at the end of each year, the buyback occurs first, and then dividends are paid to the remaining shareholders.

i. At what price (value) per share should they expect to be able to buy back equity at time 1?

ii. How many shares can they expect to buy back at time 1 at this price (in mill.)?

iii. How many shares can they expect to remain outstanding at time 1 after this buyback (in mill.)?

iv. What are expected dividends per share at time 1 (on the remaining equity)?

v. What is the expected ex-dividend value (price) per share at time 1?

vi. What is the expected cum-dividend value (price) per share at time 2?

vii. How many shares can they expect to buy back at time 2 at this price (in mill.)?

viii. How many shares can they expect to remain outstanding at time 2 after thisbuyback (in mill.)?

ix. What are expected dividends per share at time 2?

x. At what annual rate do expected dividends grow from time 1 to time 2?

xi. Assume that an equity holder at time 0 expects to receive the time 1 dividend per share from part iv and expects dividends to grow in perpetuity at the growth rate calculated in part x. What is the value of this growing dividend stream at time 0?