Omicron Technologies has $50 million in excess cash and no debt. The firm expects to generate additional free cash flows of $40 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron’s unlevered cost of capital is 10% and there are 10 million shares outstanding. Omicron’s board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm’s stock. Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. Assume that you own 2,500 shares of Omicron stock. Suppose you are unhappy with Omicron’s decision and would prefer that Omicron used the excess cash to repurchase shares. The number of shares that you would have to buy in order to undo the special cash dividend that Omicron paid is closest to:

278  Shares

Explanation:

According to the scenario, computation of the given data are as follow:-

We can calculate the no. of shares to be bought by using following formula:-

Unlevered cost of capital = 10% = 0.10

Value of Enterprise = Additional Free Cash Flow ÷ Unlevered Cost of Capital

= $40 million ÷ 0.10 = $4 million

Market Value of Shares = Value of Enterprise + Excess Cash

= $400 million + $50 million = $450 million

Per Share Market Value = Market Value of Shares ÷ Share Outstanding

= $450 million ÷ $10 million shares = $45 per share

Per Share Special Dividend = Excess Cash ÷ Share Outstanding

= $50 million ÷ $10 million shares = $5 per share

Dividend Per Share = Own Shares × Per Share Special Dividend

= 2500 shares × $5 per share = $12,500

No. of Shares to Be Bought = Dividend Per Share ÷ Per Share Market Value  

= $12,500 ÷ $45 per share

= 277.78 or 278