( Dividend policy and free cash flow to equity ) NanoSoft is a software firm tha

Question

(Dividend policy and free cash flow to equity)

NanoSoft is a software firm that has never paid a dividend before but its boards of directors is considering whether to initiate dividends and if so, how much to pay. You have collected the following information on the firm:

- The most recent year’s income statement is as follows:

Revenues                     $ 500 million

- Cost of goods sold    $ 340 million (includes depreciation of $ 40 million)

EBIT                             $ 160 million

- Interest expense       $ 10 million

Taxable income           $ 150 million

- Taxes                         $ 42 million

Net Income                 $ 98 million

- The revenues, operating income and depreciation are expected to grow 8% a year for the next 3 years, but the tax rate for the company will change to 40% of taxable income.

- The non-cash net working capital is currently 20% of revenues and this ratio is expected to not change over the next 3 years.

- The firm reported gross capital expenditures of $ 50 million last year, a level that will be maintained for the next 3 years.

- The firm has an old fixed rate bank loan of $ 100 million (which is the firm’s only debt) and it is expected to pay off the entire loan at the end of year 2. The firm does not plan any new borrowings for the next 3 years.

- The firm is planning one major acquisition next year and it expects the acquisition to cost $ 50 million. There are no other acquisitions planned for the next 3 years.

- The current cash balance of the firm is $ 75 million.

Questions:

a. Estimate the FCFE for the firm each year for the next 3 years.

b. Now assume that the firm wants to initiate dividend payments. Assuming that it wants to end up with a cash balance of $ 50 million at the end of the third year, what is the total amount of dividends that the company would be able to pay out to it’s stockholders?

Explanation / Answer

(a)

(b) 337 - 50 = 287.

Particulars Base Year Year 1 Year 2 Year 3 Revenue 500 540 583 630 COGS 300 324 350 378 EBDIT 200 216 233 252 Dep 40 43 46 50 EBIT 160 173 187 202 Interest 10 10 10 0 EBT 150 163 177 202 Tax 42 65 71 81 EAT 108 98 106 121 Interest 10 10 10 0 Tax 42 65 71 81 FCF 160 173 187 202 Opening Cash 0 75 148 185 CAPEX 50 50 50 50 Bank Loan 0 0 100 0 Acquisition Cost 0 50 0 0 FCFE 75 148 185 337

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