NanoSoft is a software firm that has never paid a dividend before but its boards
ID: 2601180 • Letter: N
Question
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
1. Calculation of Free Cash flows during three years
Particulars
Year 1
Year 2
Year 3
Sales (Increase at 8%)
540
583.2
629.856
Less Cost of Goods Sold Excluding Depreciation
(300 / 500 x 100) = 60% of sales
(324)
(349.92)
(377.914)
EBITD
216
233.28
251.9424
Less: Depreciation (increase @8%)
(43.2)
(46.656)
(50.389)
EBIT
172.8
186.624
201.5534
Less: Interest Expense
(10)
(10)
0
Taxable Income
162.8
176.624
201.5534
Less: Taxes 40%
(65.12)
(70.6496)
(80.62134)
Net Income
97.68
105.9744
120.932
Since the non-cash net working capital of the company will be 20%, EBITD of the company will be 80% in cash and therefore for calculation of FCFE, we are required to take 80% of the EBITD.
Cash Flows (Only cash items considered)
Particulars
Year 1
Year 2
Year 3
EBITD
216
233.28
251.9424
Cash EBITD
172.8
186.624
201.5534
Less: Interest Expense
(10)
(10)
0
Less: Taxes 40%
(65.12)
(70.6496)
(80.62134)
Less: Payment of Bank Loan
0
(100)
0
Less: Capital Expenditure
(50)
(50)
(50)
Less: Acquisition
(50)
0
0
Net Cash Flows Generated
-2.32
-44.0256
70.93206
Opening Balance of Cash
75
72.68
28.6544
Closing Balance of cash
72.68
28.6544
99.58646
Note: Depreciation is a non-cash item and hence ignored for FCFE. Moreover, it is interpreted from the question that capital expenditure will be incurred every year by the company at same amount of $50 Million.
2. Since the company wants $50 Million of cash in hand at end of third years, it means it can distribute dividends of total amount of $(99.58646 - 50) = $49.59 Million Approx.
Particulars
Year 1
Year 2
Year 3
Sales (Increase at 8%)
540
583.2
629.856
Less Cost of Goods Sold Excluding Depreciation
(300 / 500 x 100) = 60% of sales
(324)
(349.92)
(377.914)
EBITD
216
233.28
251.9424
Less: Depreciation (increase @8%)
(43.2)
(46.656)
(50.389)
EBIT
172.8
186.624
201.5534
Less: Interest Expense
(10)
(10)
0
Taxable Income
162.8
176.624
201.5534
Less: Taxes 40%
(65.12)
(70.6496)
(80.62134)
Net Income
97.68
105.9744
120.932
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