Use the Information for the Question(s)below

question 62

Essay

Use the information for the question(s)below.
Iota Industries is an all-equity firm with 50 million shares outstanding.Iota has $200 million in cash and expects future free cash flows of $75 million per year.Management plans to use the cash to expand the firm's operations,which in turn will increase future free cash flows by 12%.Iota's cost of capital is 10% and assume that capital markets are perfect.
-Suppose that Iota is able to invest the $200 million in excess cash into a project that will increase future free cash flows by 30%.If you were advising the board,what course of action would you recommend,investing the $200 million in an expansion project that will raise future free cash flows by 30% or use the $200 million to repurchase shares? Which provides the higher stock price?

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Definitions:

Contribution Margin Ratio

The percentage of sales revenue that exceeds variable costs, indicating how much sales contribute to fixed costs and profit.

Budgeted Sales

Projected sales figures that are estimated by a business for a future accounting period, used for planning and strategic purposes.

Operating Income

A measure of a company's profitability that excludes non-operating income and expenses, focusing on core business activities.

Fixed Costs

Expenses that remain constant regardless of the business's production or sales activity, including insurance and lease payments.