Question

Awake Corporation is evaluating an extra dividend versus a share repurchase. In either case, $10,000 would be spent. Current earnings are $1.90 per share, and the stock currently sells for $50 per share. There are 4,000 shares outstanding. Ignore taxes and other imperfections.

a.	Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth per share. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

b.	What will the company's EPS and PE ratio be under the two different scenarios? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

    

Answer 1

If the company makes a dividend payment, we can calculate the wealth of a shareholder as:

Dividend per share = $10,000 / 4,000 shares = $2.5

The stock price after the dividend payment will be:

Pric = $50 - 2.50

Price = 47.50 per share

The shareholder will have a stock worth 47.50 and a 2.50 dividend for a total wealth of $50.

If the company makes a repurchase, the company will repurchase:

Shares repurchased = $10,000 / $50 = 200.00 shares

If the shareholder lets their shares be repurchased, they will have $50 in cash. If the shareholder keeps their shares,they’re still worth $50.

Part B

If the company pays dividends, the current EPS is $1.90, and the P / E ratio is:

P/E = $47.50 / $1.90

P/ E = 25

If the company repurchases stock, the number of shares will decrease. The total net income is the EPS times the current number of shares outstanding.

Dividing net income by the new number of shares outstanding, we find the EPS under the repurchase is:

EPS = 1.90 * (4,000) / (4,000 - 200.00)

EPS = $2.00

The stock price will remain at $50 per share, so the P / E ratio is:

P/E = $50 / $2.00 = 25