Question

(i) The equity of John Blunt limited have a total market value of $86,000. Currently, Blunt limited has excess cash of $6,000 and a net income of $67,000. There are 1,500 shares of stock outstanding. What will be the percentage change in the stock price per share if the firm pays out all of its excess cash as a cash dividend?                                                                                                                                                                                                       

(ii) Explain how cash dividends affect individual shareholders differently than an equal amount of funds spent on a repurchase.   

Answer 1

(i) Given,

Total market value = $86,000

Stock outstanding = 1,500 shares

Let us calculate value per share:

Value per share = market value / no of shares

= $86,000/1500

= $57.33

Value per share = $57.33

Excess cash of Blunt limited having is $6,000.

Dividend per share is = $6,000/1500

= $4 per share

Whenever dividend is paid the value of share will be reduced by the amount of dividend paid.

Therefore,

The Value of share after dividend paid   = $57.33 - $4

= $53.33

% change in value of share = Dividend per share / Value of share before dividend paid

= $4 / $57.33

= 0.0698 or 6.98%

The percentage change in the stock price per share will be 6.98% if the firm pays out all of its excess cash as a cash dividend.

(ii) Dividends are obligatory to all shareholders on an equivalent share basis. Shareholders do not have any authority over the timing of this dividend amount. Repurchase regarded by those shareholders who wish to sell shares. The shareholders who engage in a repurchase will usually carry taxes at the capital gains rate formulated at the time of sale, which is managed by the shareholder.

Shareholders who do not engage in the repurchase do not get any cash and do not incur any taxes. Repurchase entitles shareholders to control the timing of their revenue and their associated tax liability. Also, the investor decisions for both dividends and the capital gains depend upon the tax laws that are in presence at an appropriate point in time.

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