Question

1.A stock is currently trading for $35. The company has a price–earnings multiple of 10. There are 100 million shares outstanding. Your model indicates that the stock is actually worth $40. The company announces that it will use $340 million to repurchase shares.

1. After the repurchase, what is the value of the stock, according to your model? Do not round intermediate calculations. Round your answer to the nearest cent.

   $  

2. After the repurchase, what is the actual price–earnings multiple of the stock? Do not round intermediate calculations. Round your answer to two decimal places.

3. If the company had used the $340 million to pay a cash dividend instead of doing a repurchase, how would the value of the stock have changed, according to your model? Do not round intermediate calculations. Round your answer to the nearest cent.

   The market value of the stock is now $   .

2.A stock is currently trading for $33. The company has a price–earnings multiple of 10. There are 100 million shares outstanding. Your model indicates that the stock is actually worth $28. The company announces that it will use $350 million to repurchase shares.

1. After the repurchase, what is the value of the stock, according to your model? Do not round intermediate calculations. Round your answer to the nearest cent.

   $  

2. After the repurchase, what is the actual price–earnings multiple of the stock? Do not round intermediate calculations. Round your answer to two decimal places.

3. If the company had used the $350 million to pay a cash dividend instead of doing a repurchase, how would the value of the stock have changed, according to your model? Do not round intermediate calculations. Round your answer to the nearest cent.

   The market value of the stock is now $   .

4. If the company had used the $350 million to pay a cash dividend instead of doing a repurchase, what would be the actual price–earnings multiple after the dividend? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

a) Given that,

Current Market Price of the stock= $35

Shares outstanding= 100 million

Available fund for repurchase= $340 million

As per the model the stock is worth for $40, so the repurchase price to be offered will be $40 per share.

So no. of shares can be repurchased= Available fund/repurchase price per stock

= ($340 million/$40)

= 8.50 million stocks

After repurchase no of shares outstanding would be=(100 million - 8.5 million)

= 91.50 million

As per market capitalisation, the overall Market capitalisation remains the same if there is no change in the basic assumptions.

So Market capitalisation before repurchase = Market capitalisation after repurchase

=>Current Market price per share x No of shares outstanding before repurchase = Market price per share after repurchase x No of shares outstanding after repurchase

=> ($35 x 100 million) =(Revised MPS x 91.50 million)

=> Market price after repurchase = ($35 x 100 million) ÷91.50 million

= $38.25

b)After the repurchase, what is the actual price–earnings multiple of the stock

Old PE multiple= 10

Old market price = $ 35

Earning per share= Market price ÷ PE multiple

= $35 ÷ 10

= $ 3.5

Total Earnings = $ 3.5 x 100 million

= $ 350 million

So revised Earnings per share after repurchase = ( $ 350 million ÷ 91.50 million)

= $ 3.83

So After the repurchase, what is the actual price–earnings multiple of the stock = Market price after repurchase ÷ Revised Earnings per share

= ( $ 38.2514 ÷ $ 3.8251)

= 10