Question

Galles Corporation is evaluating an extra dividend versus a share repurchase. In either case, $16,000 would be spent. Current earnings are $1.60 per share, and the stock currently sells for $64 per share. There are 5,000 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. Round your answers to 2 decimal places, e.g., 32.16.)

Alternative I	Extra dividend
Price per share	$
Shareholder wealth	$

Alternative II	Repurchase
Price per share	$
Shareholder wealth	$

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

Alternative 1
EPS	$
P/E ratio

Alternative II
EPS	$
P/E ratio

Answer 1

Alternative 1 : If the company makes a dividend payment

Dividend per share = Earnings / No of shares outstanding = $16,000/5,000 shares = $3.20

Price per share = MPS - DPS = $64 - $3.20 = $60.80

Share holders wealth = MPS + DPS = $60.80+$3.20 = $64.00

EPS = $1.60

P/E RATIO = MPS/EPS = $60.80/$1.60 = 38

MPS = Market price per share

DPS =Dividend per share

Alternative 2 : If the company makes Repurcahse

Shares repurchased =Earnings / MPS = $16,000/$64 = 250 shares

If the shareholder lets their shares be repurchased, they will have $64 in cash. If the shareholder keepstheir shares, they’re still worth $64.

Price per share = $64

Share holders wealth = $64

If the company repurchases stock, the number of shares will decrease.

EPS = (EPS*No.of shares outstanding before repurchase) / No.of shares outstanding after repurchase

EPS = ( $1.60 * 5000shares) / (5000 - 200)shares

EPS = $1.67

P/E RATIO = MPS/EPS = $64/$1.67 = 38.32