Question

Suppose there is a corporate bond. Its face value is $2000. And the maturity is 4 years. Its coupon is $10 issued at the end of each year. Its price is $1900 right now. The interest rates for bonds and stocks are 2% and 3%, respectively. The market price of stock of this company is $25 right now. And the shares outstanding is 25,000 shares. And the tax rate is 20%. The ratio of debt to equity is 0.2.

1. Suppose the firm is going to repurchase some stocks now. It repurchased 5000 shares from the market at the current price. What is the stock price after the repurchase?
2. Suppose the firm is going to split its stock. It is a 2-to-1 split. (a share becomes two.) It requires commission of $ 2000. What is the stock price afterwards?
3. Suppose the firm issued cash dividend of $2 per share. What is the price afterwards?

Answer 1

Method 1: When all the events are assumed to be interlinked to each other

1. Stock Price remains the same after the purchase of stocks at market price i.e., 25$

2. Stock Price after Split

Total shares value = (25000-5000)shares*25$ = 500000$

Shares Value after commission  = 500000$ - 2000$ = 498000$

Number of shares after Split = 20000shares*2 = 40000 shares

Stock Price after split = 498000$/40000shares = 12.45$

3. Price after 2$ cash dividend is issued = 12.45-2 = 10$

Method 2; When all the events are assumed to be independent of each other

1. Stock Price remains the same after the purchase of stocks at market price i.e., 25$

2. Stock Price after split

Total shares value = 25000shares*25$ = 625000$

Shares Value after commission  = 625000$ - 2000$ = 623000$

Number of shares after Split = 25000shares*2 = 50000 shares

Stock Price after split = 623000$/50000shares = 12.46$

3. Price after 2$ cash dividend is issued = 25-2 = 23$

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