Question

Hors d’Age Cheeseworks has been paying a regular cash dividend of $4.25 per share each year for over a decade. The company is paying out all its earnings as dividends and is not expected to grow. There are 122,000 shares outstanding selling for $85 per share. The company has sufficient cash on hand to pay the next annual dividend at t = 1. Suppose that, starting in year 1, Hors d’Age decides to cut its cash dividend to zero and announces that it will repurchase shares instead. a. What is the immediate stock price reaction? Ignore taxes, and assume that the repurchase program conveys no information about operating profitability or business risk. Increase Decrease Remain the same b. How many shares will Hors d’Age purchase? (Round your answer to the nearest whole number.) Number of shares repurchased 6100 c. Project and compare future stock prices for the old and new policies. (Do not round intermediate calculations. Round your old policy answers to the nearest whole number and your new policy answers to 2 decimal places. Share Price Year Old Policy New Policy 1 $ $ 2 $ $ 3 $ $

Answer 1

(a) Due to buyback the immediate stock price reaction is that the share price of the company gets increased

because the no. of dshares after buyback is decreased and company earning is now distributed to remainings

shareholders only. The profitability of the company remains the same but the risk of shareholder is get increased because now the risk gets divided only between new share holders

(b) In the question the amount of dividend is given per year is 4.25$

and it is given that there is no retained earning as company can distribute its full earning so EPS = 4.25

therefore company total earning for shareholders is 122000*4.25 = 518500$

now company can buy back shares with the earnings so total amount for buyback is 518500$ and

mrt price of share is 85 therefore no. of shares buyback is 518500/85 = 6100 Shares

(c) Here let us suppose company is earning profit of 518500$ same as the last year and the amount of

dividend for the last year is $ 4.25 per share (518500/122000) but now the EPS or the amount of dividend paid to shareholders is 518500/115900 = $4.47 per share and 115900 is new no. of equity shares that comes from 122000-6100 = 115900 . as the EPS increase so the stock price also gets increases from the next year