House of Haddock has 5,170 shares outstanding and the stock price is $157. The company is...

House of Haddock has 5,170 shares outstanding and the stock price is $157. The company is expected to pay a dividend of $26 per share next year and thereafter the dividend is expected to grow indefinitely by 2% a year. The President, George Mullet, now makes a surprise announcement: He says that the company will henceforth distribute half the cash in the form of dividends and the remainder will be used to repurchase stock. The repurchased stock will not be entitled to the dividend. a-1. What is the total value of the company before the announcement? Total value $ 811690 a-2. What is the total value of the company after the announcement? Total value $ 811690 a-3. What is the value of one share? Value per share $ 157 b. What is the expected stream of dividends per share for an investor who plans to retain his shares rather than sell them back to the company? Check your estimate of share value by discounting this stream of dividends per share. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Year Expected Dividend 1 $ 2 $

Expert Solution

(a1) Number of Outstanding Shares = 5170 and Price per Share = $ 157

Company Value pre-announcement = 5170 x 157 = $ 811690

(a2) As the firm announces a share repurchase financed by retained earnings, this announcement will not have any immediate impact on the firm's share prices. Any immediate impact would have involved share repurchase using freshly raised debt which would have altered the firm's value owing to value enhancing feature of the interest tax shields. Retained earnings have no such tax shields and share repurchase would simply reduce retained earnings which would be matched by an equal reduction in the common stock account. Hence, the firm value would remain constant.

Therefore, firm value post-announcement = $ 811690

(a3) Price per Share = $ 157 (given)

(b) Expected Dividend = $ 26 which would grow perpetually at 2% per annum

Assuming current time is end of Year 0, Year 1 dividend = $ 26 and Year 2 dividend = 26 x 1.02 = $ 26.52

jeff jeffy answered 2 years ago

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