Question

Paradox Corporation is evaluating an extra dividend verses a share repurchase. In either case, $14,500 would be spent. Current earnings are $1.65 per share, and the stock currently sells for $58 per share. There are 2,000 shares outstanding. Ignore taxes and other imperfections in answering the following questions:

Required

1.       Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth.

2.       What will be the effect on Paradox Corporation’s EPS and P/E ratio under the two different scenarios?

3.       In the real world, which of these actions would you recommend? Why?

Answer 1

1
If dividend is paid
Dividend per share	14500/2000
Dividend per share	$7.25
Price per share	58-7.25
Price per share	$50.75
Total shareholder wealth	$50.75+7.25
Total shareholder wealth	$58
If shares are repurchased
No of shares purchased	14500/58
No of shares purchased	250
If shareholder allows repurchase they would get $58 in cash and if they retain the shares then also their wealth is $58
Price per share	$58
Shareholder wealth	$58
2
If dividend are paid EPS = 1.65
PE ratio	Price/EPS
PE ratio	50.75/1.65
PE ratio	30.76	times
If shares repurchased
EPS	(2000*1.65)/(2000-250)
EPS	3300/1750
EPS	$1.89
PE Ratio	58/1.89
PE Ratio	30.76	times
3
In real world, share repurchase would be preferable as share price would not be impacted and it would also increase EPS