Question

The Carlton Corporation has $5 million in earnings after taxes and 2 million shares outstanding. The stock trades at a P/E of 15. The firm has $4 million in excess cash.

a. Compute the current price of the stock. (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

b. If the $4 million is used to pay dividends, how much will dividends per share be? (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

c. If the $4 million is used to repurchase shares in the market at a price of $42 per share, how many shares will be acquired? (Do not round intermediate calculations and round your answer to the nearest whole share.)
  

d. What will the new earnings per share be? (Use the rounded number of shares computed in part c but do not round any other intermediate calculations. Round your answer to 2 decimal places.)
  

e-1. If the P/E ratio remains constant, what will the price of the securities be? (Use the rounded answer from part d and round your answer to the nearest whole dollar.)
  

e-2. By how much, in terms of dollars, did the repurchase increase the stock price? (Use the rounded whole dollar answer from part e-1. A negative value should be indicated with a minus sign. Round your answer to the nearest whole dollar.)
  

f. Has the stockholders' total wealth changed as a result of the stock repurchase as opposed to receiving the cash dividend?
  

	Yes
	No

Answer 1

Earnings per share = Total Earnings / Number of shares

Earnings per share = 5,000,000 / 2,000,000

Earnings per share = 2.50

Stock price = P/E ratio * Earnings per share

Stock price = 15 * 2.5

Stock price = 37.50

Part B

Dividends per share = Total dividends / Number of shares

Dividends per share = 4,000,000 / 2,000,000

Dividends per share = 2

Part C

Number of shares acquired = Acquisition funds / Stock price

Number of shares acquired = 4,000,000/ 42

Number of shares acquired = 95,238 shares

Part D

New earnings per share = Earnings / Number of shares

New earnings per share = 5,000,000 / (2,000,000 - 95,238)

New earnings per share = 2.63

Part E

Stock price = P/E ratio * Earnings per share

Stock price = 15 * 2.63

Stock price = 39

Change in stock price = New stock price - Old stock price

Change in stock price = 39 - 37.5

Change in stock price = 2

Part F

Stockholder wealth with dividend = Stock price + Dividend income

Stockholder wealth with dividend = 37.5 + 2.0 = 39.5

Stockholder wealth with repurchase = 39.5

Stockholder wealth is not affected by the dividend/repurchase decision