Question

A company’s assets have a total market value of €400 mil. of which €40 mil. are cash. The Company’s debt amounts to €100 mil. The company has 5 million shares.

a. What is the share price of the company?

b. If the company pays out €40 mil. of dividend, what will be the share price after the dividend payment?

c. Rather than distributing cash dividend, the company repurchases stocks worth €40 mil. What will be share price after the repurchase program?

d. What will the company’s new market debt-equity ratio be after either transaction?

Answer 1

Question 1 Market Value = $400 Millions

Cash - $40 Millions

Debt - $100 Millions

Stock Holders Equity = Market Value - Cash - Debt

= 400 - 40 - 100

= $260 Millions

A) Share Price = Market Value of Equity / Number of Shares

= $260 Millions / 5 Millions

= $ 52 Per share

B) Cash Dividends Paid reduce the market value of the debt by the dividend amount as this is the which is paid to the investors. Therefore, Value gets reduced.

Market Value after Dividends = $260 Millions - $ 40 Millions

= $220 Millions

Share Price = Market Value of Equity / Number of Shares

= $220 Millions / 5 Millions

= $44 Per Share

C) Buy back refers to repurchasing the shares of the company from the investors, The Buy back reduces the number of shares outstanding while the market value of equity remains same.

Market Value = $260 millions

Number of Shares before buy back = 5 Millions Shares

Price per share = 260 / 5

= $72

Number of shares buy back = $40 Millions / 72

= 0.555 Millions Shares

So, Share Price = Market Value /( Number of Shares Before Buyback - Number of shares buyback)

= 260 / (5 - 0.555)

= $58.5

After Buy back share price will be $58.5.

D) Debt ratio = Debt / Equity

Debt = $100 Millions

Market Value in Case of equity in case of dividend = $220 Millions

= 100 / 220

= 0.4545

Debt Ratio = 0.4545

In Case of buy back market value of equity = $260 Million

= 100 / 260

Debt ratio = 0.3846