Question

QUESTION ONE

Pukri Ltd is deciding whether to pay out R90 000 in excess cash in the form of an extra dividend or a share repurchase. Current profits are R2,40 per share and the share sells for
R20. The abbreviated balance sheet before paying out the dividend is:

Equity:240 000 Bank/cash: 90 000
Debt:  160 000 Other Assets: 310 000
400 000 400 000

Evaluate each alternative (i.e: pay the dividend or repurchase the shares) by:

1.1 Calculating the number of shares in issue
1.2 The dividends per share (for the first alternative, i.e. pay the dividend)   

1.3 Calculate:
1.3.1 The new share price
1.3.2 The EPS
1.3.3 The price-earnings ratio

Answer 1

1.1

Since the Par value of Shares is not given, the market value of R20 is taken as Par value and calculated the number of shares

Number of shares = Total Equity/Price = R240,000/R20 = 12,000 shares (present number of shares)

This many shares will remain shares issued if the dividend in paid. But if the share repurchase option is exercised, then some shares will be purchased back and shares in issue will come down

Number of shares purchased = R90,000/R20 = 4,500 shares

Remaining shares in issue, if repurchase option is preferred = 12,000 - 4,500 = 7,500 shares

The number of shares in issue will come down under repurchase option

1.2 (for first alternative only)

Dividend per share = R90,000/12,000 shares = R7.5

There will be dividend only in the first option as the second option is dealing with stock repurchase

1.3

1.3.1

New Share price

If Dividend is paid,

New Share Price = Net assets/Total number of shares

= (R310,000 - R160,000)/12,000

= R150,000/12,000

= R12.5 per share

If Repurchase option is preferred

New Share price = (R310,000 - R160,000)/7,500

= R150,000/7,500

= R20 per share

The share price will come down from R20 to R12.5 if we pay dividend as there is cash outflow but no change in shares in issue. Whereas in Stock repurchase the stock price will remain constant as the decrease in assets will lead to simultaneous decrease in shares outstanding.

1.3.2

Total existing profit = R2.4 x 12,000 = R28,800

The EPS

If Dividend was paid, EPS = Total Profit/number of shares

= R28,800/12,000

= R2.4

If Stock Repurchase, EPS = R28,800/7,500 = R3.84

The EPS under first option will remain same as there is no change in number of shares but in stock repurchase there is reduction in number of shares leading to increase in EPS.

1.3.3

PE ratio = Price/Earnings

If Dividend is paid, PE ratio = R12.5/R2.4 = 5.2083

If Stock repurchase, PE ratio = R20/R3.84 = 5.2083

The PE ratio will remain constant and will not change based on the cash distribution option.