Question

Given the information below (in millions):

Value of operation $2,000

Short-term investments $30

Debt $50

Value of preferred stock $ 5

Number of shares 100

Demonstrate that the stock price will drop by exactly the amount of dividend per share in the model if this firm pays dividend. Assume that the firm uses the its short-term investment account to fund its dividend payment

Use the information in above to demonstrate that share per stock will remain unchanged after a stock repurchase. Assume that the firm uses the its short-term investment account to fund the stock buyback.

Answer 1

	Current Stock Price
	= Market Value / No of Shares
	= (Value of Oprations+Short Term Invetsments-Debt+Value of Preferred Stock) / No of Shares
	= ($2000 + $30 - $50 + $5) / 100
	= $1985 / 100
	= $19.85
a)	If Firm Pays Dividend
	Dividend per Share = Short Term Investments / No of Shares = $30/100 = $0.30
	As dividend paid out of short term investments, they are no more part of Market Value
	Stock Price after payment of Dividend
	= (Value of Oprations-Debt+Value of Preferred Stock) / No of Shares
	= ($2000 - $50 + $5) / 100
	= $1955 / 100
	= $19.55
	Difference between Stock Prices
	= Current Stock Price - Stock Price after payment of Dividend
	= $19.85 - $19.55
	= $0.30
	= Dividend Per Share
b)	If Firm Repurchase Stock
	Shares repurchased = Short Term Investment/Current Stock Price = $30/$19.85 = 1.5 Shares
	Shares after Repurchase = Shares before repurchase - Shares repurchased = 100-1.5 = 98.5 Shares
	As repurchase of shares done out of short term investments, they are no more part of Market Value
	Stock Price after Repurchase of Shares
	= (Value of Oprations-Debt+Value of Preferred Stock) / No of Shares after Repurchase
	= ($2000 - $50 + $5) / 98.5
	= $1955 / 98.5
	= $19.85
	So there will be no change in current stock price and price after repurchase of shares.