Question

The market value balance sheet for Corona Enterprise reflects cash of $43,433, fixed
assets of $65,580, and equity of $368,400. There are 5,505 shares of stock outstanding
with a par value of $1 per share. The company has announced that it is going to
repurchase $28,000 of stock. Calculate what the price of a company’s stock would be
after this repurchase

(b) Dividend relevance theory is the theory, advanced by Gordon and Lintner, that identifies
there is a direct relationship between a firm’s dividend policy and its market value.
Compare and contrast the bird-in-the-hand argument and informational content theories.

Answer 1

Answer to question 1 -

The Market value of the equity stock of Corona Enterprise is given as $368,400, which in turn is the market value of 5505 shares outstanding in the market at the moment with a par value of  $1.

Now to calculate the market value per stock, the formula of which is

which is equal to or $ 67 (app)

Now if Corona Enterprise wants to repurchase $28,000 worth of equity then we can calculate the net number of stock bought by simply dividing $28,000 by the market value per stock we just derived i.e. $67

So the number of stock repurchased = or 418 units (app)

So price of the company's stock will be the number of stock remaining multiplied by the market value per stock,

Market Value of stock = $ { (5505-418) * 67}

= $ 340,829

Answer to question 2 -

Myron Gordon and John Lintner proposed the dividend relevance theory in opposition of the dividend irrelevance theory proposed by Modigliani and Miller, in that theory the defined how 'a bird in hand" i.e. a fixed rate of dividend is better than 'two birds in the bush' i.e.the amount gained by selling stock and earning capital gain. Here they specify how an average investor looks to earn regular guaranteed dividends than getting the capital gains from selling it off, which is also not guaranteed to be a positive number. Investing in capital gains is mainly predicated on conjecture. An investor may gain an advantage in capital gains by conducting extensive company, market, and macroeconomic research. However, ultimately, the performance of a stock falls on a host of factors that are out of the individual investor's control, this may even be negative which brings in a risk factor to the capital gains side. Thus investors prefer a fixed regular dividend-paying company than an erratic one, hoping for its success in the future.

The informational content theory says that a company paying a high dividend indicates that the company has a strong and good presence in the market. The general idea according to this theory is that a company that pays high dividends is paying because they are financially sound and will subsequently earn a lot in future endeavors which in turn will ensure a regular dividend as well as a rising market value of its outstanding stocks.

As we can see both the theories are focused on how an investor prioritizes earning dividends over the gain over the sale of stock.

The place where they vary is the mindset the investors stand by before making the judgment to choose dividends over capital gain. For the Bird in Hand theory, the investor is said to prioritize dividends as its a continuous flow of a fixed return rather than a risky and market-driven capital gain earning. Whereas for the Information Content Theory the investor has the view that a high dividend-paying company is being able to do so because of the good financial performance they have as they have operated efficiently in the market, and the investors hope this to continue in the future resulting in positive growth in stock price and a regular rate of dividend.