Question

Shaan Company will either payout $4,000 extra dividend or do a $4,000 share repurchase. Its current EPS are $ .90 and its stock is currently trading at $35 per share. Shaan has 150 shares outstanding. Ignoring taxes:

a. How will each alternative affect the share price and shareholder wealth?

b. How will each alternative impact Shaan's EPS and PE ratio?

c. What would be your advice as to which alternative should be chosen, in view of the real would considerations? Reason out your advice.

Answer 1

Answer :

(a.)

Evaluation of Alternative of Dividend payment :

Dividend per share = 4000 / 150 = 26.67

Price per share before dividend payment = 35

Price per share after dividend payment = 35 - 26.67 = 8.33

Wealth of the share holder before dividend payment = Value of the share held by them = 35

Wealth of shareholder after dividend payment = Dividend per share + Value per share after dividend payment

= 26.67 + 8.33

= 35

Evaluation of Alternative of Stock repurchase :

Price per share before stock repurchase= 35

Price per share after stock repurchase = 35

Wealth of the share holder before stock repurchase = Value of the share held by them = 35

Wealth of shareholder after stock repurchase = Cash Received on repurchase

= 35

(b.) Impact on EPS and PE ratio in Alternative of Dividend payment :

Current EPS = 0.90

Price per share after dividend payment = 35 - 26.67 = 8.33

Price Earning Ratio after dividend payment = 8.33 / 0.90 = 9.26

Impact on EPS and PE ratio in Alternative of stock repurchase :

New EPS = Earning / Total number of shares after repurchase

Number of shares repurchased = 4000 / 35 = 114.285714285 or 114 shares

New EPS = (EPS * Number of shares before repurchase) / (150 - 114.285714285)

= (0.90 * 150 ) / 35.714285715

= 3.78

PE ratio = 35 / 3.78

= 9.26

(c.) Stock repurchase should be preferred by Shaan Company in view of the real would considerations as under this option shareholders who wants to sell will sell their shares and other who don't want can retain their shares, giving shareholder tax timing option which is not there in case of dividend payment.