Question

Awake Corporation is evaluating an extra dividend versus a share repurchase. In either case, $15,000 would be spent. Current earnings are $1.60 per share, and the stock currently sells for $48 per share. There are 2,500 shares outstanding. Ignore taxes and other imperfections. a. Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth per share. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) b. What will the company's EPS and PE ratio be under the two different scenarios? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

a). Alternative I: Extra dividend

Dividend per share = $15,000 / 2,500 shares = $6

The stock price after the dividend payment will be:

PX = $48 - $6 = $42 per share

The shareholder will have a stock worth $42 and a $6 dividend for a total wealth of $48.

Alternative II: Repurchase

Shares repurchased = $15,000 / $48 = 312.50 shares

If the shareholder lets their shares be repurchased, they will have $48 in cash. If the shareholder keeps their shares,they’re still worth $48.

b). Alternative I: Extra dividend

If the company pays dividends, the current EPS is $1.60,

and the P / E ratio is:

P/E = $42 / $1.60 = 26.25

Alternative II: Repurchase

If the company repurchases stock, the number of shares will decrease. The total net income is the EPS times the current number of shares outstanding. Dividing net income by the new number of shares outstanding, we find the EPS under the repurchase is:

EPS = $1.60(2,500) / (2,500 - 312.50) = $4,000 / 2,187.50 = $1.83

The stock price will remain at $48 per share, so the P / E ratio is:

P/E = $48 / $1.83 = 26.25