Question

A firm is debating whether or not to conduct a share repurchase or pay a special dividend with $2,000,000 cash.

Current EPS is $3.00 per share, and the 500,000 shares outstanding currently sell for $40 each.

You own exactly 1,000 shares. If the firm repurchases shares, what will the new P/E ratio be? From your perspective as an investor, would your prefer a special dividend or a share repurchase? Why?

Answer 1

A	B	C	D	E	F	G	H	I	J	K
2
3		Amount for repurchase or dividend	$2,000,000
4
5		Number of shares outstanding	500,000
6		Current Share price	$40
7		Current EPS	$3.00
8		Total Earnings	$1,500,000.00	=D5*D7
9		Market Value of Equity	$20,000,000	=D5*D6
10		Total number of shares repurchased	=Amount Available / Current Share Price
11			=$2,000,000 / $40
12			50,000
13
14		Number of shares outstanding after the repurchase	=Number of shares outstanding before repurchase - Number of shares repurchased
15			=500,000 - 50,000
16			450,000
17
18		EPS after Repurchase	=Total Earnings / Number of shares outstanding
19			=$1,500,000 / 450,000
20			$3.33
21
22		Price per share after repurchase	=Total market value of Equity / Number of shares outstanding after repurchased
23			=$20,000,000 / 450,000
24			$44.44
25
26		P/E ratio after the repurchase	= Price per share after repurchase/ Earnings per share after the repurchase
27			=$44.44 / $3.33
28			13.33
29
30		Hence P/E ratio after the repurchase	13.33
31
32		In the case of a dividend, the cash is received by the investor, whereas in the case of
33		share buyback the price of share increases which result in capital gain.
34		In the absence of taxes and transaction costs, the dividend and buyback both are equally beneficial for the investor.
35