Question

Just Right Incorporated is considering the option of an extra dividend versus a share repurchase and the impact of both decisions on the firm. Just Right plans to spend $85,000 in respect of both scenarios. Just Right’s current earnings are $2.10 per share, and the stock currently sells for $45 per share. Just Right currently has 5,000 shares outstanding.

You own one share of stock in this company.

If the company issues the dividend, what will your total investment be worth? If the company pursues a share repurchase what will be your total investment be worth?

Kindly Ignore taxes and other imperfections. Show all workings.  

b) (i) The equity of John Blunt limited have a total market value of $86,000. Currently, Blunt limited has excess cash of $6,000 and a net income of $67,000. There are 1,500 shares of stock outstanding. What will be the percentage change in the stock price per share if the firm pays out all of its excess cash as a cash dividend?                                                                                                                                                                                                         

(ii) Explain how cash dividends affect individual shareholders differently than an equal amount of funds spent on a repurchase.                                                                                

Answer 1

Market value of just incorporation is

= Shares outstanding × price of share

= 5000×45 = 225000

It is planning to spend 85000 on dividend or repurchase

Dividend per share is = 85000/5000 = 17

So if dividend issued market value of share will be reduced by dividend

= 45-17 = 28

If repurchased no of shares can be purchased is = 85000/45 = 1889

Earnings of just is = 5000×2.1 = 10500

Earnings per share after repurchase = 10500/(5000-1889) = 3.375

Now new value of share will be = 45×3.375/2.1 = 72.32

If we hold 1 share in just Inc

Our investment value would be 28 if it paid dividend

Our investment Value would be 72.32 if share repurchase happens

B) value per share = market value/no of shares

= 86000/1500 = 57.33

Dividend per share is = 6000/1500 = 4

If dividend is paid then value of share will be reduced by dividend paid

Value of share is = 57.33-4 = 53.33

Percentage change = (57.33-53.33)/57.33

= 6.98%

C) when cash dividends are paid market value of share decrease by the amount of dividend but when shares are repurchased then market value in incerease as earnings per share will increase