Question

The stock of Lamatar Company will go ex-dividend tomorrow. The current market-value based balance sheet of the company is follows:
Assets		Liabilities & Equity
Cash	$         232,630	Equity	$      1,022,630
Fixed Assets	$         790,000
	$      1,022,630		$      1,022,630
Other information:
Number of outstanding shares:		20870
Cash dividend (per share):		$4.90
Answer the following questions:
i. What price is Lamatar stock selling for today?
ii. What price will it sell for tomorrow? Ignore taxes.
Now suppose that Lamatar announces its intention to repurchase 10% worth of stock instead of paying out cash divided.
iii. Prepare the pro-forma balance sheet (as shown above) after the stock repurchase?
iv. What price will it sell for tomorrow (after stock repurchase)?
Now suppose that Lamatar again changes its mind and decides to issue a 10% stock dividend instead of either paying the cash dividend or repurchasing 2% of the outstanding shares.
v. Prepare the pro-forma balance sheet (as shown above) after the stock dividend payment?
vi. What will be the price per share after the stock dividend?
vii. If you currently own 10% shares of Lamatar Company, what will be the changes in the value of your investment in Lamatar stocks?
viii. Based on your answers to (i) to (vii) above, compare the effect of different divided payout policies on stock price, market value of the firm, the shareholder's wealth.

Answer 1

i. The market price of the stock= Market price of equity/No. of shares

                                                  = $1,022,630/20870

                                                  = $49.

As the dividend amount is $4.90 per share, the price of stock of Lamatar Company today would include the dividend payment. Therefore, it would sell for $49 + $4.90= $53.90 today.

ii. The price of stock of Lamatar Company tomorrow would reduce by the extent of cash dividend per share i.e. it would sell for $53.90 - $4.90= $49.

iii. The journal entry for stock repurchase is as follows:

Treasury stock A/c....Dr    102,263 (10% * 10,22,630)

To cash A/c    102,263

Hence the pro-forma balance sheet would look as follows after the stock repurchase:

Assets	Amount ($)	Liabilities and Equity	Amount ($)
Cash	1,30,367	Equity	10,22,630
Fixed Assets	7,90,000	(-) Treasury stock	1,02,263
	9,20,367		9,20,367

iv. The stock of Lamatar Company after the repurchase of stock would sell for as follows:

Market price of equity/No. of shares outstanding= ($10,22,630 - $102,263)/(20,870 - 2,087)

                                                                               = $49.