Question

Divido Corporation is an all-equity financed firm with a total market value of $100 million. The company holds $10 million in cash equivalents and has $90 million in other assets. There are 1,000,000 shares of Divido common stock outstanding, each with a market price of $100. What would be the impact on Divido's stock price, market value, outstanding shares, and on the wealth of its shareholders?

1. Of the payment of a cash dividend of $10 per share?
2. If the company repurchases 100,000 shares?
3. If the company paid out a 10% stock dividend?

Answer 1

1. the effect of cash dividend of 10 per share=

Cash will reduce by 10*1000,000 shares= 10 Mn

Retained earnings will also reduce by 10 Mn as company makes payment out of profits.

Effect on Stock Price= earlier= $100 Mn/ 1Mn shares= $100 per share

Now, stock price= $90 Mn/ 1Mn shares= $ 90 Mn pe share

So stock price has reduced.

Effect on market value= Market value of shares reduces i.e. 1 Mn shares* 90= $90 Mn

Effect on outstanding shares= they reamin the same

Effect on wealth of shareholders= shareholder's wealth will not get affected ay $10Mn of dicidend +$90 Mn worth of stock= $100Mn

2. the effect of repurchase of 100,000 shares=

Retained earnings will reduce by 100*100,000 shares= 10 Mn

treasury stock will increase by 100*100,000 shares= 10 Mn

Effect on Stock Price= now= $100 Mn/ 0.9 Mn shares= $111.11 per share

So stock price has increased.

Effect on market value= Market value of shares remains the same i.e. 0.9 Mn shares*111.11= $100 Mn

Effect on outstanding shares= reduce to 0.9 Mn shares

Effect on shareholders wealth= shareholder's wealth will not get affected

3. 10% stock dividend

total shares= 1Mn

10% stock dividend= 100,000 shares given as dividend at $ 100 so worth of stock dividend= 100*100,000+ $10 Mn

Retained earnings will reduce by $10 Mn

equity increase by $10 Mn

Effect on Stock Price= now= $100 Mn/ 1.1 Mn shares= $90 per share

So stock price has decreased.

Effect on market value= Market value of shares remains the same i.e. 1.1 Mn shares*90= $100 Mn

Effect on outstanding shares= increases to 1.1 Mn shares

Effect on shareholders wealth= shareholder's wealth will not get affected