Question

  The following financial data on the Bond Recording Company are​ available:  . The firm is currently considering whether it should use ​$450,000 of its earnings to help pay cash dividends of ​$1.29 per share or to repurchase stock at​$41per share.

a. Approximately how many shares of stock can the firm repurchase at the ​$41-per-share ​price, using the funds that would have gone to pay the cash​ dividend?

b.  Calculate the EPS after the repurchase.

c. If the stock still sells at 20 times​ earnings, what will the market price be after the​ repurchase?

d. Compare the​ pre- and​ post-repurchase earnings per share.

e.  Compare and contrast the​ stockholders' positions under the dividend and repurchase alternatives. What are the tax implications under each​ alternative?

Earnings available for common stockholders	$700,000
Number of shares of common stock outstanding	350000
Earnings per share ($700,000/350,000)	$2
Market price per share	$40
Price/earnings (P/E) ratio ($40/$2)	20

Answer 1

ANSWER

a)

Funds that would have gone to pay the cash dividend = Cash dividend * No of shares outstanding

= $1.29 * 350,000= $451,500

No of shares to repurchase = (Funds that would have gone to pay the cash dividend) / Share purchase price = 451,500/ 41 = 11,012.19

= 11,012(Rounded)

And total funds used for this repurchase = 11,012* 41 = $451,492

b)

EPS after the purchase = Earnings / Shares outstanding after the repurchase

= 700,000/ (350000- 11,012)

= 700,000/ 338,988

= $2.06

c)

Price to earning = 20

So, Price = (Price to earning) * EPS after repurchase

= 20 * 2.06

= $41.20

d)

Post repurchase, as outstanding shares get reduced, So, EPS increases after repurchase. Here also, pre-repurchase EPS = $2 & post repuchase EPS = $2.06

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