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The stock of Payout Corp. will go ex-dividend tomorrow. The dividend will be $1 per share,...

The stock of Payout Corp. will go ex-dividend tomorrow. The dividend will be $1 per share, and there are 10,000 shares of stock outstanding. The market-value balance sheet for Payout is shown below.

                     

Assets Liabilities and Equity
Cash $200,000      Equity $1,000,000     
Fixed assets 800,000     

     

Suppose that Payout changes its mind and decides to issue a 1% stock dividend instead of either issuing the cash dividend or repurchasing 1% of the outstanding stock. How would this action affect a shareholder who owns 900 shares of stock? (Round your answers to the nearest dollar.)
  Total value of the position $  
Compare the effects of the repurchase to the effects of the cash dividend.
  The value of the position is (Click to select)lower thanhigher thanthe same as under the cash dividend.
Compare the effects of the repurchase to the effects of repurchasing 1% of the outstanding stock.
  The value of the position is (Click to select)the same aslower thanhigher than under the repurchase.

Solutions

Expert Solution

1. Shareholder holding 900 shares would have got $900 as dividend if cash dividend is given.

However, the market value of each stocks would also fall by $1 or the overall market value will fall by the dividend paid ie $ 10,000. The current market value per share is Total Equity/number of shares outstanding = $1,000,000/10,000 = $100.

This becomes $99 after dividend is paid.

Hence the value received and balance share value for the shareholder = $ 900 (cash dividend received) + $99 *900 (value of 900 shares) = $900 + $89,100

= $ 90,000

Now if 1% share dividend is given, then the shareholder does not receive any dividend. The overall market value remains the same as $1,000,000 but the number of shares outstanding increase by 1% of 10,000 = by 100.

New number of shares outstanding = 10,100

Hence, new per share value = $1,000,000/10,100 = $99.01 (rounded off)

The shareholder who had 900 shares will get 1% extra shares as share dividend = 900*1% = 9

Hence he has 909 shares now with per share value of $ 99.01

His total share value = 909*$99.01 = $90,000 (rounded off)

2. Repurchase to cash dividend:

If 1% shares are repurchased, then shares to be repurchased = 10000 *1% = 100

then number of shares outstanding = 10,000 -100 = 9,900

Te market value of all shares will reduce by the value paid for share purchase.

The market value of each share is $100 (as shown earlier). Hence cash paid for repurchase of 100 shares = 100 *$100 = $10,000

Market value of all shares after share purchase = $1,000,000 - $10,000 = $990,000

Market value per share of the 9,900 shares after share repurchase= $ 990,000/9,900 = $ 100

The number of share repurchased from shareholder having 900 shares = 900 * 1% = 9

The cash value given to him = 9 * $100 = $900

The market value of remaining 891 shares (900 - 9) = 891 * 100 = $ 89,100

Hence the value received and balance share value for the shareholder = $ 900 (share repurchase cash) + $89,100 (market value of remaining shares)

= $ 90,000

Value of position in cash dividend is also $90,000 (as calculated above in 1)

Hence value of position is same in 1% share repurchase and cash dividend

3.  Compare the effects of the repurchase to the effects of repurchasing 1% of the outstanding stock.

There seems a typing error here as repurchase and repurchase 1% of outstanding stock seems same here.

Perhaps it wanted to compare repurchase of shares to stock dividend

Value of position of repurchase of shares = $90,000 (as calculated in 2)

Value of position of stock dividend = $ 90,000 (as calculated in 1)

Hence the value of position of both is same.


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