Question

Stock Repurchases – Beta Industries has net income of $2,000,000, and it has 1,000,000 shares of common stock outstanding. The company’s stock currently trades at $32 a share. Beta is considering a plan in which it will use available cash to repurchase 20% of its shares in the open market. The repurchase is expected to have no effect on new income or the company’s P/E ratio. What will be Beta’s stock price following the stock repurchase?

Answer 1

Stock repurchase is the process in which the company buy back its own shares from the market, this is done by the companies to increase the EPS, and to benefit from the decrease share prices.

When shares are repurchased number of o/s common shares reduced and Earning per shares will increase that will cause share prices to improve.

Current EPS = Net income/ number of common share o/s

                      = 2000000/1000000

                       = $2 per share

20% of the share will be repurchases by the company, so 1000000* .2 = 200000 shares will be repurchased.

Number of o/s shares = 1000000 – 200000 = 800000

Now new EPS = 2000000/800000

                          = $2.5 /share

Price earning ratio = Stock price/ EPS

                                  = 32/ 2

                                    = 16

The Price earning ratio will not change after stock repurchase, so it will remain same when EPS has increased to 2.5

Price earning ratio = Stock price/ EPS

16 = Stock price/2.5

Stock price = 16 * 2.5

                     = 40

So the price of the stock will increase to $40.

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Hope this answer your query.

Feel free to comment if you need further assistance. J