Flychucker Corporation is evaluating an extra dividend versus a share repurchase
ID: 2727974 • Letter: F
Question
Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $15,000 would be spent. Current earnings are $2.50 per share, and the stock currently sells for $50 per share. There are 4,000 shares outstanding. Ignore taxes and other imperfections.
a.) Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth per share. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
Alternative I, Extra dividend
Price per share $_______?
Shareholder wealth $__________?
Alternative II, Repurchase
Price per share $_______?
Shareholder wealth $________?
b.) What will be the effect on the company’s EPS and PE ratio under the two different scenarios? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
Cash dividend
EPS $_____?
PE ratio_____?
Share repurchase
EPS $_____?
PE ratio_____?
Explanation / Answer
a)
ALTERNATIVE 1 EXTRA DIVIDEND
Price per share $ 50 - ( $ 15000 /4000) = $ 46.25
Shareholder wealth $ 50
ALTERNATIVE 1 REPURCHASE
Price per share $ 50
Shareholder wealth $ 50
b)
ALTERNATIVE 1 EXTRA DIVIDEND
EPS $ 2.50
PE RATIO $46.25 / $2.50 = 18.5
ALTERNATIVE 1 REPURCHASE
EPS (WN-1) $ 2.70
PE RATIO $ 50 / $2.70 = 18.51
WN-1)
No. of shares to be repurchased = $ 15000 / $ 50 = 300 shares
If the company repurchases stock, the number of shares will decrease. The total net income is the EPS for the current number of shares outstanding. Dividing net income by the new number of shares outstanding, we find the EPS under the repurchase is:EPS = $2.50(4,000) / (4,000 – 300) = $2.70. The stock price will remain at $50 per share, so the P / E ratio is:P/E = $50 / $2.70 = 18.51