Flychucker Corporation is evaluating an extra dividend versus a share repurchase
ID: 2767833 • Letter: F
Question
Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $16,000 would be spent. Current earnings are $2.00 per share, and the stock currently sells for $50 per share. There are 2.500 shares outstanding. Ignore taxes and other imperfections. 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 final answers to 2 decimal places, (e.g., 32.16)) What will be the effect on Flychucker's EPS and PE ratio under the two different scenarios? (Do not round intermediate calculations and round your final answers to 2 decimal places, (e.g., 32.16))Explanation / Answer
(a) (i) Extra Dividend.
Stock price = $ 50
shares outstanding = 2,500
Extra cash = $ 16,000
Extra cash dividend per shares = 16,000/2,500 = $ 6.40
After Ex-dividend, the price of stock is reduced by $ 6.40.But, earning per share is same.
Price per share = 50-6.40 = $ 43.60
Shareholder wealth = Number of share outstanding x New price of stock
Shareholder wealth = 2,500 x (50-6.40) = 2,500 x 43.60 = $ 109,000
Hence, the shareholder wealth is $ 109,000
(ii) Repurchase option.
Number of share repurchased for $ 16,000 = 16,000 / 50 = 320 shares
Total number of share residue after repurchase = 2,500 - 320 = 2,180 shares
Price per share = $ 50.00
Shareholder wealth = 2,180 x 50.00 = $ 109,000
(b) (i) Cash Dividend:
EPS would be same after cash dividend.
EPS = $ 2.00
P/E ratio = New Stock price / EPS
P/E ratio = 43.60/ 2.00 = 21.80 times
(ii) Share repurchase:
EPS = Total earnings/ share outstandings
EPS = (2.00 x 2,500) / 2,180 = 5,000 /2,180 = $ 2.29
P/E ratio = Share price / EPS = 50/2.29 = $ 21.83