Flychucker Corporation is evaluating an extra dividend versus a share repurchase
ID: 2770235 • 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 $1.60 per share, and the stock currently sells for $64 per share. There are 5,000 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))
Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $16,000 would be spent. Current earnings are $1.60 per share, and the stock currently sells for $64 per share. There are 5,000 shares outstanding. Ignore taxes and other imperfections.
Explanation / Answer
Part A
Alternative Extra dividend
Extra dividend will reduce the price per share.
Dividend per share = cash dividend / no. of shares
= 16,000 / 5000
= 3.20
Price per share= current price – dividend per share
= 64 -3.20
= 60.80
Shareholder’s wealth = price per share x no. of shares
= 60.80 x 5000
= 304,000
Alternative repurchase
No. of shares repurchased = 16000/64 = 250
No. of shares outstanding after repurchase = 5000-250
= 4,750
Price per share will remain the same 64 per share.
Shareholder’s wealth = price per share x no. of shares
= 64 x 4750
= 304,000
Part B
Cash dividend
Net Income = 1.60 x 5000 = 8,000
EPS = Net Income / no. of shares
= 8000 / 5000
= 1.60
P/E ratio = price/ EPS
= 60.80/ 1.60
= 38
Share Repurchase
EPS = 8000/4750
= 1.68
P/E ratio = 64/1.68
= 38.10