Flychucker Corporation is evaluating an extra dividend versus a share repurchase
ID: 2782154 • Letter: F
Question
Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $17,000 would be spent. Current earnings are $1.60 per share, and the stock currently sells for $40 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 answers to 2 decimal places, e.g., 32.16.)
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.)
Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $17,000 would be spent. Current earnings are $1.60 per share, and the stock currently sells for $40 per share. There are 2,500 shares outstanding. Ignore taxes and other imperfections.
Explanation / Answer
Current EPS= $ 1.60
Share price= $ 40
Alternative 1: Extra dividend
DPS= 17000/2500= $ 6.8
Ex dividend share price= 40-6.80= $ 33.20
Shareholders' wealth= Exdiv stock price+DPS= 33.20+6.80= $40 ( there is no change in wealth of shareholders)
Alternative 2: Share repurchase
No of share repurchased= 17000/40= 425 shares
Share price after buyback= (Market cap- amount used for buy back)/ No of shares outstanding= (2500*40-17000)/(2500-425)= $40 per share
Shareholders wealth remain same , there is no change in shareholders wealth.
2.
Alternative 1: Extra dividend
There will no change in EPS i.e., EPS will be $1.60
Ex dividend share price= 40-6.80= $ 33.20
therefore P/E ratio= 33.20/1.60= 20.75 times
Alternative 2: Share repurchase
Earnings were 1.60*2500= $ 4000 earlier
No of shares outstanding now= (2500-425)= 2075
EPS = 4000-1700/2075= 1.108
Price after buyback= 40
PE ratio= 40/1.108= 36.10 times