Tools Corporation is evaluating an extra dividend versus a share repurchase. In
ID: 2789398 • Letter: T
Question
Tools Corporation is evaluating an extra dividend versus a share repurchase. In either case $4,000 would be spent. Current earnings are $2.10 per share, and the stock currently sells for $46 per share. There are 800 shares outstanding. Ignore taxes and other imperfections in answering parts (a) and (b).
1. Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth.
2. What will be the effect on Tools Corporation EPS and PE ratio under the two different scenario?
Explanation / Answer
Current EPS=2.1
P/E=46/2.1
In case of share repurchase, price remains the same at 46 so shareholder wealth remains same-he can tender the stock at 46 or hold the stock whose value is 46
In case of dividend, the price will be reduced by dividend of 4000/800=5 per share to 41 but then he will get diivdend of 5 per share so total shareholder wealth remains same
In case of share repurchase
Shares repurchased=4000/46=86.9562=87
Shares outstanding=800-87=713
EPS=2.1*800/713=2.36
Price=46
P/E=46/2.36=19.49
In case of dividends
EPS=2.1
Price=46-4000/800=41
P/E=41/2.1=19.52