Question

Stock repurchase The following financial data on the Bond Recording Company are

available:

Earnings available for common stockholders $800,000
Number of shares of common stock outstanding 400,000
Earnings per share ($800,000, 400,000) $2
Market price per share $20
Price/earnings (P/E) ratio ($20, $2) 10
The firm is currently considering whether it should use $400,000 of its earnings to
pay cash dividends of $1 per share or to repurchase stock at $21 per share.

a. Approximately how many shares of stock can the firm repurchase at the $21-pershare
price, using the funds that would have gone to pay the cash dividend?
b. Calculate the EPS after the repurchase. Explain your calculations.
c. If the stock still sells at 10 times earnings, what will the market price be after the
repurchase?
d. Compare the pre- and postrepurchase earnings per share.
e. Compare and contrast the stockholders’ positions under the dividend and repurchase
alternatives. What are the tax implications under each alternative?

Answer 1

Answer:

a. 19,048

b. 2.1

c. $21

d. Before $2

After $2.1

e. Explanation of tax implication is below

Explanation:

a. Number of shares  = Dividend per share × Number of shares outstanding ÷ cost per share

= 1 × 400,000 ÷ $21

= 19,048

b. Earning per share after repurchase = earnings ÷ (shares before-shares outstanding)

= $800,000 ÷ (400,000-19,048)

= 2.1

c. Market Price = Earning per share  Price × Earning

= 2.1 × 10

= $21

d. Earning per share before = Earnings ÷ Before shares

= $800,000 ÷ 400,000

= $2

Earning per share after repurchase = $2.1

After share repurchase  the earning per share has increased.

e) Price increased 21 dollars in share repurchased. The price remain constant in dividend payout the amount but additional 1 dollar in dividend the investors gains. If dividend is lesser than tax on capital gain then it will become drawback over collect dividend and vice versa.