Nick Adams is receommending to the board ofo Directors that they share th eprofits from an excellent year with shareholders by either de claring a special cash dividend of $20 million, or using the $20 illion to repurchase shares of VOlksberger comon stock in the open arket. Selected financial information about the firm is shown below. Share Outstanding: 40m Current stock price: $28 52 week trading range: $20 to $36 book value of equity: $880 million after tax cost of borrowing: 5.5% Adams drafts a emo to the board of directors detailing the financial impact of declaring a special cash dividend versus repurchasing shares. His memo includes two statements: (1) The total shareholder wealth resulting from owning one share of stock with the speical dividend option is $28.5, assuming the stock price does not change on the announcement of the special dividend. (2) Our company’s P/E ratio after the share buyback will remain 20 times earnings Evaluate both statement…
singlesong80 Wrote: ------------------------------------------------------- > Adams drafts a emo I thought that emos were anti-war?
singlesong: how come the letter M doesnt show up in your question? very hard to read i think both are true…
I agree with Mike…after the share buyback, those shares in treasury stock can’t be used for any ratios (EPS, P/E, etc), so I would think there’s no impact to what their 20x was before the transaction. Oui, non?
Could someone work this out if possible?
I’m not 100%, but … since the company is paying $28 to buy back a share that has a $22 book value, it will drive down P and lower P/E.
sorry, ppl. M key is kina sticky on my laptop. i think its from the pizza, or maybe grape juice. i’ll type slower next time. answers are both incorrect. statement (1) is easy, because the stock holder’s weath won’t change, by either issuing dividend or repurchasing. So price stay at 28. Statement(2) I am not getting the calculation. Can someone show work?
edit: read the question wrong
I dont think calculation necessary. Price stays same after share buyback. EPS increases due to less shares. So P/E is lower.
The price shouldn’t change for statement 2, but I think statement 1 is wrong. The price will adjust downwards to take into account the dividend, so shareholder wealth will be $28.00, not $28.50. Even assuming the price doesn’t change on the day of the announcement, it will change on the ex-dividend date.
- Price will rise on the announcement and then return to 28 after distribution ceteris paribus. You will recieve the 50 cents and still have shares worth 28. In reality, the price was 28 when informed investors took into account the cash on the books, so most likely, the share price will actually be less than 28 after the distribution. 2) Assuming purchase of shares does not affect price P/E will drop since earnings per share will rise, but the assumpttion the price does rise upon purcashe is inconsistent with with equilibrium theory. Hence the price should rise and return the P/E to pre buyback levels assuming CAPM. Hence P/E should remain the same.