you own 100k shares of a stock that’s trading at $40 a share. you invest the gross amount of all dividends to purchase additional shares. if the company pays a $1.5 dividend, your new share ownership after reinvesting the dividends at the ex-dividend price is closest to: A. 103,600 B. 103,750 C. 103,900
1.5*100/(40-1.5) = 3.896 --> Choice C
1.5*100 = 150 div money new price = 40-1.5 = 38.5 new shares = 150/38.5=3.896 100 + 3.896 = 103.896 =C?
yep. i’m breezing through these and foolishly used the $40 px not the ex div px. so dumb. follow up-if a company borrows to finance a share repurchase, the likely result is: A. an increase in the mkt value of the company B. an increase in the mkt value of debt offset by a decrease in the mkt value of equity C. an increase in the mkt value of equity offset by a decrease in the mkt value of debt
B. Debt up, Equity down.
you are correct and intuitively, i was led to that answer. the answer says share repurchase using borrowed funds will rearrange the company’s value b/t debt and equity, but the value of the company remains unchanged. my question- wouldn’t it depend on what the cost to borrow funds is in terms of making the value of the company remain unchanged? what if the cost to borrow funds for whatever reason were ridiculously high or low?
or maybe that’s why they said the “likely” effect and didn’t make it an absolute statement?
correct. Share repos are very commonly used to shuffle the company’s capital structure. Since when you buyback shares -> Treasure stock contra account is up --> which reduces E Also borriownf will increase D Thus if initially D was 40% and E = 60%, the management shuffled the weights by decreaing outstanding equity and increasing debt. (so may be the new weights might be D =50% and E =50%) . . . . Thanks cp 
cool, thanks. and that concludes all of SS8 in the CFAI books for me. only area i got smoked- EP and MVA… that item set was not good for me. need to review. aside from that, bring on the corp fi ss8 item set on the exam. mergers, corp governance, i’m coming at you strong in a sec. 4:10pm sox game may slow down my intensity a bit, but I AM STILL HUNGRY.
I got nuked in that vignette too - EP and EI one! Also Corp Finance all were 3/6 or max 4/6 for me. Keeping it for the end.
Of course in reality it rarely occurs like that. On ex-div day, the price drops intrinsically by $1.5, but all kinds of other factors will make the price go any where you can think of. For the exam, accept that this is what happens.