The following is from Schweser question bank and I believe their answer is wrong. The following information is from the 10-k of Laura’s Chocolates, Inc.(LC), a maker of nut-based toffees. Cash----------- -------------------------------------= 25,000,000 Share price---- ------------------------------------= 40.00 Shares outstanding (prior to transaction)—= 20,000,000 LC decides to spend $20 million repurchasing common stock. What is the value of a share of stock after the share repurchase?
why is the answer of 40$ wrong? Share repurchase and dividend payment are the same as far as the company are concerned. Assumption being made is that the company is repurchasing at the current share price (market available price) … Post purchase: total Book Value= 20M * 40 - 20 = 780M # of Shares = 20 - 20/40 = 19.5 Mill Price per share = 40.
cpk123 Wrote: ------------------------------------------------------- > why is the answer of 40$ wrong? > > Share repurchase and dividend payment are the same > as far as the company are concerned. Assumption > being made is that the company is repurchasing at > the current share price (market available price) > … > > Post purchase: total Book Value= 20M * 40 - 20 = > 780M > # of Shares = 20 - 20/40 = 19.5 Mill > > Price per share = 40. May be I am confused here. Somehow thought the share repurchase will increase the price of the remaining shares.
the only time it will increase is if the price of shares are repurchased is lower than the current price of shares. e.g. if the shares were repurchased for say 30$ is the above example: No. of shares available after repurchase: 20 - 20/30 = 19.33 M Share price after repurchase: (20*40-20) / 19.33 = 40.34 Conversely if shares were repurchased at 45 # of shares = 20 - 20/45 19.56 Share price after repurchase: 39.88
CP you need to let some other folks get a chance… 
Intutively, share repurchase will not change the Market Price of that share. What it will effect though is the Book Value of that share. If shares are repurchased at price LESS than its existing Book Value, its Book Value after transaction will INCREASE. And if shares are repurchased at price HIGHER than its existing Book Value, its Book Value after transaction will DECREASE. I think it is more important to comprehend changes in book value rather than market price due to repurchases.
Book value shouldn’t change that much , cash lower and treasury stock , if valued fairly , equalling the cash out. Go IFRS
Janakisri, treasury stock is a contra account, which when increased, decreases your equity. So, in a repurchase, cash comes down and so does the equity in the same amount. Now, how much did the number of shares outstanding came down, will determine the new book value. If, repurchase was done at a market price below current book value, more shares are bought with same cash, which decreases outstanding shares out of proportion and the new book value increases. (that is less equity remaining to even lesser outstanding shares).
@CPK123 Wrote: ---------------------------------------------------------- Post purchase: total Book Value= 20M * 40 - 20 = 780M This will only be true if you assume that $40/share is the BV/share and NOT the mkt price/share, otherwise you are calculating the post purchase market value. Correct? This concerns me, seems like a distant memory. help!
achilles Wrote: ------------------------------------------------------- > @CPK123 Wrote: > -------------------------------------------------- > -------- > Post purchase: total Book Value= 20M * 40 - 20 = > 780M > > This will only be true if you assume that > $40/share is the BV/share and NOT the mkt > price/share, otherwise you are calculating the > post purchase market value. Correct? > > This concerns me, seems like a distant memory. > > help! Firstly, as illustrated in Schweser P.253, we assume market price doesn’t change in stock market, which is driven by supply and demand. Consequently, 20M * 40 - 20 = 780M is about the post purchase market value. As the company has 25M cash, it has sufficient internal funding to repurchase. Cash itself is a fair value. It makes sense that the total market value reduced from 800M to 780M.