Question

Gibson Co. has a current period cash flow of $1.3 million and pays no dividends at present. The present value of the company’s future cash flows is $20 million. The company is entirely financed with equity, and has 790,000 shares outstanding. Assume the dividend tax rate is zero.

a) What is the share price of Gibson Stock?

b) Suppose the board of directors of Gibson Co. announces its plan to immediately pay out 50 percent of its current cash flow as cash dividends to its shareholders. How can Jeff Ziller, who owns 1,200 shares of Gibson stock, achieve a zero payout policy on his own, by buying or selling shares. How many shares should he sell or buy?

Answer 1

a). Stock Price = [Current Cash Flow + PV of the future cash flows] / No. of Shares Outstanding

= [$1,300,000 + $20,000,000] / 790,000 = $21,300,000 / 790,000 = $26.96

b). Dividends per share = [Current Earnings x Payout Ratio] / No. of Shares Outstanding

= [$1,300,000 x 0.50] / 790,000 = $650,000 / 790,000 = $0.82

Dividends Paid to Shareholder(Jeff) = Dividends per share x No. of shares

= $0.82 x 1,200 = $987.34

Ex-Dividend Stock Price = Stock Price - Dividends per share = $26.96 - $0.82 = $26.14

No. of Shares to buy = Dividends Paid to Shareholder / Ex-Dividend Stock Price

= $987.34 / $26.14 = 37.77 shares