Question

Stock repurchase The following financial data on the Bond Recording Company are available: EE repurchase stock at $32 per share. The firm is currently considering whether it should use $450,000 of its earnings to help pay cash dividends of $1.80 per share or to b. Calculate the EPS after the repurchase. c. If the stock still sells at 15 times eamings, what will the market price be after the repurchase? d. Compare the pre- and post-repurchase eamings per share e. Compare and contrast the stockholders' positions under the dividend and repurchase alternatives. What are the tax implications under each altenative? $500,000 Earnings available for common stockholders Number of shares of common stock outstanding Earnings per share ($500,000 250,000) Market price per share Price/earnings (P/E) ratio ($30+$2) 250,000 $2 $30 15

Answer 1

a. No. of shares can be repurchased using fund available for cash dividend = Fund for Dividend / per share repurchase price

No. of shares = $450000 / $32

= 14063

b. EPS after purchase

EPS = Total Earnings / Total outstanding shares after repurchase

EPS = ($500000) / (250000 - 14063)

EPS = $500000 / 235937

= $2.12

c. Stock selling at 15 times earning means PE Ratio = 15

PE Ratio = Market Price per share / EPS

15 = Market Price / $2.12

Market Price= 15 * $2.12

= $31.8

d. Pre purchase EPS =$2

Post purchase EPS = $2.12

EPS increases due to repurchase plan as no. of outstanding shares decrease which increases EPS.

e. Under dividend plan, they will be receiving dividend per share $1.8 but under repurchase plan they will receive less dividend currently (only from remaining $50000), as repurchase done from the net earnings. So repurchase plan from earnings not good for equity holder in this situation.

Dividend are subject to ordinary income tax and repurchase are taxed at capital gain rate.