Stock repurchases Beta Industries has net income of $3,100,000, and it has 1,145

Question

Stock repurchases

Beta Industries has net income of $3,100,000, and it has 1,145,000 shares of common stock outstanding. The company's stock currently trades at $74 a share. Beta is considering a plan in which it will use available cash to repurchase 25% of its shares in the open market. The repurchase is expected to have no effect on net income or the company's P/E ratio. What will be its stock price following the stock repurchase? Round your answer to two decimal places.

$

Quantitative Problem: Lane Industries is considering three independent projects, each of which requires a $2.8 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here:

Note that the projects' costs of capital vary because the projects have different levels of risk. The company's optimal capital structure calls for 40% debt and 60% common equity, and it expects to have net income of $4,000,000. If Lane establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to 2 decimal places.
%

Project H (high risk): Cost of capital = 16% IRR = 18% Project M (medium risk): Cost of capital = 9% IRR = 7% Project L (low risk): Cost of capital = 6% IRR = 7%

Explanation / Answer

1) Compute the stock price after repurchase:

Common stock value before repurchase = (1,145,000 X $74) = $84,730,000

25% of the stock is repurchased

Shares repurchased = 25% (1,145,000) = 286,250

Shares outstanding after repurchase = 1,145,000 - 286,250 = 858,750

Value of shares repurchased = (286,250 X $74) = $21,182,500

Common stock remaining = $84,730,000 - $21,182,500 = $63,547,500

Share price = value of common stock after repurchase / Share outstanding after repurchase

                   = $63,547,500 / 858,750

                  = $74

Therefore, the share price after repurchase is $74

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b) The total capital budget required for all the three projects is ($2.8 million X 2)= $5.6 million

The optimum capital structure requries 60% of equity.

Equity = 60% ($5.6 million) = $3.36 million

To find the dividends declared, deduct the needed equity from the net income.

Dividends = $4,000,000 - $3,360,000 = $640,000

Dividend payout ratio = $640,000 / $4,000,000 = 0.16 or 16.00%

Therefore, the dividend payout ratio is 16.00%

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