American Beverage Company (ABC) has released the following information: Earnings

Question

American Beverage Company (ABC) has released the following information:

Earnings available to common stockholders: $5,000,000

Number of shares of common stock outstanding: 1,000,000

Market price per share: $50

Retained earnings: 11,600,000

(a) What are ABC's current earnings per share?

(b) What is ABC's current P/E ratio?

(c) ABC wants to use half of its earnings either to pay shareholders dividends or to repurchase shares for inclusion in the firm's employee stock ownership plan. If the firm pays a cash dividend, what will be the dividend per share received by existing shareholders?

(d) Instead of paying the cash dividend, what if the firm uses half of its earnings to pay $55 per share to repurchase the shares, what will be the firm's new EPS? What should be the firm's new share price?

(e) Compare the impact of a stock dividend and stock repurchase on shareholder wealth.

Explanation / Answer

Answer:

(b)ABC's current P/E ratio = Market Price / EPS = $50/$5 = 10 Times

(c)Total Dividend to be paid = $5000000*1/2 = $2500000

Number of shares = 1000000

Dividend per Share = $2500000 / 1000000 = $2.5 per Share

(d)Total Earnings = $5000000

Repurchase price = $55

Hence Number of shares repurchased =5000000/55 = 90909 Shares

Number of shares outstanding after repurchase = 1000000-90909 = 909091 Shares

New EPS = $5000000 / 909091 = $5.50 Per Share

New Price = EPS * P/E ratio = 5.50*10 =$55

(e)Stock dividend does not effects shareholders wealth. But stock repurchase does.

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