Stock repurchase The following financial data on the Rond Recording Company are

Question

Stock repurchase The following financial data on the Rond Recording Company are available: Earnings available for common stockholders $800,000 Number of shares of common stock outstanding 400,000 Earnings per share ($800,000 division sign 400,000) $2 Market price per share $20 Price/earnings (P/E) ratio ($20 division sign $2) 10 The firm is currently considering whether it should use $400,000 of its earnings to pay cash dividends of $1 per share or to repurchase stock at $21 per share. Approximately how many shares of stock can the firm repurchase at the $21-per-share price, using the funds that would have gone to pay the cash dividend? Calculate the EPS after the repurchase. Explain your calculations. If the stock still sells at 10 times earnings, what will the market price be after the repurchase? Compare the pre- and postrepurchase earnings per share. Compare and contrast the stockholders' positions under the dividend and repurchase alternatives. What are the tax implications under each alternative?

Explanation / Answer

a)

400,000 / 21 = 19,047 Shares

b)

400,000 - 19,047 = 380,953

EPS = 400,013 / 380,953 = $1.05

c)

10*2 = 20- > 400,000/20 = 20,000 - > 400,000 - 20,000 = 380,000 - > 380,000 /20,000 = $19

Market Price = $19

d)

After selling the shares in part b the EPS dropped substantially. Previous to the repurchase the EPS was $2 but after the repurchase it is changed to to $1.05

e)

Through dividends the stockholders will most likely be making more return over more time although the repurchase would give the most initial return. The repurchase would also have less taxes with it whereas the dividends would have a higher tax attached to it for the stockholders. The EPS drop for the repurchase would also make the stockholders lean towards dividends as well.

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