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Braxton Enterprises has made a before-tax profit of $300 million
Braxton Enterprises has made a before-tax profit of $300 million. The firm has no debt and 100 million shares outstanding, with a current market price of $15 per share. Braxton’s board is currently deciding whether to pay out this profit to shareholders through a dividend or a one-time share repurchase.
- If the board chooses to pay a dividend, what is the ex-dividend price of the shares in a perfect capital market with no taxes?
- If the board instead chooses to use the cash to do a one-time share repurchase, in a perfect capital market with no taxes, what is the price of the shares once the repurchase is complete?
Expert Solution
Let's first understand what the ex-dividend price is
The ex-dividend price change measures the drop in the stock price as the stock goes ex-dividend. In fact, the share price always drops after the ex-dividend date. That's because money is leaving the company and thus the investor's ownership in the company is worth less.
In our case
Profit = $300 mn
Shares outstanding = 100 mn
Payout Ratio = 100%
Therefore, Dividend per share = Net Profit / No of shares = 300/100 = 3/ share
Current Share price = $15/ share
Dividend per share = $ 3/ share
Therefore Ex-Dividend price = Current price - dividend per share = 15 - 3 = $12/ share
B)
Net Profit = $300 mn
No of shares = 100mn
Price/ share = $15
Total Equity base = 15 * 100 (Price * Shares outstanding) = 1,500 mn
At the current level, Company can buy-back 20mn shares (300/15)
No of shares outstanding after buyback = 100 - 20 = 80 mn
Value of share after buy-back = Value of Total Equity / No of shares outstanding = 1,500/ 80 = $18.75/
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