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XVZ co
XVZ co. has 1 million shares outstanding and $5 million in earnings after taxes. The stock trades at a P/E ratio is 10. XYA co. has $4 million in excess cash.
1) What is the current price of the stock?
2) If the $4 million is used to pay dividends, how much will dividends Per share be.
3) If the $4 million is used to repurchase shares in the market at a premium price of $54 per share, how many Mares will be reacquired?
4) What will the new EPS be?
5) If the P/E remains constant, what will Me new price of the securities be? By how much, in terms of dollars, did the repurchase increase the share price?
6) Has the shareholder's total wealth changed as a result of the stock repurchase as opposed to the cash dividend?
Expert Solution
1) Computation of the current price of stock:-
EPS = NET income / Number of shares
= $5,000,000 / 1,000,000
= $5
P/E Ratio = Price / EPS
10 = Price / $5
Price = 10 * $5
= $50
2) Computation of the dividends per share:-
Dividend per share = Cash paid / Number of shares
= $4,000,000 / 1,000,00
= $4
3) Computation of the number of shares will be reacquired:-
Number of shares reacquired = Cash used / Price per share
= $4,000,000 / $54
= 74,074.07 Or 74,074 shares
4) Computation of the new EPS:-
Shares outstanding after repurchase = 1,000,000 - 74,074
= 925,926 shares
New EPS = Net income / Shares outstanding after repurchase
= $5,000,000 / 925,926
= $5.40 per share
5) Computation of the new price:-
P/E ratio = New price / New EPS
10 = New price / $5.40
New price = $5.40 * 10
= $54
Computation of the change in stock price:-
Change in stock price = New stock price - Old stock price
= $54 - $50
= $4
6) Stockholder wealth with dividend = Stock price + Dividend income
= $50 + $4
= $54
Stockholder wealth with repurchase = $54
Stockholder wealth is not affected by the dividend/repurchase decision
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