Question

A firm has a market value equal to its book value. Currently, the firm has excess cash of $400 and other assets of $2,600. The operating profit of the firm is $500. The firm is 100% financed through equity. The firm has 300 shares of stock outstanding.

a. What is the stock price per share at the beginning?

b. If the firm decides to spend all of its excess cash on a share repurchase program. How many shares of stock will be outstanding after the stock repurchase is completed? What will be the stock price per share?

c. If the firm decides to spend all of its excess cash on a share repurchase program. How many shares of stock will be outstanding after the stock repurchase is completed? What will be the stock price per share?

Answer 1

PT a Stock price = Book value / Number of share

= (400+2600)/300 i.e. $10

PT b Number of share repurchase = Amount for repurchase/ Price

=400/10 i.e. 40 shares

Shares outstanding after repurchase = 300-40 i.e. 260 shares

Current EPS = Profit/ outstanding shares

= 500/300 i.e. i.e. 1.66667

Current P/E ratio = Price / Earning

= 10/1.66667 i.e.6 approx

New EPS =500/260 i.e.1.92308

Assuming p/e ratio to be same then Price = EPS* P/E ratio

=1.92308*6 i.e. $11.53 approx

PT c Answer is same as point b