Question

Problem 10-07 A stock is currently trading for $36. The company has a price-earnings multiple of 10. There are 100 million shares outstanding. Your model indicates that the stock is actually worth $46. The company announces that it will use $300 million to repurchase shares a. After the repurchase, what is the value of the stock, according to your model? Do not round intermediate calculations. Round your answer to the nearest cent. b. After the repurchase, what is the actual price-earnings multiple of the stock? Do not round intermediate calculations. Round your answer to two decimal places. c. If the company had used the $300 million to pay a cash dividend instead of doing a repurchase, how would the value of the stock have changed, according to your model? Do not round intermediate calculations. Round your answer to the nearest cent. The market value of the stock is now $ d. If the company had used the $300 million to pay a cash dividend instead of doing a repurchase, what would be the actual price-earnings multiple after the dividend? Do not round Intermediate calculations. Round your answer to two decimal places.

Answer 1

	Particulars	Actual	As per our Model
	Market Price	36	46
	PE Ratio	10	10
	No. of Shares outstanding	100	100
	PE Ratio = MPS / EPS
	So we have EPS = MPS / PE Ratio	=   36 / 10	=   46 / 10
	=	3.6	4.6
	Total earnngs = EPS * No. of Shares	=   3.6 * 100	=   4.6 * 100
	=	360	460
	Earnings Used to Buy Back the Shares =	300	300
	Net Earnings	60	160
	Number of Shares Brought Back = Buy Back Value / MPS
		= 300 / 36	= 300 / 46
	=	8.33	6.52
	Number of Shares outstanding after Repurchase	= 100 - 8.33	= 100 - 6.52
	=	91.67	93.48
	EPS after repurchase	= 60 / 91.67
a	Actual EPS =	0.65	1.71
	Considering the Price Earning Ratio to be unchanged	10	10
	Market Price = EPS * PE Ratio	=   0.65 * 10	= 1.71 * 10
		6.55	17.12
b	EPS	0.65
	MPS	36.00
	PE Ratio = MPS / EPS	= 36 / 0.65
		55.00
c	Total earnngs = EPS * No. of Shares		=   4.6 * 100
			460
	Earnings Used to pay Cash dividends=		300
	Net Earnings after cash dividends		160
	Revised EPS		= 160 * 100
			1.6
	PE Ratio		10
	Revised MPS = Revised EPS * PE Ratio		= 1.6 * 10
			16.00
d	Total earnngs = EPS * No. of Shares		=   4.6 * 100
			460
	Earnings Used to pay Cash dividends=		300
	Net Earnings after cash dividends		160
	Revised EPS		= 160 * 100
			1.6
	PE Ratio = MPS / EPS		= 46 / 1.6
			28.75