Question

The Carlton Corporation has $6 million in earnings after taxes and 1 million shares outstanding. The stock trades at a P/E of 15. The firm has $3 million in excess cash.

a. Compute the current price of the stock. (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

b. If the $3 million is used to pay dividends, how much will dividends per share be? (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

c. If the $3 million is used to repurchase shares in the market at a price of $93 per share, how many shares will be acquired? (Do not round intermediate calculations and round your answer to the nearest whole share.)
  

d. What will the new earnings per share be? (Use the rounded number of shares computed in part c but do not round any other intermediate calculations. Round your answer to 2 decimal places.)
  

e-1. If the P/E ratio remains constant, what will the price of the securities be? (Use the rounded answer from part d and round your answer to the nearest whole dollar.)
  

e-2. By how much, in terms of dollars, did the repurchase increase the stock price? (Use the rounded whole dollar answer from part e-1. A negative value should be indicated with a minus sign. Round your answer to the nearest whole dollar.)
  

f. Has the stockholders' total wealth changed as a result of the stock repurchase as opposed to receiving the cash dividend?
  

	Yes
	No

Answer 1

a. Compute the current price of the stock-

Earnings per share= Stock price / Number of shares= $6,000,000 / 1,000,000= $6.00

Stock price = P/E ratio ×Earnings per share= 15 ×$6.00= $90.00

b. If the $3 million is used to pay dividends, how much will dividends per share be?

Dividends per share= Total dividends / Number of shares= $3,000,000 / 1,000,000= $3.00

c. If the $3 million is used to repurchase shares in the market at a price of $93 per share, how many shares will be acquired?

Number of shares acquired=Acquisition funds / Stock price= $3,000,000 / $93 = 32,258 shares

d. What will the new earnings per share be?

New earnings per share=Earnings / Number of shares=$6,000,000 / (1,000,000 – 32,258)= $6.20

e-1. If the P/E ratio remains constant, what will the price of the securities be

Stock price= P/E ratio ×Earnings per share= 15 ×$6.20 = $93

e-2. By how much, in terms of dollars, did the repurchase increase the stock price?

Change in stock price = New stock price - Old stock price= $93 – $90.00= $3

f. Has the stockholders' total wealth changed as a result of the stock repurchase as opposed to receiving the cash dividend?

Stockholder wealth with dividend= Stock price + Dividend income= $90.00 + $3.00= $93.00

Stockholder wealth with repurchase= New stock price= $93.00

Stockholder wealth will not be affected by the dividend/repurchase decision. Thus the answer is No.