Question

Alex, Inc. is financed 100% with equity. The firm has 100,000 shares of stock outstanding with a market price of $5 per share. Total earnings for the most recent year are $50,000. The firm has $25,000 excess cash. It is considering using this excess cash to pay it out as dividend or use it to repurchase $25,000 of its own stock. The firm has other assets worth $475,000 (at market value). For each of the questions that follow, assume no transaction costs, and no taxes except for question 22 and 23. Assume the firm uses the $25,000 excess cash to buy back its stock at $5 per share. You own 10% of the firm's stock before the repurchase and this comprises your total wealth. How will you create "home-made dividend"? A) Sell 450 shares B) Sell 475 shares C) Sell 500 shares D) Sell 600 shares E) Sell no shares

Answer 1

Dividend per share = total dividend supposed to pay/ no of shares =25000/100000 =.25 $ per share

We have 10% of total share =10000 shares;

total dividend we were supposed to get=.25*10000 =2500 $

To get the same result from buyback ; we need to sell 2500/5= 500 shares (optionC) ---- each share has a price of 5$