Question

Use the following information to answer the questions. 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. What will be the market price per share of Alex's stock after the repurchase? OA) $4.50 OB) $4.75 C) $5.00 D) $5.25

Answer 1

Given,

Shares outstanding = 100000 shares

Current market price = $5

Excess cash = $25000

Buy back price = $5

Solution :-

Current value of equity = shares outstanding x current market price

= 100000 shares x $5 = $500000

Number of repurchased shares = Excess cash/buy back price

= $25000/$5 = 5000 shares

Value of repurchased stock = excess cash = $25000

Now,

Market price per share after the repurchase

= (Current value of equity - value of repurchased stock)/(shares outstanding - Number of repurchased shares)

= ($500000 - $25000)/(100000 shares - 5000 shares)

= $475000/95000 shares

= $5.00