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. You own 10% of the firm's stock before the repurchase and this comprises your total wealth. How will you create "home-made dividend"? O A) Sell 450 shares OB) Sell 475 shares C) Sell 500 shares OD) Sell 600 shares

Answer 1

If company pays dividend, dividend per share = 25000/100000 = 0.25

As you hold 10% of shares = dividend = 100000 x 10% x 0.25 = 2500

Now price per share = 5

so you need to sell = 2500/5 = 500 shares

So you will 2500 as home made dividend and your holding will remain at 10%

Because, company has repuchased shares = 25000/ 5 = 5000

so no of share left after repurchase = 100000 -5000 = 95000

And your shares are = 10000 -500 =9500

so your holding is 10% = 9500/95000

Answer : sell 500 shares [Thumbs up please]