Question

The HNH Corporation will pay a constant dividend of $ 2.00$2.00 per​ share, per​ year, in perpetuity. Assume all investors pay a 20 %20% tax on dividends and that there is no capital gains tax. Suppose the other investments with equivalent risk to HNH stock offer an​ after-tax return of 12 %12%. a. What is the price of a share of HNH​ stock? b. Assume that management makes a surprise announcement that HNH will no longer pay dividends but will use the cash to repurchase stock instead. What is the price of a share of HNH stock​ now?

Answer 1

a. The price of a share of HNH​ stock is $13.33 per share

b. The price of a share of HNH stock​ now is $16.66 per share

Step-by-step explanation:

a. According to the given, in order to calculate the price of a share of HNH​ stock we would have to use the following formula:

Price of the stock = Constant Dividend * (1-T) / Required Return

Price of the stock= 2 * (1-.20)/0.12

Price of the stock= $13.33 per share

b. If management will not pay dividend but will use the cash to repurchase stock, so now the only change to the cash flows will be that there will be no tax. Share repurchase equals dividend per share without taxes.

Now, the price of the stock = 2 / 0.12 = $16.66 per share