Question

Galles Corporation is evaluating an extra dividend versus a share repurchase. In either case, $13,000 would be spent. Current earnings are $2.00 per share, and the stock currently sells for $50 per share. There are 5,000 shares outstanding. Ignore taxes and other imperfections.

a. Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth per share. (Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.)
Alternative I Extra dividend
Price per share $
Shareholder wealth $
Alternative II Repurchase
Price per share $
Shareholder wealth $
b. What will the company's EPS and P/E ratio be under the two different scenarios? (Do not round intermediate calculations. Round your final answers to 2 decimal places, e.g., 32.16.)
Alternative 1
EPS $
P/E ratio
Alternative II
EPS $
P/E ratio

Answer 1

$13,000 must be either spent as a dividend or used to repurchase stocks

they can be used to repurchase $13,000 / $50 = 260 stocks

or pay an extraordinary dividend of $13,000 / 5,000 = $2.60

A) assuming a perfect capital market:

if stocks are repurchased, then the price of the stocks will not change

if a cash dividend is paid, after the dividend is paid, the price of the stocks will fall to $50 - $2.60 = $47.40

B) current EPS = $2, so net income = $10,000

if stocks are repurchased, then the EPS = $10,000 / (5,000 - 260) = $2.11

if a cash dividend is paid, EPS will not change

current P/E ratio = $50 / $2 = 25

if stocks are repurchased, then the P/E ratio = $50 / $2.11 = 23.7

if a cash dividend is paid, then the P/E ratio = $47.40 / $2 = 23.7