Business, 17.03.2020 00:02 Countryqueen525

Payout Corp. has regularly paid a quarterly dividend of $.50 per share on its 20,000 outstanding shares. Now suppose that Payout announces that instead of paying this dividend, it plans to repurchase $10,000 worth of stock instead. (LO17-1) a. What effect will the repurchase have on an investor who currently holds 100 shares and sells 1 of those shares back to the company in the repurchase? b. Compare the effects of the repurchase to the effects of the cash dividend that you worked out in Problem 5.

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Stock Repurchase is refers to the mechanism through which company buy backs its own shares. When the shares are repurchased the number of shares that an investor holds reduces and his cash balance increases by the amount of purchase.

Part a.

PC is regularly paying a quarterly dividend of $0.50 per share. If the company instead of paying dividend announces the buyback of $10,000 market value stock.

Compute the effect on the wealth of the shareholder who holds 100 shares and sells 1 of the shares in the following manner:

Market value of shares =100 × $50

Market value of shares = 55,000

Before repurchasing, the total value of the shares for the investor is $5,000

After repurchasing, for 1 share repurchased, the company will pay him $50.

Compute the value of the remaining shares in the following manner.

Market value of remaining shares = Remaining shares x Price after repurchase

Substitute $50 for price after repurchasing and 100 - 1 = 99 for remaining number of shares.

Market value of remaining shares = Remaining shares × Price after repurchase

Market value of remaining shares = 99 × $50

Market value of remaining shares = $4950

The total wealth of the shareholder after the repurchase is $4,950 + $50 =$5,000

Part b.

There would be no effect because the share price would remain at $50 irrespective of whether the company repurchases the shares or offers dividend.

The only difference is that the total market capitalization of the company would be reduced to $990,000 (19,800 shares at 50 per share) in case of repurchase as against the market capitalization of $1,000,000 (20,000 shares at 50 per share) in case of issuing dividend.

However, this is not important since the market price per share remains the same.

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