Rudolph Corporation is evaluating an extra dividend versus a share repurchase. I
ID: 2640322 • Letter: R
Question
Rudolph Corporation is evaluating an extra dividend versus a share repurchase. In either case, $19,000 would be spent. Current earnings are $1.60 per share, and the stock currently sells for $50 per share. There are 2,500 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. (Round your answers to 2 decimal places. (e.g., 32.18)) h. What will Rudolph?s EPS and PE ratio be under the two different scenarios? (Do not round intermediate calculations anti round your final answers to 2 decimal places. (e.g., 32.16))Explanation / Answer
1)
a)
Alternative I
The market value of the equity = 50*2500 = $ 125000. The price per share is $50, so there are
2500 shares outstanding. The cash dividend would amount to $19000/2500 $7.6 per
share. When the stock goes ex dividend, the price will drop by $7.60 per share to
$42.40. Put another way, the total assets decrease by $19000, so the equity value goes
down by this amount to $19,000.So new Shareholders wealth = 125000 - 19000 = 106000
Answer
Price per share = $ 42.40
Shareholders wealth = $ 106000
After the dividend, EPS will be the same, $2.50, but the PE ratio will be
$20/2.50 8 times.
Alternative II
With a repurchase, $19000/50 380 shares will be bought up, leaving 2120. The
equity will again be worth $106,000 total. With 2120 shares, this is $106000/2120 $50
per share, so the price doesnt change.
Answer
Price per share = $ 50
Shareholders wealth = $ 106000
1 b)
Alternative I
After the dividend, EPS will be the same, $1.60, but the PE ratio will be
$ 42.40/1.60 = 26.50 times.
Answer
EPS = $ 1.60
PE ratio = 26.50
Alternative II
Total earnings for Gothic must be $1.60*2500 = $ 4000.
After the repurchase, EPS will be higher at $4000/2120 = $1.89
The PE ratio, however, will be $ 50 /1.887 = 26.50 times.
Answer
EPS = $ 1.89
PE ratio = 26.50
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