Tangshan Mining Company has released the following information. Earnings availab

Question

Tangshan Mining Company has released the following information. Earnings available to common stockholders................................$5,000,000 Number of shares outstanding.......................................................... 1,000,000 Market price per share.....................................................................................$50 Retained earnings............................................................................$11,600,000 (a) What are Tangshan Mining's current earnings per share? (b)

Explanation / Answer

Tangshan Mining wants to use half of its earnings either to pay shareholders dividends or to repurchase shares for inclusion in the firm's employee stock ownership plan. If the firm pays a cash dividend, what will be the dividend per share received by existing shareholders? Dividends/Share = $2,500,000/1,000,000 = $2.50/share (b) Instead of paying the cash dividend, what if the firm uses half of its earnings to pay $55 per share to repurchase the shares, what will be the firm's new EPS? What should be the firm's new share price? If the firm paid $55 to repurchase stock, then it can repurchase approximately 45,455 shares ($2,500,000 ÷ $55 per share). Now, the firm would have 954,545 shares outstanding (1,000,000 shares - 45,455 shares). In this case, EPS would increase from $5.00 to approximately $5.24 per share ($5,000,000 ÷ 954,545 shares). Assuming the stock still sells at 10 times earnings, the new market price could be estimated by multiplying the new EPS by the PE ratio. The new price would thus be $52.40 per share, again of approximately $2.40 in share price. Note that this amount would have been precisely $2.50 cents per share if not due to rounding. Compare the impact of a stock dividend and stock repurchase on shareholder wealth. The net effect of a stock dividend and a stock repurchase is the same. As can be seen here, under both, shareholders would have received a net gain of approximately $2.50 per share.

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