Whole Foods Donuts, Ltd. has generated profits of $2 per share for many years an

Question

Whole Foods Donuts, Ltd. has generated profits of $2 per share for many years and has consistently paid 100% of those profits to shareholders via a dividend. Investors do not expect Hole Foods Donuts to grow in the future. The company has 200,000 shares of stock outstanding worth $20 per share. Suppose the firm decides to eliminate its dividend and instead use the money to repurchase shares.

Required:

(a) Assuming that there are no taxes and that the repurchase announcement conveys no new information to investors about the profitability or risk of Hole Foods Donuts, how do you think the stock price will react to the announcement? Provide a written (in words) explanation or a numerical example to provide support for your answer.

(b) How many shares will Hole Foods Donuts repurchase?

(c) If the signaling argument for repurchases is valid, what stock price would you expect for Hole Foods Donuts one and two years after this announcement? What would the stock price have been in the next two years if the company had simply maintained its old dividend policy?

Explanation / Answer

a.) Every year the company generating profits $4,00,000(200000*2) . definately the stock price will react to this announcement.since in future remainig shareholdres will get high dividend.

b.) The company can purchase 20,000 shares(400000/20)

c) Before repurchase total value of shares = 200000*20

= 40,00,000

after repurchase = 40,00,000/180000

= 22.22

if company had maintained its old dividend policy, then share price will be 20 only

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