Company Oakland has 100 shares of common stock outstanding. Its current stock pr

Question

Company Oakland has 100 shares of common stock outstanding. Its current stock price is $10 per share. Its current book value is $800 and total debt is $400. The company has $300 of excess cash. Assuming there are no personal income taxes or transaction costs, answer the following questions (i) – (iii). (i) If the company distributes the excess cash to shareholders as cash dividends, what would be the (a) share price, (b) number of shares outstanding, (c) book value of equity, (d) market value of equity, and (e) debt to equity (market value) ratio before and after the dividend payment? (f) Does debt to equity ratio increase after the dividend payment? (ii) If the company uses the excess cash to buy back its shares, what would be the (a) share price, (b) number of shares outstanding, (c) book value of equity, (d) market value of equity, and (e) debt to equity (market value) ratio before and after the share repurchase? ( (iii) Which distribution policy above ((i) dividends or (ii) share repurchase) would result in greater wealth for shareholders? Provide your answer and briefly discuss the reasoning.

Explanation / Answer

shares outstanding 100 current stock price 10 total book value 800 8 Total debt 400 cash 300 Dividend per share 3 300/100 a) share price 7 ('10-3) b) No. of shares outstanding 100 shares c) book value of Equity 800 Market value of Equity 700 (100*7) Debt to equity(before dividend) 0.40 400/1000 Debt to equity(after dividend) 0.57 400/700 Increases after dividend 0.17 2) share price 10 shares bought back 30 300/10 shares outstanding 70 100-30 c) book value of Equity 560 8*70 Market value of Equity 700 10*70 Debt to equity(before share repurchase) 0.40 400/1000 Debt to equity(after dividend) 0.57 400/700 Increases after dividend 0.17 both have the similar impact as the market value of share doestnot change. in the long run if the share price increases then share bought back would have greater wealth for shareholders

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