1) A firm has had the indicated earnings per share over the last three years: (a

Question

1) A firm has had the indicated earnings per share over the last three years:

(a) If the firm's dividend policy was based on a constant payout ratio of 50 percent, determine the annual dividend for each year. (b) If the firm's dividend policy was based on a fixed dollar payout policy of 50 cents per share plus an extra dividend equal to 75 percent of earnings per share above $1.00, determine the annual dividend for each year.

2) Tangshan Mining Company has released the following information.

(a) What are Tangshan Mining's current earnings per share? (b) What is Tangshan Mining's current P/E ratio? (c) 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? (d) 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? (e) Compare the impact of a stock dividend and stock repurchase on shareholder wealth.

Explanation / Answer

1. a)

Year

EPS

Dividend per share

2003

$3.00

$1.50

2002

$2.00

$1.00

2001

$1.00

$0.50

b)

Year

EPS

Dividend per share

2003

$3.00

$2.00

2002

$2.00

$1.25

2001

$1.00

$0.50

2. a) EPS=$5,000,000/1,000,000=$5.00 per share

     b) P/E Ratio=$50.00/$5.00=10

     c) Dividends/Share=$2,500,000/1,000,000=$2.50/share

     d) If the firm pays $55 to repurchase of stock, it can repurchase nearly 45,455 shares i.e ($2,500,000   ÷ $55 per share).

Hence, the firm will have 954,545 shares outstanding i.e (1,000,000 shares – 45,455 shares).

So , the EPS rises from $5.00 per share to $5.24 per share ($5,000,000 ÷ 954,545 shares).

The new price is thus be EPS x P/E Ratio=5.24 x 10 =$52.40 per share,

it is $2.40 in share price.

   e) The net effect of a stock dividend and a stock repurchase is equal. In either of the cases, shareholders will have receiv gain of $2.50 per share.

1. a)

Year

EPS

Dividend per share

2003

$3.00

$1.50

2002

$2.00

$1.00

2001

$1.00

$0.50

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